Financial Regulatory Forum

ANALYSIS-Dividend-tax fate leaves firms, investors guessing

By Reuters Staff
May 18, 2010

By Kim Dixon

WASHINGTON, May 18 (Reuters) – Companies and investors can only guess whether dividend taxes for high-income Americans will skyrocket next year, a distinct possibility.

If the U.S. Congress fails to take action, taxes on dividends will more than double to about 40 percent next year for individuals earning more than $200,000 and couples with annual incomes of more than $250,000.

The Obama administration favors preventing the tax rate from skyrocketing, but the need for revenue may make that position irrelevant.

The key sticking point is that unlike most of the Bush-era tax cuts expiring at year-end, Congress must dig up tens of billions of dollars in new funds to prevent the dividend levy from spiking.

Last month the Senate passed its budget “resolution,” which sets parameters on spending in different categories and special rules on votes required to pass certain items. For example, it was a budget resolution provision that allowed Senate Democrats to pass the healthcare overhaul with a simple majority vote in March.

House lawmakers have not yet decided whether to adopt their own resolution. In an election year, putting such numbers — including the current budget deficit — on paper could be dangerous.

“No budget means bad news on dividends,” analyst Jim Lucier of Capital Alpha Partners in Washington said in a note this week. “No budget resolution means the 40 percent rate could be effectively baked in.”

President Barack Obama, for his part, backs a less severe increase that would lift the rate to 20 percent from the current 15 percent for upper-income households.

Meanwhile, companies issuing dividends are watching.

Last week Ingersoll-Rand Chief Executive Officer Michael Lamach said he was inclined to boost the dividend, but was waiting for a signal from Washington.

If future dividends are taxed at a higher rate, he told the Reuters Manufacturing and Transportation Summit, the company may instead use its cash for a stock buyback or acquisition.

BLENDED RATE

The possible changes are part of the broader expiration of tax cuts enacted under former President George W. Bush earlier in the decade. Obama and most of his fellow Democrats want to extend the personal income tax cuts for all those making under $200,000, but let them expire for those making more, about 3 percent of the population.

One option under discussion is a higher “blended” rate, an increase for both capital gains and dividend taxes, to soften the impact on shareholder payouts, according to analysts.

Goldman Sachs estimates that lawmakers could boost both rates to 25 percent and stay within budget rules. Capital gains, like dividends, are currently taxed at a 15 percent rate.

“To keep the rates equal without affecting the budget balance, the most obvious option is to set both rates at some equilibrium level,” Alec Phillips, the firm’s Washington analyst, wrote recently.

With or without a budget resolution, lawmakers could find a way to keep the dividend tax rate lower if the political will exists, said Mark Bloomfield, president of the American Council for Capital Formation, a group backed by companies that oppose higher investment taxes.

Business groups have hired Jim McCrery, a former top Republican on the tax-writing Ways and Means Committee, to lobby on their behalf.

“We’re putting the issue on the radar screen,” McCrery said, adding that he believes Congress is still “quite a ways away” from making decisions about the Bush-era tax cuts.

Backers of keeping the rate lower argue a dividend tax increase could spur companies to take on more debt and hurt the economy.

The consumer group Citizens for Tax Justice backs taxing investment income on par with ordinary income. The highest marginal tax bracket is now 35 percent.

The group argues that the economy did just fine under former President Bill Clinton, when dividends were taxed at nearly 40 percent.

“I don’t think anyone would say the economy was crashing then,” said Steve Wamhoff, the group’s legislative director.

American Council for Capital Formation President Bloomfield said he has been meeting with lawmakers to press his case for lower taxes, but has not seen congressional leaders make a serious push.

“Somebody in a position of power needs to decide,” he said.

But for at least another month, investors will remain in suspense as lawmakers slog through financial reform and other matters.

(Reporting by Kim Dixon; Editing by Lisa Von Ahn) ((kim.dixon@reuters.com; +1 202 354-5864; Reuters Messaging:kim.dixon.reuters.com@reuters.net))

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