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Would President Obama’s Demand For A Huge Hike In Tax On Dividend Income Trigger A Market Meltdown?

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From my colleague at Chapman University, Hank Adler, a professor of accounting and retired partner at a Big Five firm, on one consequence of President Obama’s demand for higher and higher tax rates:

Tax rates and tax rules impact decision making by everyone who pays taxes. These decisions impact what is purchased, what is not purchased, how people invest their money and therefore changes in tax rates and tax rules impact the economy. No one is immune from the economy. We should be seriously fearful of one of the tax law changes that will occur if the “Bush Tax Cuts” are not extended for income earners over $250,000. If this law comes to pass, it will impact the economy negatively and therefore hurt everyone.

When a Federal income tax rate essentially triples, that should get our attention. If no tax laws are changed, the Federal tax rate on dividends will increase from the current 15% rate to 43.4% on January 1st. (This rate includes the new regular Federal tax rate of 39.6% plus the Obamacare investment tax of 3.8%.) The limitation on the deductibility of investment losses will remain unchanged at $3000 for a married couple. If tripling the tax rate on dividends will not discourage investments in stocks, nothing will.

If the law is not changed, the tax on dividends will be the highest it has been since the middle of the Reagan presidency. (Contrary to what one sees on television ads, the tax will be almost four percentage points higher than it was during any moment in the Clinton presidency.)

What will be the analysis a high income taxpayer will make if the Federal tax rates on investment income triple?

Today, let us assume a wealthy investor invests in conservative investments: utility companies. For each $1000 invested, the investor can expect to receive a dividend of about $45.00, pay a tax of $6.75 and be left with cash to spend of $38.25. The investor’s risk is if the stock goes down in value, his losses are limited to $3000. If the law is not changed, that same $45.00 dividend will result in a tax of $19.53 and the investor will be left with only $25.47 to spend. The after-tax return for the investor will go down by one-third on January 1st. This projected after-tax return is the driver in the decision to invest or not invest in a dividend paying stock.

There are three concerns that this tax increase should cause every American. First, will investors be willing to take any financial risk to earn a 2.547 percent return on their risk capital or will they put the money in the bank or under their mattress? Second, will the market value of dividend paying stocks collapse to prices that would reflect the current after-tax yield return received by investors? (The price of a $1000.00 stock paying a $45.00 dividend would need to fall to about $666.00 to achieve the same after-tax return to the investor.) Third, will the lack of a reasonable return from investing in dividend paying stocks result in a significant impact on the economy and drive hiring down?

This author can only conclude that if the tax rate on dividends increases from 15% to 43.4%, investor interest in dividend paying stocks will melt. If individual investor interest in dividend paying stocks melts; the economy could melt along with it. When the economy melts, unemployment explodes and everyone loses.

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