Two Steps Back: Capital Gains and Dividends Taxes will Revert to Pre-2003 Rates

This content is provided by the Americans for Tax Reform Foundation.

Current Law

Title III of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) enacted favorable tax rates on dividends and capital gains. These low rates apply today: qualified dividends and long-term capital gains are taxed at a maximum of 15%.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIRPA) eliminated the capital gains and dividends taxes entirely for investors in the 10% and 15% income tax brackets.

Expiration

These provisions will vanish January 1, 2013. Rates will then revert to their retrograde, pre-2003 levels.

The top rate on long-term capital gains will rise by one-third to 20%. The 10% tax on capital gains for lower- and middle-income investors will also make an unwelcome return.

The dividends tax will increase even more to match the investor’s individual income tax rate.

ATRF Analysis

This slew of tax increases punishes individuals who provide vital capital to private firms by double-taxing their investment income at prohibitive rates.

The most harmful of the three is the change to the dividends tax, which raises rates to match those of the individual income tax. Income tax rates are scheduled to rise the same day that this change takes place, which means the top marginal rate for both will skyrocket to 39.6%. A looming 3.8% Obamacare surtax on investment income will force the effective rate on dividends as high as 43.4%, almost tripling its pre-Taxmageddon rate.

The capital gains zero-rate applies to individual filers with taxable income under $34,500 and joint filers with taxable income under $69,000, which is the majority of taxpayers. The unwelcome return of the 10% rate, then, will impose a burden on a vulnerable class of taxpayers. The 10% tax increase will hit the retirement savings of countless middle-income Americans who invest in mutual funds, at a time when they can least afford it.

The one-third increase in the top capital gains rate will have deleterious effects of its own by creating a disincentive to invest for individuals who fall in the 28% and above income tax bracket. The 3.8% Obamacare surtax, which applies to capital gains as well as dividends, will only strengthen this disincentive.

If we want to unleash the investment market and provide much-needed capital for businesses buffeted by harsh economic conditions, the current capital gains and dividends rates cannot be allowed to expire. Better yet, this opportunity should be utilized to eliminate the taxes entirely, so that government can no longer double-dip out of the taxpayers’ wallet.

10-Year Cost to Taxpayers

U.S. Department of the Treasury: $403.4 billion

This content is provided by the Americans for Tax Reform Foundation. To donate to ATRF, click here.