Study Highlights High US Investment Tax Rates

by Leroy Baker, Tax-News.com, New York

16 February 2012

A study on United States corporate dividend and capital gains taxation, prepared for the Alliance for Savings and Investment (ASI) by Ernst & Young, discusses the negative impact high tax rates on capital gains and dividends have on key economic factors, including productivity, wages and decision making by investors and companies.

In order to inform the current US tax reform debate, the report calculates US integrated tax rates on capital gains and dividend income by combining taxes paid at the corporate and individual levels, and then compares the rates against the total rates in other Organization for Economic Co-Operation and Development (OECD) and BRIC (Brazil, Russia, India and China) countries.

The report calculates that the current top US integrated dividend tax rate is 50.8%, the fourth highest among OECD and BRIC countries, and that the rate will rise sharply to 68.6% in 2013, significantly higher than all other countries measured.

In addition, the current top US integrated capital gains tax rate is also 50.8% - again, the fourth highest among OECD and BRIC countries – and that rate will rise to 56.7% in 2013, the second highest among countries measured.

The present reduced individual income tax rate on investment income from dividends and long-term capital gains was established in 2003 to reduce the effects of the double tax on corporate profits, which arises from subjecting corporate income to tax at both the corporate and shareholder levels. However, the current tax rates will expire on December 31, 2012 without further action by Congress and the Administration.

With the sunset of the 2001/2003 Bush tax cuts, at the beginning of 2013 the top federal income tax rate on dividends will increase from its current level of 15% to 39.6%, and the top federal income tax rate on long-term capital gains will rise from its current level of 15% to 20% (and from zero to 10% for lower income taxpayers).

For many taxpayers, both dividends and capital gains will also become subject to the additional 3.8% Medicare tax in 2013, due to changes under the Affordable Care Act of 2010.

It is pointed out that most developed countries provide relief from the double tax on corporate profits “because it distorts important economic decisions that waste economic resources and adversely affects economic performance”.

The authors of the report specify that such double taxation discourages capital investment, particularly in the corporate sector, reducing capital formation and, ultimately, living standards; and favours debt over equity financing, which could leave certain sectors and companies more at risk during periods of economic weakness.

Furthermore, it is added that a tax policy that discourages the payment of dividends can impact corporate governance, as investors’ decisions about how to allocate capital are disrupted by the absence of signals dividend payments would normally provide.

About four-fifths of OECD and BRIC countries tax capital gains at rates below the rates applied to ordinary income, while 30 of the 34 OECD nations, and all BRIC countries, have lowered their statutory corporate tax rates since 2000. In addition, scheduled reductions in corporate income tax rates will further drive down competitors’ integrated dividend and capital gains tax rates.

“To get the full picture of the tax rates on capital gains and dividends received by individuals, you need to factor in taxes already paid on this income at the corporate level,” said Robert Carroll of Ernst & Young. “Lawmakers need to consider this integrated rate closely because a further increase could discourage capital investment, lower productivity and real wages, and lead companies to favour risky debt financing.”

“Capital is mobile and the US risks losing ground to our competitors if investment tax rates increase,” added Jim McCrery, Manager of ASI. “Allowing these rates to increase in 2013 would place us further behind in the global economy, and send the wrong signal to businesses looking to grow and create new jobs here in the US.”

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