Warning: Obama proposes tripling dividend tax rate

Pete Souza/White House

Article Highlights

  • Obama to raise dividend tax rates on high-income stockholders; Americans at all income levels will feel the impact

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  • Raising the dividend tax will hamper investment, eroding the capital stock and slowing long-run economic growth

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  • Urge #Congress to promote long-run economic growth by moving the tax system toward lower #taxes on investment

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In the summer of 2008, the Obama campaign's two top economists proudly proclaimed that their candidate favored a dividend tax rate of 20 percent, "lower than all but five of the last 92 years." Well, that was then. In a sharp break from that campaign stance and the Administration's first three budgets, President Obama is now calling for an all-in dividend tax rate of almost 45 percent, the highest rate in 27 years. The president's about-face bodes ill for the economy.

While the president's proposal raises dividend tax rates only on high-income stockholders, Americans at all income levels will feel the economic impact of the tax hike. Higher dividend taxation will impede the investment that fuels long-run growth, depress stock prices, and weaken incentives for good corporate governance.

While the president's proposal raises dividend tax rates only on high-income stockholders, Americans at all income levels will feel the economic impact of the tax hike.

The president's proposal would allow the 2003 dividend tax cut to expire for high-income households at the end of the year, pushing the top dividend tax rate up from 15 to 39.6 percent. That's a dramatic increase in its own right. But, other provisions make the true increase even larger. The president also wants to bring back a provision phasing out deductions for high-income taxpayers, which will cause each additional dollar of dividends to trigger 1.2 cents of extra taxes. And, beginning next year, the president's health care law will impose an additional 3.8 percent tax on dividends and other investment income of high-income households. Under the president's proposal, the top all-in dividend tax rate will be 44.6 percent - almost triple today's 15 percent rate.

Dividend taxes were lowered in May 2003 to reduce the tax penalty on investment, especially stock-financed investment. The president's new proposal would move us in the opposite direction. Raising the dividend tax will hamper investment, eroding the capital stock and slowing long-run economic growth. A smaller capital stock makes workers less productive, holding down their wages.

Higher dividend taxes also encourage more corporate borrowing. When a corporation issues stock to finance new investment, today's tax system imposes two levels of tax-the corporate income tax plus the dividend tax paid by the stockholders. But, when a corporation borrows, there's only one level of tax because the corporation can write off its interest payments.

The lower dividend tax rate has helped undo part of this pro-debt bias by giving stockholders a tax break at the individual level. In last year's budget, the Obama administration noted that the lower dividend rate "reduces the tax bias against equity investment and promotes a more efficient allocation of capital." Unfortunately, that insight is not reflected in this year's budget. While the president's new corporate tax reform framework rightly denounces the tax system's favoritism toward debt and even urges Congress to "consider" trimming corporations' writeoff for interest payments, his proposal to hike dividend taxes tilts the playing field back in favor of debt.

The dividend tax hike will also undermine good corporate governance by prompting firms to reduce dividend payouts. As economists Raj Chetty and Emanuel Saez have documented, the 2003 dividend tax cut induced firms to pay more of their earnings out to stockholders. After holding roughly constant near $25 billion from 1998 to 2002, annual dividend payouts rose following the 2003 rate reduction, reaching $33 billion a year by 2005. The number of corporations paying regular dividends surged after the tax cut. Increased dividend payments make it harder for management to hide a company's true financial condition or divert corporate funds to their own pet projects. The president's dividend tax hike will undo the recent progress on this front.

It's unfortunate that President Obama, after spelling out the case for low dividend taxes so clearly, has now reversed direction on this important issue. Perhaps, the president is trying to turn out his base on Election Day by appealing to their concerns about the gap between rich and poor. Regardless, Congress will need to address this matter before the 2003 dividend tax cut expires. We urge Congress to promote long-run economic growth by moving the tax system toward lower taxes on investment.

AEI research fellow Alex Brill served as an adviser on tax policy to the President's Fiscal Commission.  He is also a former senior adviser and chief economist to the House Ways & Means Committee, and was on the staff of the President's Council of Economic Advisers. 

AEI resident scholar Alan D. Viard previously served as a senior economist at the Dallas Fed.  He has also worked for the White House's Council of Economic Advisers, the Joint Committee on Taxation in Congress, and the Treasury Department's Office of Tax Analysis.

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About the Author

 

Alan D.
Viard
  • Alan D. Viard is a resident scholar at the American Enterprise Institute (AEI), where he studies federal tax and budget policy.

    Prior to joining AEI, Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also been a visiting scholar at the US Department of the Treasury's Office of Tax Analysis, a senior economist at the White House's Council of Economic Advisers, and a staff economist at the Joint Committee on Taxation of the US Congress. While at AEI, Viard has also taught public finance at Georgetown University’s Public Policy Institute. Earlier in his career, Viard spent time in Japan as a visiting scholar at Osaka University’s Institute of Social and Economic Research.

    A prolific writer, Viard is a frequent contributor to AEI’s “On the Margin” column in Tax Notes and was nominated for Tax Notes’s 2009 Tax Person of the Year. He has also testified before Congress, and his work has been featured in a wide range of publications, including Room for Debate in The New York Times, TheAtlantic.com, Bloomberg, NPR’s Planet Money, and The Hill. Viard is the coauthor of “Progressive Consumption Taxation: The X Tax Revisited” (2012) and “The Real Tax Burden: Beyond Dollars and Cents” (2011), and the editor of “Tax Policy Lessons from the 2000s” (2009).

    Viard received his Ph.D. in economics from Harvard University and a B.A. in economics from Yale University. He also completed the first year of the J.D. program at the University of Chicago Law School, where he qualified for law review and was awarded the Joseph Henry Beale prize for legal research and writing.
  • Phone: 202-419-5202
    Email: aviard@aei.org
  • Assistant Info

    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

 

Alex
Brill
  • Alex Brill is a research fellow at the American Enterprise Institute (AEI), where he studies the impact of tax policy on the US economy as well as the fiscal, economic, and political consequences of tax, budget, health care, retirement security, and trade policies. He also works on health care reform, pharmaceutical spending and drug innovation, and unemployment insurance reform. Brill is the author of a pro-growth proposal to reduce the corporate tax rate to 25 percent, and “The Real Tax Burden: More than Dollars and Cents” (2011), coauthored with Alan D. Viard. He has testified numerous times before Congress on tax policy, labor markets and unemployment insurance, Social Security reform, fiscal stimulus, the manufacturing sector, and biologic drug competition.

    Before joining AEI, Brill served as the policy director and chief economist of the House Ways and Means Committee. Previously, he served on the staff of the White House Council of Economic Advisers. He has also served on the staff of the President's Fiscal Commission (Simpson-Bowles) and the Republican Platform Committee (2008).

    Brill has an M.A. in mathematical finance from Boston University and a B.A. in economics from Tufts University.

  • Phone: 202-862-5931
    Email: alex.brill@aei.org
  • Assistant Info

    Name: Brittany Pineros
    Phone: 202-862-5926
    Email: brittany.pineros@aei.org

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