Tags: Obama | Dividend | Tax | Rate

American Enterprise Institute: Obama to Triple Dividend Tax Rate

Wednesday, 07 Mar 2012 02:31 PM

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The latest proposal from the White House on dividend taxes is on a collision course with investors and corporations, raising the tax rate on dividends for the highest earners close to 45 percent — triple the current rate, warn experts who advise government on tax policy.

Under the new rules, the tax rate on high earners would jump to nearly 40 percent, plus a 3.8 percent tax to pay for healthcare reform, explain American Enterprise Institute (AEI) research fellow Alex Brill and AEI resident scholar Alan D. Viard, in a column for RealClearMarkets.

The result: A top dividend tax rate of 44.6 percent, almost three times the current 15 percent rate.

Editor's Note: Obama Donor Banned This Video But You Can Watch it Here

“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,” they warn. “Higher dividend taxation will impede the investment that fuels long-run growth, depress stock prices, and weaken incentives for good corporate governance.”

If enacted, the change in tax policy would undo rates that were lowered in 2003 to encourage investment and move companies to borrow more, since it will be cheaper in comparison.

Worse yet, a dividend tax hike will encourage companies to hoard cash and reduce dividend payouts, they warn, undoing what has been a rise in transparency for stock investors.

“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,” they write. “The president's dividend tax hike will undo the recent progress on this front.”

Dividend stocks have been a haven for investors. Low interest rates mean that bond yields have cratered, along with certificate of deposit and money market payouts. The need for income has driven some investors into dividend stocks to replace missing fixed-income cash flow.

The current S&P 500 dividend yield is 1.95 percent, compared to an historic median of 4.27 percent. Ten-year Treasurys pay almost the same — 1.96 percent — but bring duration risk: If rates rise quickly, bond prices fall. Fine if you hold individual bonds to maturity but not good news if you own a bond fund, for instance.

Even if you hold bonds, you lose the potential for higher returns that rising rates offer, and loss from inflation is higher.

In comparison, popular dividend exchange-traded funds have done quite well over the past 12 months. The iShares Dow Jones Select Dividend ETF (DVY) has returned 7.35 percent in appreciation alone, plus a 3.37 percent dividend yield. The Vanguard Dividend Appreciation ETF (VIG) is up 4.13 percent, plus a 2.06 percent yield.

On the downside, there is the rising risk that dividend stocks have become a crowded trade. Higher prices mean lower yields and an increased risk of loss of capital if investors are coaxed back to bonds (once rates finally rise) or into riskier but better returns on technology or small cap stocks.

Experts recommend that investors buy dividend stocks for stability rather than simply for high yield, and they encourage investors to use ETFs to avoid owning small numbers of stocks, which concentrates risk of loss.

“One way to avoid the riskier dividend-payers is to focus on high-quality companies,” writes Hortense Bioy, a European ETF analyst at Morningstar.

“Investors may want to look for ETFs that hold stocks that can sustain their current dividends or even raise them in the future. These companies usually are market leaders with strong brand names that have exhibited consistent dividend growth to date.”

Editor's Note: Obama Donor Banned This Video But You Can Watch it Here

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