obama dividend taxWho likes paying more taxes? You? I don’t! But sometimes, raising taxes is a very good move…

 

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:

 

dividend tax

 

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!

 

 

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12 Comments   |  

12 Comments

Millionaire
April 16, 2012, 12:05 pm

I’m afraid taxing more dividends will result in US dividend stock prices to go down. What do you think?

clocks
April 16, 2012, 1:32 pm

I’m ok raising taxes on the wealthy, if they also make the 48% that don’t pay any federal income taxes start paying something. In addition, $2 in spending cuts for every $1 increase. Spending is a far larger issue that our tax rates.

Mike
April 16, 2012, 3:12 pm

@Millionaire,

It might have an effect on the stock especially if companies start looking for other ways to use their money (such as share repurchase program vs dividend increase).

@Clocks,

you make a good point, everybody should pay their share of taxes. Unfortunately, it is easier said than done :-(

cooled
April 16, 2012, 5:11 pm

I really dont like this idea of taxing dividends at that level, investing is risky and people that do it should get rewarded for it not punished. As a one time Obama fan I’m no longer, this guy does not seem to get it.

Paul N
April 16, 2012, 5:41 pm

I’m going to disagree with you on this issue.

Many of these “terrible” rich people have been taxed in other ways before their final tax hit through their companies in many different levels of tax.

If a person creates a a constructive company that employ’s even a small number of people what is that worth? The people who work in that company have jobs so their lives are better off.

This will just cause more companies to move their businesses somewhere offshore where they can shelter their profits. Between all the taxes, rules, safety regulations, union nonsense and employee babysitting required these days, I’m really starting to not blame them for doing so even though it could affect me. I won’t be happy but i understand it.

In my book the government should be cracking down on useless programs, tax cheats, welfare cheats (and getting people off long term welfare and mothers assistance programs) , pandering to every special interest group, and reducing costs everywhere. (Including the size of government and streamlining the entire taxation system and reduce the number of tax collectors needed).

Finding out why we are in this mess and how we got here so it doesn’t occur ever again. Even if the populace paid off this massive debt in some way today in one shot, we will be right here again a few years later in debt.

I have to balance my houshold so I don’t lose my house. No one will bail me out and I can’t ask my neighbours for $50.00 each to help me. Particularly when they see me at the casino, and have driving 2 or three new cars always eating at fancy restaurants, dressed up nicely, while they all toil to make a decent life for themselves. This is pretty well the equivelant of what the government expects from us… more tax?!? No we should be taxed less.

Let’s fix everything first, then we can talk about how much tax needs to be collected.

April 17, 2012, 12:14 am

I wouldn’t mind the Buffet rule if SOMEONE…ANYONE reigned in spending in Washington!

joey
April 17, 2012, 9:29 am

Thanks for this article!

The chart “Dividends Rise as Tax Rate Falls” shows a reversal in 2008, which continued in 2009.

What explains this?

April 17, 2012, 12:37 pm

We have to remember, taxes on dividends weren’t this low always. It used to be much higher and brought down as a temporary measure.

April 18, 2012, 8:42 am

>The Government spends more than it collects and this is a huge problem for any country…

There’s the real cause of the problem: Spending.

The U.S. does not have a revenue problem, it has a spending problem. The answer is not higher taxes, because as we have seen the government cannot spend within its means today – increasing tax revenue will lead to increased spending, not reduced deficits.

Mike
April 20, 2012, 2:35 pm

@Joey,
the economic crash ;-). Most companies hold off on their dividend on those 2 years.

@MoneyCone,
You are right, dividend was still interesting in the 90’s. It’s just that people like “free” stuff. I can relate!

@Charlie,
This is an interesting point of view. Cutting on expenses is also a very effective way to balance a budget! I’m just thinking that US has a lot of space to increase taxes if we compare this country to other ones. But then again, it doesn’t mean that it must waste this money!

Joe
April 26, 2012, 11:00 pm

@Charlie Foxtrot
Agreed 100%. Increasing taxes on Dividends is not a solution for anything. Spending is the problem!!

November 12, 2012, 7:20 am

[…] arrives in January 2012 when several spending cuts and tax increases are going to happen (including taxing dividends!) if a solution is not found. So the problem is not being a democrat or a republican at this stage. […]

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