From an economic and financial perspective, one of the worst things about Washington’s “fiscal cliff” tax deal is that it increases the double taxation of corporate dividends.
Adding to the 35% that dividends are first taxed at the corporate level, the now 20% top personal tax rate on dividends, plus the “Obamacare” dividend surtax of 3.8%, gets a total federal tax of over 50% on dividends (35% + [23.8% x 65%]= 50.5%)—a ridiculous level. Congratulations to the White House and its political allies on creating this investment disincentive.
Increasing double taxation of dividends also increases the tax advantage of debt over equity. Interest on debt of course has zero tax at the corporate level, so at the new top individual ordinary income tax rate of 39.6%, interest has an 11% total tax advantage over dividends. This is exactly what we need—more encouragement for debt and leverage: Didn’t we just try that one?
The right answer would be to eliminate taxation of dividends at the corporate level and then tax them as ordinary income at the personal level. Then interest and dividends would be treated exactly the same, as they should be, and double taxation of dividends eliminated, as it should be. This could be easily accomplished by making cash dividends paid as a tax deduction for corporations. While taking away the onerous double taxation, this would also take away the political argument that the “rich” are paying a favored low tax rate on dividend income.
Maybe next time.