On Jan. 1, 2013, last year’s agreement to extend the federal debt ceiling kicks in. That means a 2 percent across-the-board reduction in spending, along with an end to Bush-era tax rates.
Assuming the US economy keeps growing, the result will be a dramatic closing of the federal budget deficits that have exploded in the last decade. Unfortunately, as we’ve seen with Europe’s slide into recession, the more likely outcome of such a “fiscal cliff” is a sharp drop in growth.
And the result could well be an actual widening of deficits as Uncle Sam’s tax receipts drop sharply.
By this time, even the densest politicians must have realized the failure of such austerity measures in Europe and that the resulting recessions have triggered massive turnover in governments.
In fact, with most countries on the Continent either in recession or headed for one, odds are the political carnage is far from done.
That makes it extremely likely that whatever party wins the hotly contested US elections this November, it’ll do what it takes to avoid a Europe-style economic disaster as its winners take office. That makes some sort of deal on spending and taxes all but inevitable.
One possibility is some sort of one-year agreement between the parties now, which would alleviate the need for the lame-duck Congress to act between November and January. Congress has been debating such an outcome in recent weeks, though it appears to still be hung up by Republicans’ demand for Bush-era rates to be extended to higher income taxpayers and Democrats’ insistence on a $250,000 a year cutoff.
In my view, it’s a little Pollyannish to expect Republicans and Democrats to reach a real deal in an election season, particularly one where so many politicians are pitching it as a battle between good and evil. But the consequences of a fiscal cliff are so severe that only the most doctrinaire on both sides will eventually oppose a solution that at least temporarily blunts austerity’s worst effects.
Rather, the key question is what the ultimate deal will look like. And as is always the case in Washington, the result will boil down to who gets heard.
One issue of extreme importance to investors will be what happens to the preferential tax rate for dividends, which limits the total levy to 15 percent.
Two years ago, with the dividend tax rate in jeopardy, I urged investors to get acquainted with the organization “Defend My Dividend.” The organization’s sole purpose is to keep the maximum tax rate on dividend income at 15 percent. The voices they and others joined together were critical in convincing Congress and the Obama administration to extend preferential rate past Dec. 31, 2010, when it was originally supposed to expire.
Marshalling these voices again will be critical if pro-savings policies are to survive austerity this time around. That may not sound like the most pressing of issues at a time when the federal government is trillions in the hole.
But, as has been proven in countries such as Canada, favorable investment taxes can do wonders for capital formation. And the needs of America’s most capital intensive industries are great.
I’m not one who lives in fear of solar flares inevitably shutting down the US electric grid. But every destructive weather system that does visit these shores reminds us time and again how increasingly dependent we are on electricity, and that much of our country’s power system is in dire need of more investment.
As I pointed out in the July issue of Utility Forecaster, the situation with the US water system is even worse.
The only companies that have the scale and expertise to reasonably bridge this gap are investor-owned utilities. And the best way to make them able to meet the need is to advantage investors who buy their stocks.
Lynn Good, Chief Financial Officer of Duke Energy Corp (NYSE: DUK), puts it this way:
Public policy that encourages individuals to buy and hold dividend-paying stocks will be more effective in helping our nation’s economic recovery than increasing the tax rate on dividends. We need long-term investors to help our company put people to work on projects that will modernize our infrastructure to meet our customers’ energy needs for decades to come.
As for the impact on individuals, before 2003 the maximum tax rate on dividends was nearly 40 percent. Throwing in the new tax on investment income that came with the president’s signature health care reform bill, a reversion to that rate would make dividend investing significantly less attractive to higher-income individuals.
The president has proposed keeping favorable rates in place for all investors with annual incomes of less than $250,000. Congressional Democrats have proposed legislation to do that for one year, which would allow the victors time to enact a more permanent budget arrangement next year.
That’s definitely better than a full-on jump in dividend taxes across the board. Meanwhile, higher-income individuals can still shelter dividend income in tax-deferred accounts such as IRAs and Roth IRAs or defer taxes with master limited partnerships (MLP).
As I’ve written in Utility Forecaster, I’m also not convinced there would be much fallout on stock prices from a higher tax rate–so called Tax-maggeddon.
We didn’t see much upside when these lower rates were enacted. And remember that Canadian and Australian stocks, for example, are mainly owned by Canadians and Australians, respectively, who could care less what US tax rates on dividends are.
If Republicans win control of the government in November, they’ve pledged to make the Bush-era tax cuts permanent and to repeal the 3.8 percent additional investment income tax attached to the Affordable Health Care Act. Presumably that would also include keeping the top tax rate on dividends at 15 percent.
Obviously, there are a lot of issues in this campaign, and I’m not about to try to convince anyone to vote one way or the other. What I am saying is investors who make their returns from dividends are betting on companies’ success over the long term.
That’s particularly difficult in this environment, where volatility is severe and many investors’ idea of “long term” is the end of the week.
But those who do adhere to a truly long view deserve to be rewarded for their patience with a competitive tax rate, no matter which party is in power.
Whether you or I like it or not, things get done in the nation’s capital not because they’re the right policy. That sometimes does happen, believe it or not, but only because the stronger side is in the right. And those who automatically assume any politician or political party is going to do what they say in their campaign have been disappointed time and again in the past, and surely will be in the future.
Consequently, the only way for the side of lower dividend tax rates to win is if enough dividend-investing Americans make their views known. If you believe as I do that those who live off dividends deserve tax rates as low or lower than those who bet on stocks to go up and down–i.e. capital gains–I urge you to contact www.DefendMyDividend.org or call 888-443-5863.
Alternatively, write your congressman an express your views. The 15 percent dividend tax rate was in large part extended to 2011 and 2012 because people like you took this action. People of both parties are sympathetic, but only if you let them know they have your support.
Here’s a sample letter:
I write to express my support for making the top 15 percent tax rate on dividends a permanent part of the US tax code.
Public policy that encourages individuals to buy and hold dividend-paying stocks encourages investment and reliable growth of savings. It also helps companies raise capital that’s needed to ensure functioning electric, communications and water systems as well as other vital infrastructure.
Taxing dividends at pre-2003 rates will raise federal revenue in the short run but at the expense of saving. Investors would be encouraged to seek returns from speculating on rising stock prices rather than investing in productive companies for the long term. Consider too that dividends are already taxed once, as they’re paid out of companies’ post-tax income.
I hope you’ll do what you can to see the top 15 percent tax rate is extended permanently and not allowed to expire on Jan. 1, 2013 per current law.
(Your Name Here)