Dividend Tax Folly - The Patriot Post

While Washington pols pose and posture on whether to raise taxes next year, American businesses are busy taking action to avoid the hit their shareholders are likely to take come January. It’s an old lesson that liberals never seem to learn. No matter how clever the tax hikers think they are, those who stand to be hurt by higher taxes usually figure out a way to protect themselves.

The Obama administration hopes to raise more revenue by allowing the top tax rate to rise to 39 percent (or 43.4 percent if you include the new tax to pay for Obamacare) on those small businesses and individuals earning more than $250,000 a year. But it also intends to hike rates on long-term capital gains and dividends, which are now taxed at a rate of 15 percent regardless of the income of the taxpayer. The dividend rates will revert to ordinary income tax rates, a more than 250 percent increase even before the Obamacare taxes are included.

The rationale for lower tax rates on investment income is sound. First of all, individuals who have chosen to invest their own money by buying stock have already paid individual and, often, payroll taxes on the money they use to do so, and the corporation pays taxes on the profits it earns as a result of that investment. When the shareholder sells the stock at a profit, or receives a dividend based on the company’s earnings, that money has already been taxed twice.

More importantly in the case of capital gains, taxing long-term gains at the same rate as ordinary income provides a disincentive for investors to invest for the long haul. The result is that there is less capital available for businesses, which lowers long-term economic growth.

But the administration is only interested in raising more revenues, any way it can. The problem is, it won’t work.

Here’s why: Companies are already protecting their investors by issuing special dividends and paying out regular dividends early to help them avoid rate hikes next year. The Wall Street Journal posts daily the companies that are making early and special payouts, which will be taxed at the 15 percent rate if they are earned in 2012. The list, now in the hundreds, is a virtual Who’s Who of top businesses: Caterpillar, Cisco, Dillard’s, Oracle, Wal-Mart and Walt Disney, to name a few. And it includes several “progressive” companies whose executives supported President Obama in 2008 and 2012.

Costco’s co-founder, former CEO and current board member Jim Sinegal, is a case in point. As the Journal reported, Sinegal went on the campaign trail in 2012 for President Obama to argue for higher taxes, but he and his fellow Costco directors figured out a way to protect themselves and their shareholders. The Costco board recently voted to approve a special $7 per share dividend to be paid to shareholders in December to avoid paying higher taxes next year. (In the interest of full disclosure, I, too, supported moving up the payout by a few days for a regular quarterly dividend for a public company on whose board of directors I serve.)

There’s nothing wrong with what Sinegal and a host of others have done (though one might question whether Costco’s decision to borrow $3.5 billion in order to award the special dividend is wise.) These companies are making decisions in their shareholders’ interests – and that is exactly what they are supposed to do. In the case of corporations, the money involved is the shareholders’ – no one else’s. And directors’ fiduciary responsibility is to maximize shareholder profit in a lawful and prudent manner.

But liberal policy makers never seem to understand the human instinct to protect and preserve what one has earned. They think that if they raise rates higher, revenues will increase automatically. What liberals never fully anticipate is that their decisions will change behavior in ways that will thwart liberal objectives. If long-term capital gains tax rates will increase next year, individuals have an incentive to sell now and pay lower taxes. If taxes on dividends will go up dramatically, corporations have an incentive (maybe even a duty if they’re sitting on a lot of cash) to pay out those dividends early so that they’ll be taxed at the lower rate.

If President Obama had ever spent one week working in the real economy, he’d understand this. But he’s too obsessed with soaking the rich to figure out that we can never tax our way to prosperity. We’re far better off trying to control government spending as a way to avoid the fiscal crisis ahead than to think we can avert disaster by waving the tax-hike magic wand.

The Patriot Post® · Dividend Tax Folly