Back in February, President Obama deposited his 2013 budget proposal. Included in this “pre-electoral” budget, 2 major tax changes for investors:
#1 The “Buffet Tax Rule” which aims to increase taxes to 30% for the 1% Americans making millions/year. This should bring in an additional $50G to the Gov’s pockets. The current tax rate is around 15%.
#2 Increase Taxes on Dividends which leads to dividend payouts being fully doubled taxed for households making $250,000/year. The tax rate would hike to nearly 40% on taxable dividends. They estimate another $200G over the next decade with measure. This would end some generous tax cuts enacted back in 2002 under Bush’s administration.
So, How Can Increasing Taxes Be a Good Idea???
If I was American, I would probably vote for such programs *PLEASE KEEP READING… There is a huge problem in America right now and it’s called a deficit budget. The Government spends more than it collects and this is a huge problem for any country, regardless if it’s a rich and powerful country like the USA or a poor country like Greece. If, it’s not healthy to spend more than you earn (as is the case fo individuals), why would it be different for a Government?
This leads to a simple equation: you either increase your revenues or decrease your spending. Since there are several places where spending needs to be increased and not cut, I guess the other solution is to tax people. Since the taxation program in the USA has been fairly generous with tax payer (this is the industrial country where the population pays the least amount of taxes), there is definitely something to do here. Over the years, we have seen several Governments offering tax cuts to the population. However, the biggest beneficiaries are probably those who make over $250K. Is it fair? Is it normal? I guess these questions are irrelevant when the country is making millions and the economy is rolling. But it’s a different dilemma when you are trying to get out of one of the worse financial crises in modern times. Especially when the Government was one of the major actors that borrowed billions to save the economy.
Why tax the rich folk? I’m not really a pro “tax the bad guys or rich guys” in general. I’m usually on the opposite side on many topics since I think that those who succeed financially should benefit from most of their fortune. After all, this is their reward to the numerous sacrifices made. However, a 30% tax on people making $1M+ is not the end of the world. Especially considering that these people hire a football team of lawyers and tax experts to save taxes each year. What’s wrong in having them pay 30% on the remaining balance? After all the deductions and tax sheltered investments, can the rich pay a few more bucks? I think so.
I know it goes against the American culture of liberalism but I think that a compromise is required now that the country is having budgeting difficulties. And these difficulties are not going to be solved any time soon. We have the biggest wave of retirees on our door step and less workers to support them. Don’t you see that we are about to be hit by an economic Tsunami?
Will Raising Taxes on Dividends Kill Dividend Stocks?
As most of you (including myself) are not part of the people who make $1M per year, I guess that this part of Obama’s proposition is not the main concern for you. On the other hand, raising taxes on dividend payouts could be more problematic. We certainly don’t want to see dividend being killed, right?
If you are an average investor, this new measure should not affect you much. Since most of our investments are in tax sheltered accounts (such as pension plans, IRAs, 401ks or RRSPs and TFSAs for Canadians), you won’t feel a big difference. For Canadians, just remember to put all your US stocks in your RRSPs so they are completely tax sheltered (including the dividend payout). Then, if you don’t make more than $250,000, you won’t be affected either.
So from a personal stand point, these 2 measures probably won’t affect your taxes.
So should you be concerned about the tax increase on dividends?
Yes, you should! Why? I don’t and you don’t decide whether a dividend is paid or not. Rich people do. Rich people are on companies’ boards of Directors and decide what is going to happen with the companies’ cash flow; reinvestment, debt repayment, share repurchase and dividend payouts. This new “double tax” structure may suggest companies stop looking for additional equity and aim for more debt since interest is tax deductible (Tim Worstall from Forbes wrote an interesting piece about this topic).
To support this theory where dividends may slowdown with such a tax hike, I would just post a simple picture:
As you can see, there is a huge increase in dividend payouts after the tax rate cut to 15% during Bush’s presidency. Mind you, this period also corresponds to a great bull market where a monkey could average a double digit return on the stock market. Is it a pure coincidence or did the tax rate cut have a direct implication in dividend increases? I guess we will get the answer if this budget is approved and applied.
Making Courageous Choices
I personally think that the dividend world will be barely affected by these chances as most dividends are paid to pension accounts and therefore remain tax free. I guess that those who pay taxes and are rich scream the loudest in this debate. It’s not a big surprise for anyone, right?
Since big pension plan managers will require and seek dividend payers, companies will see a great incentive to continue their dividend distribution policy. Company decisions should not be directed solely by tax implications but rather by what is best for the company. I guess that equity funding will speak louder than taxes to be paid.
If this “deal” is applied, it would be a great step forward to a more responsible and sustainable economy. This requires a lot of courage as most people don’t like to hear about climbing taxes. But I rather see a responsible government making courageous choices instead of trying to be re-elected based on goodies that will put the country deeper in the hole! Kudos to Obama for offering real solutions to real problems!