Taxing Dividends or Not
Recall
the George W Bush era 2003 tax cuts came with a ten year expiration date, a
necessary concession to get the additional votes for passage by Congress. If
the expiration date passed without a legislative renewal, then the Personal
Income Tax reverted to what it was right before the Bush tax cuts. Negotiations
for renewal and adjustments began as the 2013 deadline approached, which
created a position of enormous advantage for President Obama. All he had to do
was let the thing expire and keep talking if he could not get the changes he
wanted. If he had done that, one especially disgusting feature of the Bush tax
cuts would have expired with it. The especially disgusting feature favored
income earned from corporate dividends with lower tax rates that did not, and
still do not, apply to wage income, or social security income or pension
income.
A
dollar of personal income provides a dollar of spending power without regard to
its source or label. Taxing dividends less than wages has no financial
advantage funding government, but it cuts tax rates in favor of those with
stock portfolios rather the jobs with wages. It makes the federal personal
income tax less progressive, or regressive – tax rates fall as incomes rise -
and means those with the same income will pay different taxes depending on how
they earn their income rather than how much.
In
2003, the first year of the Bush Tax cuts, the tax rate on general dividend
income was capped at 15 percent. A worksheet – Qualified Dividends and Capital
Gains Tax Worksheet-Line 41 - was added to the Form 1040 instructions with an
algorithm that separated dividend income from other taxable income. Taxable
income without the dividends was taxed at rates starting at 10 percent and
rising to 35 percent for taxable income over $311,950, while dividend income
was taxed at 15 percent, or 20 percent lower than the 35 percent applied to the
highest personal income. Since the median family income in 2003 was $43,318,
the 20 percent rate reduction applied for those with taxable income over
$311,950, which means a large savings for the highest incomes. Many years of
annual tax savings reinvested in the stock market year by year might be a tidy
little nest egg. However, there is no reason to speculate how much it might be.
It is not difficult to generate dollar amounts from the tax rate schedules and
stock market returns for the years 2003 to 2022.
Suppose a married couple both in the teaching profession
in 2003 had a typical median salaries providing a joint taxable income of $110,000. In the first year a married couple with jobs
paying a joint taxable income from wages of $110,000 would pay a federal
personal income tax of $21,120. If our married couple had $10,000 of their
$110,000 income as dividends their tax bill would drop $1,000 to $20,120
because their marginal tax rate dropped from 25 percent to 15 percent. In 2003
that $1,000 would have purchased just over 39 shares of Microsoft Corporation
stock at $25.08 a share, the price on April 1, 2004. On April 1, 2022 the 39 shares
had a value of $12,024.09. (1)
Since
the tax cut on dividends continues to the present, suppose tax savings on
$10,000 of dividends as part of a taxable income of $110,000 continued to be
$1,000 a year for 15 years until 2017. For the remaining years after the Trump
tax cuts the 15 percent marginal rate dropped to 12 percent leaving the tax
savings at $700 a year. If our hypothetical couple continued purchasing shares
each April they would add to their 39 shares from 2003. By doing so until April
2022 they would own 497 shares of Microsoft stock worth $153,397.83.
Suppose a married couple both in a professional occupation
like law, engineering or medicine where median salaries of $125,000 in 2003
provide a joint taxable income of $125,000. In the first tax cut year 2003 a
married couple with a joint taxable income from wages of $250,000 would pay a
federal personal income tax of $63,945.17. If $25,000 of the $220,000 was
dividend income the personal income tax for 2003 drops by $4,500.00 to
$59,445.17. The $25,000 of dividend income presumes a stock portfolio of
$1,000,000 and a 2.5 percent yield on dividends would be reasonable for a
professional couple of forty years of age. If, as above, our wealthier couple
continues to reinvest tax savings on $25,000 of dividend income year by year
until 2021 they would own 2,186 shares of Microsoft stock worth $674,084.00:
funds they would not have from wage income alone.
In
2003, the 2002 tax rates were lowered for personal income above $46,700, but
excluding dividend income. The $46,700 was a little above the median family
income at that time. The top rate was lowered from 38.6 percent to 35 percent,
where it stayed until 2013. The top rate was 39.6 percent from 2013 until 2017
when the Trump tax cuts cut it to 37 percent. These rates apply to those with
high taxable incomes: $311,950 and higher in 2003 up to $628,300 and higher in
2021. It is for these incomes that the tax savings for dividend income over
such a long period as 2003 to 2022 can become enormous.
Married couples with personal income ranging above
$628,300 can be expected to have a stock portfolio in six or seven figures.
Interest rates on savings, CD’s and bonds at historically lows and the steady
rise in the Standard and Poors or Dow Jones industrial index, guarantees the
well-to-do were putting lots of financial capital into stocks. Dividend income
during these years provided a secure and steady return even without considering
capital gains, also taxed at the same favorable rate as dividends.
Suppose we figure the tax savings from taxable income of
$700,000 and $100,000 of dividend income by assuming a $4,000,000 portfolio at
2.5 percent dividend and ignores any capital gains. The savings in the first
year are $20,000 but dips below $17,000 in the later years as marginal rates
dropped in the Trump years. Again if we have our hypothetical couple continue
purchasing shares with their annual tax savings each April until 2022 they
would own 9,871 shares of Microsoft stock worth $3,043,486.45.
Suppose though we talk about the very rich and start them
out in 2003 with $2,500,000 in taxable income and $1,500,000 in dividend
income. If all the $2.5 million of taxable income paid tax at the same tax
rates as wages the personal income tax would be $850,206.50, but with
$1,500,000 as dividends the personal income tax drops to $550,206.50, a savings
of $300,000 dollars given the tax rate for dividends drops from 35 percent to
15 percent. In 2003 that $300,000 would have purchased just over 11,961 shares
of Microsoft Corporation stock at $25.08 a share, the price on April 1, 2004.
On April 1, 2021 the 11,961 shares had a value of $3,687,695.91. Again if we
have our hypothetical couple continue purchasing shares with their annual
dividend tax savings each April until 2021 they would own 148,018 shares of
Microsoft stock worth $45,635,408.08.
Dividend
tax savings and the advancing inequality they create have brought to America a
new term: the Teardown. Tear is a verb with synonyms cut, split, lacerate, rip,
sever, cleave, rend, shred or pull apart. In the new United States, the
Teardown has become a noun that defines a house about to be demolished and
replaced in the same space with another house between four and eight times
bigger. In Arlington, Virginia in the 1950’s and 1960’s the Broyhill family
built thousands of 1,400 to 1,800 square foot one story rambler and two story
colonial homes. They were brick and block three bedroom homes with basements
that included necessary plumbing and electricity to finished off, which many
families did. In 2003 these homes would sell in the $350,000 range and by 2020
many of them sell for $1,000,000, but they are fast disappearing.
Drive
or walk through north Arlington and there will be treeless squares of plowed
ground along streets in every neighborhood where the day before there stood a
Broyhill rambler, Broyhill colonial or other 1950’s brick and block home.
Wealthier neighborhoods have become construction zones with mostly Hispanic
crews coming to build 7,500 to 10,000 square foot mansions. They generally have boxy shapes where the
zoning permits an average four-corner height of forty feet. They have finished
space in basements and typically three finished above ground floors with six
and seven bedroom, six, six and a half baths and two or three car garages. Yard
space shrinks but these homes always include elaborate driveways, walkways and
landscaping on what space remains.
Some
of the builders find a Teardown house for a client and some build for
speculation. The replacement mansions sell quickly with little in the way of
bargaining and the new owners soon contract with landscaping and housekeeping
services to keep houses, lawns and gardens in glorious perfection. Other crews
arrive with ladders and lifts to install elaborate holiday lighting or
equipment for party events. These “transition” neighborhoods feature a steady
stream of UPS, FedEx, and Amazon delivery vans with drivers who scurry up the
walkways balancing the days pile of boxes. Lots of cardboard fills recycling
tubs.
Arlington
County government makes it convenient to study this new trend by graciously
putting building and demolition permits in a downloadable text file for
importing into an Excel spreadsheet. The files have application and approval
dates, project address, and a description of the project along with contractor
information. For a file with permit application dates from June 2019 until June
2021 I found 465 records from a filter containing DEMO for demolition and SFD
for single family dwelling. Demolition valuations given in the file were
typically $10 to $15 thousand.
The
buyers of Arlington mansions tend to be empty nest couples moving into their
mansions after the kids are gone. No one will ask them if two people need a six
or seven bedroom house, it’s impolite and probably embarrassing among the
always appearance conscious well to do. No one dares to say these people have
too much money, there is no such thing among the well-to-do of the 21st
century.
In
his 1946 autobiography national journalist and writer William Allen White wrote
that the “decade which climaxed in 1912 was a time of tremendous change in our
national life[.] . . . “The people were
questioning the way every rich man got his money.” . . . “Some way, into the
hearts of the dominant middle class, of this country, had come a sense that
their civilization needed recasting, that their government had fallen into the
hands of self-seekers, that a new relation should be established between the
haves and the have nots[.]” (2)
American
politics no longer supports a constructive discussion of inequality and the
well-to-do work to avoid and evade discussion of class, they prefer to
advertise their class in silence from their mansions. William Allen White would
have no trouble informing these new mansion dwellers they got rich and joined
the upper class exploiting tax favors not usable by the working class. Mr.
White would not regard their conspicuous consumption as a result of work in a
meritocracy. No doubt some of them give a can of corn to the Thanksgiving food
drive and donate to water conservation and the fair housing fund, but dividend
tax breaks debase work and the people who work for a living. They ought to be
smart enough to know the dangers of extreme inequality and take some
responsibility for the country’s bitter and angry divisions and the peril it
brings.
For
the first ten years of Bush tax cuts the wealthy paid a rate of 15 percent on
dividends instead of 35 percent at the highest marginal tax rate. While
President Obama could have attacked the whole idea as an indefensible attack on
working families, he did not. Instead he negotiated an increase of the marginal
tax on dividends to 20 percent for 2013 taxable incomes over $450,000 while
raising the highest tax bracket on taxable income from 35 to 39.6 percent. For
my hypothetical couple with $2.5 million of taxable income and $1.5 million of
dividend and capital gains, their tax savings dropped from $300,000 to
$294,000. Apparently $6,000 of additional taxes on $2.5 million of taxable income
passes for Democratic Party liberalism in 2013.
(1)
All dividend shares and values were, and
can be, verified on spreadsheets
(2)
William Allen White, The Autobiography of William Allen White, (NY: The MacMillan & Co, 1946), p.
427-429
