Threat of Higher Dividend Tax Looms Over Income Investors

Investors, dividend-paying companies both at risk

     

The dividends that utilities pay help to make their stocks more attractive to investors. And through the issuance of stock, utilities can get the investment capital they need at a lower cost. Since the dividend tax rate reduction took effect, electric utility capital expenditures have increased 84% — from $43.0 billion in 2003 to $79.1 billion in 2011.

These investments are building clean energy facilities that range from large nuclear plants to small renewable-energy projects, as well as state-of-the-art, coal-based generating units and high-efficiency combined-cycle natural gas plants. They are automating distribution networks, and replacing analog electric meters with advanced digital meters. And they are preparing for the advent of mass-produced electric vehicles that are just now entering the U.S. market.

Q: Looking at the business side of things, will a higher dividend tax affect companies at all or just investors?

A: Dividend-paying companies as well as investors will be affected by the dividend tax increase. A tax hike will make their stocks less attractive to investors, which will reduce the investment capital they can get through the issuance of stock, and in turn, will raise their borrowing costs.

Higher dividend tax rates also can cause stock market investors to move from investing in companies that pay dividends to buying growth stocks that typically don’t pay dividends, or pay less in dividends.

Q: Anything else you’d like to add?

A: Another factor that Congress needs to consider is that shareholder income is already essentially taxed twice. The company pays a corporate income tax on its earnings, which reduces the amount of net income that can be paid out to shareholders in the form of dividends. The company’s shareholders then pay a personal tax on their dividend income.

The top U.S. integrated dividend tax rate is currently 50.8% (when both corporate and individual tax levels, as well as state and local taxes, are factored in), according to a February 2012 study prepared for the Alliance for Savings and Investment by Ernst & Young. If Congress and the president don’t act to stop a dividend tax hike, the top U.S. integrated dividend tax rate will rise to 68.6% — the highest level among developed nations.

A recent Bloomberg Government report looked at studies conducted in 1992 by the Treasury Department. The Bloomberg Government report looked specifically at what would happen if individuals excluded dividends from their taxable income, eliminating the double taxation of dividends. Bloomberg contends in their analysis that the exclusion of dividends “may help to encourage companies to increase dividends, giving them more financing, and reduce borrowing, which reduces their debt financing.” Additionally, Bloomberg notes that “If the tax on dividends is reduced, companies that already pay high dividends per share … may see an increase in investment in their shares without having to change their current dividend payout structure.”

Finally, I would like to add that time is quickly running out on today’s dividend tax rates. With the still-fragile economy finally starting to show signs of recovery, now is not the time to reduce dividend income through higher taxes and punish Americans who invest in our nation’s future.

For more information on the issue, visit the Defend My Dividend website.

Jeff Reeves is the editor of InvestorPlace.com, and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace??.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves did not own a position in any of the investments named here.

The opinions contained in this column are solely those of the writer.

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