I’ve always loved the appeal of dividends. Investors are paid along the way for the risks they take by owning shares of a company. Unlike capital gains, which may disappear, real cash shows up.
Since the financial crisis, dividends have become more important than ever.
Today’s interest rates provide almost zero income to anyone in a fixed-rate investment like a CD or bond.
These low rates have forced investors out of Treasurys and into riskier assets like stocks, and all for a modest 2 percent to 3 percent average annual yield. This payout comes at a steep price, as bondholders get paid first in the event of bankruptcy. Stock owners may be left with nothing after the bonds have been paid.
When it comes to risk, dividend stocks are an imperfect substitute for bonds. Over time, the increased volatility of stocks will be offset by higher returns. But that won’t help retirees (and near-retirees), who need a consistent and safe source of income now.
We’ve all been burned by the insultingly low returns of bonds. Now we’re about to be burned for reaping a modest cash payout for taking the risk of owning stock. That’s because President Barack Obama wants to raise the tax rate on dividends from the current 15 percent to a maximum of 39.6 percent, in line with the personal income tax rate. This will, the president assures us, help reduce the deficit.
Such an act will undo one of the economic bright spots of Obama’s predecessor. The dividend tax cut in 2003 unleashed a slew of dividend increases by companies. The Wall Street Journal reported that the cut led to dividend payments surging from $103 billion to $337 billion by 2006.
In other words, when the government cut itself a smaller slice of the pie, it ended up tripling in just three years. Everybody won, as investors got paid more, and the government received more dividend taxes.
Why? Because companies pay attention to dividend tax rates. It relies on one simple aspect of human nature: incentives. An increase in the dividend tax rate will cause some companies to re-consider sending it out to shareholders. Instead, they’ll focus on reinvesting that capital for more growth. Tax receipts from dividends will decline—and the government deficit will worsen as a result.
This is yet another front on the war on capitalism. Dependency on government programs is rising. Incentives to produce are disappearing. Millions have disappeared from the workforce to make the labor market appear to be in recovery. Gas prices have nearly doubled in three years, yet government statistics show only modest inflation.
Yet, somehow, we’ll get past this. We survived the last Great Depression. We’ll survive this one too. But it won’t be easy.
There remain some strategies to protect your investment income. Investors can—and should—fund tax-deferred retirement vehicles like IRAs, Roth IRAs, and 401(k) plans. For IRAs, individuals can still make contributions for the 2011 tax year through April 15.
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