Busting Two Big Myths About Dividend Tax Hikes (Part 1)
Update: Part 2 of this article can be found here.
I’ve already explained why the current hullabaloo over the potential – and severe – increase to dividend tax rates is unwarranted. (See here and here.) And it’s simply because tax increases won’t win the White House. So dividend tax rates are not going to skyrocket.
For argument’s sake, though, let’s assume they do increase sharply in 2013. Under such a scenario, countless pundits are warning of disastrous repercussions. Two “imminent” repercussions in particular seem to be really striking fear in the hearts of dividend investors.
The first suggests the escalation in dividend tax rates to 43.4% for America’s highest earners is going to precipitate a mass exodus from dividend-paying stocks. As a result, dividend stock prices are going to collapse. And we’ll all suffer.
The rationale behind this argument is that these Americans rake in a majority of the dividends paid out each year. So it’s only natural for them to bail on dividend stocks in favor of more tax-efficient investments.
Sounds reasonable. But it’s total hogwash! And today I’m going to prove it.
Then, in Part 2 – which we’ll publish next Thursday – I’ll show you why the second most feared repercussion of a dividend tax hike is similarly bogus.
I’m talking about the notion that companies are going to stop paying dividends and/or stop increasing dividends in favor of share repurchases because it will be the most tax-efficient way to return cash to shareholders.
Consider this our version of the Discovery Channel’s “MythBusters” show. Instead of science, we’re taking on conventional wisdom in finance. And it starts right now…
Stop Spreading the Untrue News…
Winston Churchill once said, “A lie gets halfway around the world before the truth has a chance to get its pants on.” That’s certainly apt in this instance.
You see, claiming that America’s highest earners receive the lion’s share of dividend payments sounds like a logical assumption. That’s probably why it’s spread so quickly. But it’s not true. Not if we look at the hard data.
Based on individual tax returns, Americans earning more than $200,000 per year actually only took home 46.6% of dividend payments made to individuals in 2010.
If we go back in time, we notice an interesting trend, too.
Earlier in the decade, the highest earners did receive the majority of dividend payments. In 2007, they collected 63% of dividend payments to individuals. More recently, though, their cut has actually been decreasing, while the “cut” for Americans making less than $200,000 per year is actually increasing.
In other words, it’s “The 99%” that benefit the most from dividends right now. They wield the most influence over dividend stocks, not “The 1%.”
Naysayers will be quick to point out that the 2011 tax return data could reverse this trend. Fair enough. Even still, America’s highest earners wouldn’t wield undue influence over dividend stock prices. And here’s why…
Not all dividends are paid to individuals. Many are paid to various types of corporations or non-profits, which aren’t concerned with individual tax rates.
Turns out, if we look at the payments to individuals from this bigger perspective, the “cut” for America’s top earners is much smaller.
Americans earning over $200,000 per year received 20.1% of total dividend payments in 2010. Meanwhile, Americans earning less than $200,000 per year received 23%.
While 20% is a meaningful amount, it’s not the majority like the headlines suggest. Nor is it enough to collapse stock prices if they suddenly bail. Too many other interested parties own the same stocks, who would likely scoop up shares on any noticeable dips.
If you’re still not convinced, chew on this: Despite numerous changes to tax rates since the early 1990s, the number of individuals reporting dividend income on their tax returns has remained fairly steady. Both in absolute terms and as a percentage of the total population.
Interestingly enough – as you’ll notice in the chart – the last time dividend tax rates rose, the number of Americans investing in dividend-paying stocks made a noticeable move higher, not lower. That runs contrary to what so many pundits are suggesting today. So unless “it’s going to be different this time,” this serves as another reminder to always dig beneath the headlines for the truth, like we did with Ritchie Bros. (NYSE: RBA or Toronto: RBA.TO).
Bottom line: Forget “plausible” or “confirmed.” The myth that America’s top earners own the majority of dividend stocks and will bail – sending prices dramatically lower if dividend tax rates spike – is busted!
Remember, in next Thursday’s article, I’ll dispel the myth that corporations are going to suddenly suspend or stop increasing dividends in favor of share repurchases.
Stay tuned and safe investing,