RALEIGH – If you want to know why the U.S. economy remains so weak, with anemic employment trends in the private sector and lots of investors and entrepreneurs staying on the sidelines, consider just this one factor: unless Congress and the Obama administration change course, the effective tax rate on investment income received in the form of dividends will soon rise to 68 percent.
In its September issue, Budget & Tax News reported on a new study by Tax Foundation Senior Fellow Robert Carroll:
“The U.S. integrated dividend tax rate of 68 percent is substantially higher than in other nations,” Carroll said. “The average rate among OECD member nations is about 44 percent, and the average among the larger G-7 economies is about 47 percent…
Corporate profits first are taxed at the individual company level and are subject to an average combined federal and state corporate tax rate of 39.1 percent. For income distributed as a dividend, the second layer of tax is then paid by individual shareholders, which before the enactment of health care reform legislation had a top rate of 17.3 percent.
With the expiration of the 2003 Bush tax cut at the end of 2010, the federal dividend tax rate will rise from 15 percent to 39.6 percent. There will also be a new Medicare tax of 3.8 percent on investment income. The integrated effective dividend tax rate will rise dramatically to 68 percent as a result.
If you had money to invest in creating or building a corporate business that might employ hundreds or thousands of new workers, would you relish the idea of surrendering more than two-thirds of your future earnings to the taxman? Wouldn’t you look for a less costly way to invest your money, such as tax-exempt bonds or offshore securities?
Of course you would. As the Wall Street Journal reported on Saturday, many Americans are already shifting their dollars to, in one investment manager’s words, “avoid the tax freight train coming our way” by “pull[ing] out of equities and mov[ing] into hard assets like gold, silver, and land.”
Investors and entrepreneurs respond to incentives. They heed the messages, explicit or implicit, that they receive from the market and from government officials in a position to do them good or ill.
Right now, the messages they are receiving from the public sector are hostile, intrusive, and punitive:
• The ObamaCare law will raise the cost of hiring and retaining employees (even its supporters are backing away from cost-savings claims) while increasing the federal deficit and thus future federal taxes.
• The Obama administration will continue its efforts to pass a cap-and-trade bill to raise energy prices in an attempt to reduce the growth of greenhouse-gas emissions.
• The Obama administration will continue its efforts to give labor unions greater power to organize private and public workplaces, further driving up the cost of hiring and retaining employees.
To these anti-recovery, anti-growth messages can now be added the manifest lack of concern by administration officials and congressional leaders about the prospect of a 68 percent marginal tax rate on dividends. No wonder entrepreneurial activity is subdued and investment capital is flowing elsewhere.
More than even before, policymakers need to rethink our idiotic, counterproductive approach to income taxation. Both North Carolina and the federal government should reform their tax codes to apply a single marginal tax rate, once and only once, to all consumed income. Invested income wouldn’t be taxed in the short run, because the return on that investment would be taxed when the income is consumed.
Tax reform isn’t simply a theoretical exercise. The current system costs Americans jobs, incomes, and economic opportunities. Reform would boost all three.
Hood is president of the John Locke Foundation.