Research & Commentary: The Effects of Dividend Tax Changes

Published June 5, 2012

Several tax increases are set to go into effect at the end of 2012 unless Congress renews the “Bush Tax Cuts.” One of the most significant increases would be a tax hike on dividends of up to189 percent. It would have a stifling effect on economic growth while slashing the value of retirement plans and other investments. 

Currently the top tax rate for dividends and capital gains is a competitive 15 percent. Under the new tax rates, dividends would be taxed as ordinary income for wealthier taxpayers, with a top tax rate topping out around 43.4 percent. 

Advocates for this tax hike claim such taxes are paid only by the super-rich. A study by Ernst & Young, however, found 65 percent of the 27.1 million tax returns in 2007 that reported dividend income showed total incomes of less than $100,000. Senior citizens would be disproportionately affected by this tax hike because they make up the majority of dividend taxpayers. 

Opponents of the tax hike say raising the dividend tax would diminish the retirement investments of middle-income Americans, because a sizeable amount of investment earnings of 401k plans, stocks, and pension plans are derived from dividends. In particular, dividend-paying stocks such as utilities would become significantly less attractive, harming both stockholders and workers. 

Changing tax rates constantly creates uncertainty in the tax code and hinders economic growth. Dividends already face double taxation—they’re initially taxed as corporate profits and then as income for shareholders. Making the current, lower tax rates permanent, or at least extending them for several years, will make businesses and investors more apt to invest and keep more of their capital working in the market, helping to spur economic growth. 

The following articles and studies offer additional information on dividend taxes.

3 Reasons to Fear Obama’s Dividend Tax Increase
Abram Brown of discusses the many economic problems a dividend tax increase could create. Brown outlines three specific problems and explains why people should oppose the plan. 

Obama Tax Hikes: Dividend Tax Increase Hurts Seniors and the Economy
Rea Hederman Jr. and Patrick Tyrrell of The Heritage Foundation explain in this Backgrounder why a dividend tax hike has no benefit for Americans on any level and will likely cause much harm. 

Raising Dividend Taxes Will Cause Unintended Consequences
In a policy statement, the Edison Electric Institute outlines several unintended consequences of a dividend tax hike. Utilities are among the most vehement opponents of the proposed dividend tax hike. 

Will a Dividend-Tax Hike Spoil the Party?
Writing in the Wall Street Journal, Jack Hough of outlines the proposed dividend tax increases, their possible effects on the financial market, and reactions from the financial sector. 

Obama’s Dividend Assault
In this Review and Outlook from the Wall Street Journal, the authors question whether the dividend tax will hurt the market more than help it and in fact decrease the dividends paid to investors. “The truth is that the plan gives new meaning to the term collateral damage, because shareholders of all incomes will share the pain,” they write. “Here’s why. Historical experience indicates that corporate dividend payouts are highly sensitive to the dividend tax. Dividends fell out of favor in the 1990s when the dividend tax rate was roughly twice the rate of capital gains.” 

Dividend Taxes and Corporate Behavior: Evidence from the 2003 Dividend Tax Cut
Writing in The Quarterly Journal of Economics, Raj Chetty and Emmanuel Saez describe the effects of dividend taxation on corporate behavior, using the large tax cut on individual dividend income enacted in 2003. They documented a 20 percent increase in dividend payments by nonfinancial, nonutility, publicly traded corporations following the tax cut. 

Economic Effects of Increasing the Tax Rates on Capital Gains and Dividends
The Heritage Foundation finds rolling back the 2003 tax cuts on capital gains and dividends would slow economic growth: “The slower economy causes employment to shrink by 270,000 job in 2011 and 413,000 in 2018. Similar job losses continue for the next seven years of our model’s forecast horizon of 2008 through 2018.” 

The Beneficiaries of the Dividend Tax Rate Reduction
This study, prepared by Ernst & Young LLP for the Edison Electric Institute and the American Gas Association, identifies who has benefited from the 2003 cut in the dividends tax rate: “Based on our analyses of all shareholders, the percentages of tax returns with qualified dividends have the following profile: 61 percent are from taxpayers age 50 and older, 30 percent are from taxpayers age 65 and older, 65 percent are from returns with incomes less than $100,000, and 36 percent are from returns with incomes less than $50,000.” 

Show Me the Money! Dividend Payouts after the Bush Tax Cut
Stephen Moore and Phil Kerpen of the Cato Institute examine the effects of the dividend tax cut on dividend payouts. After the tax cut went into effect, “dividends increased 18 percent without special dividends and 23 percent with special dividends.” 

The 2003 Dividend Tax Cuts and the Value of the Firm: An Event Study
The National Bureau of Economic Research analyzes the effect of the dividends tax cut on investment values. The study found “strong evidence that the 2003 change in the dividend tax law had a significant impact on equity markets.”