Jeanne Sahadi
NEW YORK (CNNMoney) – Eighteen CEOs urged Treasury Secretary Tim Geithner this week to rethink the Obama administration’s proposal to raise the 15% tax rate on dividends and capital gains for high-income households.
A hike in investment tax rates “could spark a new wave of volatility in our financial markets and give a competitive edge to overseas corporations at a time when we need capital formation here in America to create jobs and expand our economy,” the CEOs said in an opinion article for Politico.
Among those signing the letter were the leaders of Duke Energy, Dominion Resources, United Parcel Service, Windstream and Verizon.
President Obama wants Congress to make permanent the 15% investment tax rate for everyone except those making more than $200,000 ($250,000 if married). The president wants to raise the capital gains rate to 20% for high-income taxpayers and to tax their dividends at their top ordinary income tax rate, which would be either 36% or 39.6% under his budget.
The Treasury Department declined to comment on the CEOs’ letter. But in documents explaining Obama’s 2013 budget proposals, Treasury offered two key reasons for the administration’s proposals: to help reduce the deficit and make the tax system more progressive.
The effects on the economy and the stock market of an investment tax hike will be a matter of debate since several factors come into play.
For example, stock prices could fall as investors recalibrate their expectations for after-tax returns. And to the extent that dividend income is relied upon to live — say by retirees with individual holdings — a higher tax rate could meaningfully reduce their after-tax income.
On the other hand, many investors have money in tax-deferred vehicles such as 401(k)s and IRAs. So an investment tax hike wouldn’t directly affect their holdings.
And while anticipation of a tax hike can cause churn in the stock market as investors seek to capture gains at the lower rate, investors over time typically don’t base their investment decisions solely or primarily on taxes.
Just what will happen to investment tax rates in 2013 is and will likely remain a huge question mark until after Election Day, and very possibly into the first quarter of next year.
There is little indication that Democrats and Republicans will be able to easily broker a deal on what to do about the so-called fiscal cliff — a host of expiring policies that would result in $7 trillion worth of tax increases and spending cuts over the next decade.
If Congress does nothing by Dec. 31, the Bush tax cuts expire and investment tax rates go up for everyone, regardless of income. Capital gains would be taxed at 20% (18% if an investment is held more than five years) and dividends would be taxed as ordinary income.
In addition, assuming the Supreme Court doesn’t overturn the health reform law, a new 3.8% Medicare surtax on investment income will go into effect for high-income tax payers in 2013. That surtax would apply to capital gains and dividends.
So, a high-income taxpayer could face a dividend tax rate as high as 43.4% (39.6 + 3.8). But in reality, those with incomes topping $200,000 ($250,000 for couples) won’t necessarily owe 3.8% on all of their investment income.(Here’s why.)
Of course, Congress may well decide to retain the 15% tax rate on capital gains and dividends, in which case high-income households would end up paying up to 18.8% on each once the Medicare surtax is thrown in.
Or if lawmakers opt for Obama’s proposal, the maximum rate for high-income households would go to 23.8% on gains and 43.4% on dividends.
A Mitt Romney win in the presidential election may influence lawmakers’ decision. He wants to eliminate the tax on capital gains and dividends altogether on income up to $200,000. And he has said he would repeal the Medicare surtax.
Congress could also do something entirely different, since investment income likely won’t be treated in isolation, given the logjam of fiscal issues that have to be addressed.
All in all, it’s not a given investors will have clarity before Dec. 31. If lawmakers fail to reach an accord by then, they may do so sometime in the first half of next year, making any changes retroactive to Jan. 1.
But the likelihood that any deal will be permanent is … well, dream on. Changes this or the next Congress agree to will be subject to revision, especially as lawmakers move closer to overhauling the tax code and coming up with a long-term deficit-reduction plan.
