The Bush tax cuts aren’t just limited to personal income: They also lowered rates on income from stocks, bonds, and other investments that are held by a fairly broad swath of Americans. A recent report from Ernst & Young reveals that a fairly diverse group — including many seniors and middle-class investors — makes money from dividends, one of the most popular kinds of investments. But the investment profit overwhelmingly accrues to the very wealthiest investors, who make the most money and thus benefit the most from low dividend tax rates.
Of the 25.4 million households that had qualified dividend income, 68 percent had incomes less than $100,000, and 40 percent had incomes less than $50,000, according to the study, which was commissioned by the Edison Electric Institute, a lobbying organization for publicly-traded electric companies. Nearly a third of the entire group were over the age of 65:
That could help explain why there’s a split even among Democrats on the future of the dividend tax rate, which was lowered to 15 percent under the Bush tax cuts scheduled to expire at the end of 2012. Obama wants dividend income be taxed as ordinary income in 2013, which means that the top rate will be as high as 39.6 percent. Senate Democrats, however, want to raise the rate only to 20 percent.
But while many ordinary Americans profit from dividend income, the benefits go overwhelmingly to the wealthiest Americans. On average, the average American with investment income — which includes both dividends and capital gains — will have $26,054 in taxable income in 2012. But middle-class Americans profit considerably less: Those with personal incomes between $40,000 and $50,000 will earn an average of $2,325 through these investments, taxed at $174 under the Bush rates, according to the Tax Policy Center.
By contrast, households with personal income between $200,000 and $500,000 will have gained $27,696 in investment income, and households with personal incomes above $1 million will gain nearly the same amount—$961,505—in investment income.
That’s why the richest Americans benefit so disproportionately from tax cuts on capital gains and dividends. Those with incomes over $200,000 pay more than 93 percent of the taxes on investment income, because they earn so much more on them.
Richard McMahon, a vice president at EEI, argues that changes in the tax rate on such investments could have a “more immediate and striking effect” on lower-income Americans than those at the top end of the spectrum. He points out, for instance, that many who benefit from dividend investments are retired seniors, who are generally more dependent on investments as a primary source of income than working Americans.
Finally, McMahon points out that raising taxes more on dividends than other kinds of investments — as Obama’s 2013 budget proposes to do — could end up encouraging more Americans to divest in more mature, dividend-bearing industries in favor of more volatile growth stocks that are bought and sold more quickly for capital gains. And he believes that Senate Democrats accommodated for this by proposing to tax both capital gains and dividends at 20 percent. “The Senate did recognize the issue of parity,” he says. “It does not make sense to favor one or the other.”
It’s unclear whether Obama will insist on letting the tax break on dividends expire entirely for everyone. Though he proposed to do so in his 2013 budget, he didn’t address the issue during his recent call to let the Bush tax cuts expire on individual income over $250,000. If he does, however, both Republicans who want a permanent tax cut and Senate Democrats who support a more moderate one are likely to argue that the tax hike will hurt ordinary Americans along with the 1 percent.