Congress Must Act to Prevent Counterproductive Tax Increases
For Capital Gains and Dividends
Unless Congress acts this year, 2011 tax rates on capital gains and dividends will automatically increase by substantial
amounts. Capital gains tax rates could increase by as much as 33 percent. For dividends, the increase is even worse,
with tax rates for many individuals increasing by nearly 164 percent. These percentage increases do not include the
recently passed 3.8 percent Medicare health insurance tax that will apply to certain investors in 2013.
If Congress fails to act, this major tax increase will create two distinct (and unnecessary) economic problems. First,
these new high tax rates will serve as a “highly contractionary” force at a time when the economic recovery is nascent
and the investment environment is still quite fragile. Second, because tax rates for capital gains and dividends will no
longer be equivalent, the current incentive to distribute meaningful dividends will be substantially diminished,
leading to greater volatility and investment risk.
Simply put: now is not the time to impose substantially higher taxes on capital and on individual investors. By making
permanent our current policy of an equivalent 15 percent maximum tax on long-term capital gains and dividends,
Congress can play a crucial role in establishing a solid and robust foundation for healthy and sustainable job creation
and long-term economic growth.
Major New Capital Investment is Needed to Sustain America’s Economic Recovery
Raising taxes on capital gains and dividends would discourage Americans from saving and investing at exactly the
wrong time. A tax penalty for investing in American corporations will drive investment dollars to investments that are
not subject to double taxation, depriving businesses of the capital they need to grow and stifling our nation’s
economic recovery.
Reasonable Tax Rates on Cap Gains and Dividends Spur Economic Growth
Dr. Christina Romer, Chair of President Obama’s Council of Economic Advisors, concluded in a November 2006
study that “tax increases are highly contractionary” and that “the large effect stems in considerable part from a
powerful negative effect of tax increases on investment.” The analysis showed that $1 in tax cuts results in a $3
increase in gross domestic product (GDP), whereas $1 of government spending increases GDP by only $1.40. Dr.
Romer’s conclusions are reflected in the President’s proposed budget, which preserves differential tax rates for capital
gains and dividends for all taxpayers.
Treasury’s Office of Tax Analysis concluded in 2006 that: “lower tax rates on dividends and capital gains….improve
incentives for work, saving, and investment by reducing the distorting effects of taxes. Capital investment and labor
productivity will thus be higher, which means higher output and living standards in the long run.”
A Reasonable Dividend Tax Rate Encourages More Companies to Pay Dividends
A study by the Cato Institute found that 19 companies in the S&P 500 began paying dividends for the first time in the
immediate aftermath of the tax reform enacted by Congress in 2003. Annual dividends paid by S&P 500 companies
rose from $146 billion to $172 billion, an increase of $26 billion in the first year following the 2003 tax cut. The
overall payout of dividends in 2005 was more than 36.5 percent higher than the payout before the 2003 tax cut, and
dividend income reported by taxpayers increased by a similar margin.
Tax Increases on Dividends Disproportionately Affects Seniors
Senior citizens and those nearing retirement age represent a substantial portion of investors who own dividendpaying stocks and would be disproportionately affected by an increase. A January 2010 study done by Ernst & Young
found that 27.1 million tax returns had dividends qualifying for the dividend tax rate reduction in 2007 (the latest
year for which complete IRS data are available), reporting a total of $155.9 billion in qualified dividends. Of these tax
returns, 61 percent were from taxpayers age 50 and older and 30 percent were from taxpayers age 65 and older.
Many of these seniors rely on dividend payments as a supplement to their retirement income. Other studies have
found that raising taxes on investment income could also depress the value of stocks held in various retirement
savings plans.
Higher tax rates for dividends provide a disincentive for corporations to distribute profits to shareholders. Therefore,
if Congress chooses to extend the current dividend tax rates for individuals making less than $200,000 and
households making less than $250,000, but allows the current rates to expire for individuals and households above
those thresholds, the net effect will still be a marked decrease in the total amount of dividends paid by corporations.
This overall decline will not just hit the wealthy; rather, it will hit all investors – including all seniors – that rely on
dividends.
Previous Increases in the Capital Gains Tax Rate Generated Less Long-Term Tax Revenue
Following the 2003 tax cuts, the Treasury saw a marked increase in receipts from capital gains, from $49 billion in
2002 to $110 billion in 2006. The inverse happened in the 1980s following the tax rate increasing from 20 percent to
28 percent in 1986. At that point, the government saw a very brief spike in tax revenues before the hike – as investors
cashed out before the tax burden increased – then dropped substantially. By 1990, the government was taking in 13
percent less revenue at the 28 percent rate than it did in 1985 at the 20 percent rate.
Tax Policy Should be Neutral in Treatment of Corporate Profits
Companies drive value for their shareholders in different ways. Some companies reinvest profits to expand or
strengthen operations, creating value for shareholders as their stock price appreciates. Other companies distribute
profits directly to shareholders in the form of dividends.
Dividend distributions are already subject to double taxation. First, corporate income, on which dividends are based,
is taxed at the 35 percent corporate tax rate. Then, the dividends distributed by the corporation to shareholders are
taxed at the individual taxpayer level. This double taxation will only be exacerbated by a tax increase on dividends.
Finally, because corporate interest expenses are deductible but dividend payments are not, double taxation
encourages the use of debt finance rather than equity finance. Firms with excessive debt are more vulnerable during
economic downturns.
Investor and corporate decisions should be “tax-neutral.” They should not be influenced by tax policy that favors one
method of value creation over another or one business structure over another. By making permanent our current
policy of an equivalent 15 percent maximum tax rate on long-term capital gains and dividends, we can ensure
corporate and investor decisions are not driven by tax considerations.
Improved Corporate Governance
Dividends serve an important corporate governance function—companies must have cash from real (not paper)
profits in order to pay dividends to shareholders. Dividend payments are the ultimate form of accounting
transparency.
About The Alliance for Savings and Investment
The Alliance for Savings and Investment (ASI) is a diverse group of dividend-paying companies, investor
organizations and trade associations committed to strengthening the economy through policies that foster private
savings and capital investment. ASI members include Altria, American Gas Association (AGA), AT&T, Capital
Research and Management Company, Edison Electric Institute (EEI), Financial Services Forum, Investment
Company Institute (ICI), Securities Industry and Financial Markets Association (SIFMA), US Telecom Association
and Verizon. In particular, ASI supports:
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Maintaining the current tax rates for capital gains and dividends;
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Making the rates permanent to provide certainty to investors and stability to the economy; and
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Ensuring that capital gains and dividends are treated equally for tax purposes.
Please visit our website www.theASI.org
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