Tuesday, President Bush proposed a tax break on dividends as part of his larger economic-stimulus plan. As can be expected, Democratic activists are describing this as yet another tax break for the “rich,” as if everyone who ever invested in a pension plan or the stock market is rich. Here are a few facts about the benefits of dividend tax relief that paint a different picture.
Dividend income is earned by taxpayers across the income spectrum. In fact, of all taxpayers that claimed some dividend income in 2000, nearly half (45.8%) earned less than $50,000 in adjusted gross income (which includes dividends), and almost two-thirds, 63.8%, of those claiming dividends earned less than $50,000 in just wages and salaries.
The dividend tax relief is especially important for seniors who will benefit little from the other changes proposed and are generally far more dependent on dividend income than other people are.
According to the most recent IRS data, 34.1 million tax returns contained some dividend income in 2000. Dividend income in 2000 totaled $147 billion, or 2.3% of total income reported by all taxpayers in that year.
Another important factor to remember is that a tax return is a piece of paper that can represent a single person, a family, or even a business. Therefore, it is important to look at the number of people affected by a change in tax law, not just the number of returns affected. It is inaccurate to say that “only 34.1 million taxpayers” would benefit from the elimination of the double-tax on dividends because these 34.1 million tax returns represent 71 million people. Could that many people be “rich”?
What many people don’t realize is that the current tax on dividends is actually a form of “double-taxation,” and has long decreased the income that many individual taxpayers receive from dividends. Corporations are not allowed to deduct dividend payments the way they can deduct wages. So after companies pay corporate income tax on profits, they use some of what’s left to send shareholders their dividends. Then those shareholders pay individual income tax on them. This double-taxation causes companies to issue far fewer dividends than they would in the absence of the tax.
The most immediate effect of eliminating the double tax on dividends would be a redirection of investment into firms that pay dividends. This should increase the incentive of firms who don’t pay dividends to start doing so. Many economists believe that investors who receive dividends put less pressure on companies to achieve short-term increases in share prices, and that this change will be a positive development in the effort to improve corporate governance.
In sum, dividends have been overtaxed since at least 1985, when a longstanding partial exemption was repealed in favor of fully taxable dividends. Since then, companies have poured all their resources into raising share prices, the only other way to reward shareholders. Some investment-fund managers have even refused to invest in companies that issue dividends because it displays a willingness to fly in the face of the tax code, rarely a wise move. Restoring the tax exemption for dividend income would be a positive step in the direction of restoring investor confidence and the economy in general.
— Scott A. Hodge is executive director of the Tax Foundation, a non-profit group that has monitored tax policy since 1937.