The Edison Electric Institute (EEI) on Thursday released a study analyzing the age, income level and investment goals of investors in dividend stocks, concluding that any rate increase could cause a major sell-off and drain value from the normally stable companies known for high yields rather than volatility.
The current tax framework caps the rates for qualified-dividend income at 15%, but it will expire on Dec. 31 without action by Congress and the president.
President Obama is calling for an extension of the cuts for all but the wealthiest Americans, or those earning $250,000 or more annually. Republicans in Congress have been united in their calls for extending all of the cuts, inviting a replay of the showdown that occurred the last time the tax rates came up for renewal in 2010.
If a standoff looms, threatening to send dividend and capital gains rates higher, Jeff Sica, president and CEO of Sica Wealth Management, anticipates a sell-off before the end of the year.
"Taxation of dividends and higher capital gains tax will make individuals more likely to sell before January if there is an anticipation of higher taxes," Sica wrote in an email. "If tax cuts expire, individuals will invest less since it will cost them more in capital gains tax."
For the highest bracket, the dividend tax rate would spike to 39.6% percent, a prospect that EEI projected would prompt wealthy investors to move money out of dividend-paying stocks in favor of alternative investments with a higher rate of return. (The authors of the report noted that with the 3.8% Medicare surcharge on investment income included in Obama's health care law, the effective rate would be as high as 43.4%.)
The ripple effect, EEI argued, would see a flight of capital from utilities and other dividend stocks, driving down share prices and harming investors of all income levels. Alternatively, the group suggested that some influential investors could pressure the firms to find another path to deliver value to shareholders, but in either scenario, the high-yield, low-risk profile of the typical dividend stock would be in jeopardy.
The study, conducted by Ernst & Young on behalf of EEI, offered a wealth of data points about the tax picture surrounding qualified dividends based on 2009 IRS records, but it does not speculate on the impact that a change in the tax rates would have on investors or the dividend companies they count on for consistent returns.
EEI offered its own analysis.
"This study illustrates the concentration of seniors and middle-income taxpayers relying on dividends," Jim McCrery, manager of the Alliance for Savings and Investment, an advocacy group championing permanent low rates for dividend and capital gains taxes, said in a news release the utility association released accompanying the report. "If the top tax rate is nearly tripled -- even if limited to upper-income taxpayers -- it is likely that companies would reduce their dividend payouts, which would hurt direct and indirect investors at every income level."
For EEI, an association of shareholder-owned utilities that represents some 70% of the U.S. electrical power industry, any policy activity that sways dividend rates and returns is of obvious interest. Appealing to investors with little appetite for volatility or risk, shareholder-owned utilities paid out 58% of their net income in dividends in 2011, according to EEI data.
The authors of the report also credited low dividend tax rates for driving appreciation in utility stocks over the past eight-and-a-half years, which in turn has afforded the utilities cheaper access to capital for infrastructure and capacity upgrades.
Ernst & Young's scouring of IRS records tallied 140.5 million tax returns filed in 2009. Of those, 25.4 million, or 18%, reported qualified dividends.
In its analysis of the study, EEI stressed the impact that allowing the dividend tax cuts to slide -- even if only for the top earners -- would have on older and lower-income investors, emphasizing the extent to which those segments are invested in dividend stocks.
