Dividend Tax - The Political Debate

Understanding the Double Taxation Fuss

Democrats and Republicans have plenty to debate as President Bush’s much-hyped tax cut makes its way through Congress. One of the main points of disagreement is the so-called dividend tax. Republicans say it’s an instance of abusive government doling out double taxation. Democrats say eliminating the tax would give an unfair advantage to the rich. The outcome could have large implications for your portfolio if you receive substantial dividend payments from your investments. Let’s take a closer look at each side’s position.

Dividend Tax Position 1 – The Republicans

Companies and business provide the very core of the American economy. Each time one of these businesses earns a profit, it pays income tax to the Federal government. After this tax bill has been paid, the company is left with its net profit. Management has several options for this pile of cash – they can expand operations by reinvesting it in the business, repurchase the company’s stock, pay down debt, purchase investments, acquire other businesses, or return the money to the owners of the business (shareholders) by paying a dividend.

Unfortunately, there is a strong disincentive to give the cash to the owners. If the company were to pay a dividend, the owners (shareholders) would have to pay personal taxes on the dividends they receive from the company in excess of $45, despite the fact that the company has already paid income taxes on those earnings. Taking both of the taxes into consideration, the owner of the business may be deprived of up to 50 or 60% of their earnings (35% corporate tax rate + 38.6% highest personal tax rate). Furthermore, the United States is one of the only industrial countries not offering a tax rebate to offset this double taxation. The government is having its cake and eating it too, sadly at the expense of the business owners and entrepreneurs fuel the economy and create jobs.

Dividend Tax Position 2 – The Democrats

It is true that the income is double-taxed. However, it is a fact that the people who hold large portions of their assets in equities in the United States generally come from higher wealth households. These are the people least in need of tax relief.

If we allow this dividend tax cut to proceed, a wealthy man or woman receiving millions of dollars a year in dividends won’t pay a single penny in taxes on those earnings, while the police officers, school teachers, and blue-collar workers statistically earning and owning fewer equities, will have little or no advantage. Congress should aid these lower income individuals directly, not pass legislation that protects the wealthiest Americans.

A Compromise to the Dividend Tax Debate

One proposed compromise has been to raise the level of tax-exempt dividends from $45 to $500 annually. This would eliminate the dividend tax for a majority of the American investing population while still requiring larger equity holders to pay. Despite the fact that some republicans feel that it fails to address the principle of double taxation, the proposal appears to hold some promise.