Trillium News

Taxes on Dividends and Capital Gains Likely to Rise by 2011–Maybe Sooner for High-Income Households

One of the things we know about investment tax rates: they change frequently. The top capital gains tax rate was almost 40% in the 1970s, 20% 1982-86, back up to 28-33% in 1987-1990, down to 20% 1997-2000, and 15% since 2003 (along with dividends). The 2003 “Bush tax cuts” are set to expire at the end of 2010; if Congress does nothing the capital gains tax rate will go up to 20% in 2011 for those in higher tax brackets, and dividends will again be taxed as regular income.
Do shifts in tax rates influence the financial markets? It is difficult to say. A Federal Reserve research study found that the Bush tax cuts did not raise stock market values.[1] Conversely, we cannot definitively predict that increases in tax rates will depress stock market values. Also, the market is very forward looking — the recent market declines may have already incorporated the risk of future tax rate changes. Most of the uncertainty about the election will be priced into the market prior to November, and some of that may already have happened.
Senator Obama has called for letting the Bush tax cuts expire, and is considering raising the capital gains tax rate as high as 28% for households with annual income of over $250,000. Senator McCain initially opposed the Bush tax cuts, but is now on record for making them permanent. A Democratic Congress would be unlikely to go along with that.
Senator Obama’s tax plan emphasizes fairness, with an eye toward narrowing the income disparities that have emerged in the American economy. Thus, tax increases are likely to be focused on the wealthiest 3-5% of households. Investment tax policy is only one piece of this multi-faceted fiscal puzzle.
There is some possibility that an Obama administration, aligned with a Democratic Congress, would raise investment tax rates as early as 2009. For those investors considering the timing of realized capital gains, it is highly unlikely that investment tax rates will be lowered, and rates might rise relatively soon. Investors may find it prudent to take more gains in 2008, especially since the recent market declines may allow for some partially offsetting realized losses. On the other hand, depending on one’s circumstances deferring taxes into the future could make sense, even if the tax rate is going to be higher. As always, before making any decisions with material tax consequences investors should consult with their accountant or tax attorney.
The bottom line is that investment tax rates are likely to be going up by 2011, and possibly sooner, but the market impact is uncertain. Tax rates are generally higher under Democratic administrations, but so is economic growth, so statistically the stock market has gained more on average under Democratic presidents.

[1] Gene Amromin, Paul Harrison, Nellie Liang, and Steve Sharpe, “How Did the 2003 Dividend Tax Cut Affect Stock Prices and Corporate Payout Policy?” Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, D.C., 2005