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The Wall Street Journal pointed out this morning that President Obama’s 2013 budget proposal would triple the tax rate on corporate dividends. Including an investment tax surcharge and a planned phasing out of deductions and exemptions, President Obama’s new dividend tax rate would be 44.8% in 2013, or three times the current rate of 15%.
That’s not good news for dividend investors. Dividend stocks were some of the best performing stocks in the market in 2011 as investors fled to safe havens in the midst of one of the more volatile years for the financial markets in recent memory. As more investors flocked to dividend-paying stocks, more companies upped their dividends. S&P stocks paid a combined $240.6 billion in dividends last year – the most since 2008. Early projections have the number climbing to $252 billion this year.
Furthermore, dividend-paying stocks were among the best performers in the market. In a year when the S&P was basically flat, the average return of S&P stocks that paid dividends was 1.5% last year. Non-payers, meanwhile, saw their stocks decline an average of 7.5%.
But dividend stocks could come to a screeching halt in 2013 if Obama’s new tax measures are implemented. Since companies already pay sizable corporate tax rates on their annual profits, throwing another 45% in dividend taxes on top of that might convince many of them to reduce their yields, or perhaps drop their dividends altogether.
The total tax on corporate earnings passed through as dividends could be as high as 64%, The Wall Street Journal estimates.
“Historical experience indicates that corporate dividend payouts are highly sensitive to the dividend tax,” the Journal notes. “Dividends fell out of favor in the 1990s when the dividend tax rate was roughly twice the rate of capital gains.
“When the rate fell to 15% on January 1, 2003, dividends reported on tax returns nearly doubled to $196 billion from $103 billion the year before the tax cut.”
The rate is still at 15%. But if this new tax rate passes, we may start seeing investors sell off their dividend stocks toward the end of this year – something that seems unthinkable now in a time when dividend stocks are red-hot.