Washington, DC, June 7, 2010 – The expiration of the Bush tax cuts and new Medicare taxes on investment income that were part of recent health care reform will push the top effective tax rate on dividends in the U.S. to 68 percent in 2011 – highest among all industrialized nations, according to a new Tax Foundation report.
The paper, authored by Tax Foundation Senior Fellow Robert Carroll, Ph.D., found that the double tax on corporate profits – first under the corporate income tax and again under the individual income tax as dividends or capital gains – discourages productive capital formation, ultimately reducing wages and living standards for U.S. citizens.
“The U.S. integrated dividend tax rate of 68 percent is substantially higher than in other nations,” Carroll said. “The average rate among OECD member nations is about 44 percent and the average among the larger G-7 economies is about 47 percent. This is in addition to the high U.S. corporate tax rate of 39.1 percent, second only to Japan among industrialized countries.”
Tax Foundation Special Report, No. 181, “The Economic Effects of the Lower Tax Rate on Dividends,” is available online at http://www.taxfoundation.org/publications/show/26384.html
Corporate profits first are taxed at the firm level and are subject to a combined federal and average state corporate tax rate of 39.1 percent. For income distributed as a dividend, the second layer of tax is then paid by individual shareholders, which prior to the enactment of health care reform legislation had a top rate of 17.3 percent. With the sunset of the 2003 Bush tax cut at the end of 2010, which will increase the federal dividend tax rate from 15 percent to 39.6 percent, and the new Medicare tax on investment income of 3.8 percent, the integrated effective dividend tax rate will rise dramatically to 68 percent.
The sunset of the 2003 tax cut will also raise the capital gains tax rate from 15 percent to 20 percent. Higher tax rates on dividends and capital gains will increase the overall effective marginal tax rate on investment for the entire economy by 10 percent, from 17.3 percent to 19.1 percent. In the business sector, the effective marginal tax rate on investment would also increase by about 10 percent, from 25.5 percent to 28.1 percent.
Even if the higher dividend tax rate resulting from the expiring Bush tax cut is limited to families earning over $250,000 as President Obama has proposed, all households that hold dividend-paying stocks, regardless of their income, would be affected – or roughly one-fifth of all federal income tax returns filed in 2007 that reported qualifying dividends.
“The combination of the high dividend tax rate and high corporate tax rate raise serious concerns over the competitiveness for the U.S. as a place to locate investment,” Carroll said. “By injecting tax considerations into investment decisions, the double tax reduces the productive capacity of the U.S. economy and serves, ultimately, to reduce the living standards of U.S. citizens.”
The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.
Natasha Altamirano is with the Tax Foundation and she authored this report