Higher taxes on dividends will discourage investment and retard economic recovery

 Some members of Congress are now arguing for an extension of these tax cuts because of the fragility of the nascent economic recovery from the Great Recession of 2008-2009 and fears of a “double-dip.”  But President Obama and the Democratic leadership are intent on letting most of the tax cuts expire, especially for individuals earning more than $200,000 and families earning more than $250,000.  Facing a $1.6 trillion federal budget deficit in the next fiscal year, some Democrats no doubt see this as an opportunity to generate additional revenue from the “wealthy” while retaining the current rates for the “middle class.”  But even limiting tax hikes to the so-called wealthy is likely to retard the halting economic recovery.

Perhaps the most worrying aspect of the pending tax increases is the treatment of dividend income.  Under current law, stock dividends are taxed at a maximum rate of 15 percent.  But if the tax preference for dividend income is removed, the result would be a 164 percent tax hike for some investors.  Contrary to the conventional wisdom that lower dividend tax rates only benefit the wealthy, just about anyone who owns a 401(k), 403(b), IRA or pension plan is benefiting from the current tax regime.  Lower dividend tax rates have also helped to attract shareholders who are more interested in a long-term buy and hold strategy which benefits stockholders, companies, and the economy.

Preferential tax treatment for dividends also provides supplemental income for seniors and people reaching retirement age.  According to a recent study by Ernst & Young, in 2007 more than 27 million tax returns reported dividend income subject to the 15 percent cap.  Of these returns, 61 percent were from taxpayers age 50 and older while 30 percent were from filers age 65 and older.

A lower tax rate on dividends, by effectively reducing the cost of capital, aids companies in financing new investments in plant and equipment. This is especially the case for investor-owned utilities and other capital-intensive industries where companies need to raise huge amounts of capital to fund capacity expansions. Importantly, capital expenditures by these firms create high-paying jobs in the manufacturing and construction industries that can help revive our moribund economy.  Should the 15 percent cap on dividends be removed, tax policy would once again favor the issuance of debt over equity—an outcome that could make investors reluctant to provide financing for major new projects.

In the utility sector, lower tax rates have helped reverse a decline in the number of companies paying dividends. In 2009, investor-owned utilities paid out $18.5 billion to investors, the highest percentage of earnings of any industry.  What’s more, the tax returns of 86 percent of utility shareholders with qualified dividends were from individuals age 50 and older while 59 percent were from filers age 65 and older.

As the nation struggles to rebound from the worst economic downturn since the Great Depression, now is not the time to enact policies that will discourage new capital outlays.  Instead, Congress should be encouraging long-term investment in our economy by retaining the preferential treatment of dividend income.

Dr. Weinstein is associate director of the Maguire Energy Institute and an adjunct professor of business economics in the Cox School of Business at Southern Methodist University in Dallas.