Corporate Dividend and Capital Gains Taxation: A comparison of the United States to other developed nations
Without action by Congress, the tax rates on dividends and capital gains are set to increase significantly on January 1, 2013. Even with the expiring tax rate reductions enacted in 2003, the United States currently imposes among the highest integrated tax rates on dividends and capital gains on corporate profits among developed nations. This study compares the tax rates on dividends and capital gains in the United States to those imposed by other developed countries and discusses the policy concerns that have caused other countries to impose lower tax rates on capital gains and dividends.
In 2003, the United States followed the standard practice of most other developed nations by providing some relief from the double tax on corporate profits (which arises from subjecting corporate income to tax at both the corporate and shareholder levels) by lowering the tax rates on dividends and capital gains. With the sunset of the 2001/2003 tax cuts at the end of 2012 these tax rates will rise significantly:
- The top federal income tax rate on dividends will increase from its current level of 15 percent to 39.6 percent in 2013.
- The top federal income tax rate on long-term capital gains will rise from its current level of 15 percent to 20 percent in 2013 (and from zero percent to 10 percent for lower income taxpayers).
- For many taxpayers, both dividends and capital gains will also become subject to the additional 3.8 percent Medicare tax in 2013 due to changes under the Affordable Care Act of 2010.
Taking into account both the corporate and investor level taxes on corporate profits and state level taxes, the United States has among the highest integrated tax rates among developed countries and these integrated tax rates will rise sharply in 2013:
- The current top US integrated dividend tax rate of 50.8 percent will rise to 68.6 percent in 2013, significantly higher than in all other OECD and BRIC countries.
- The current top US integrated capital gains tax rate of 50.8 percent will rise to 56.7 percent in 2013, the second highest among OECD and BRIC countries.
Most developed countries provide relief from the double tax on corporate profits because it distorts important economic decisions that waste economic resources and adversely affect economic performance:
- It discourages capital investment, particularly in the corporate sector, reducing capital formation and, ultimately, living standards.
- It favors debt over equity financing, which may result in greater reliance on debt financing and leave certain sectors and companies more at risk during periods of economic weakness.
A tax policy that discourages the payment of dividends can impact corporate governance as investors’ decisions about how to allocate capital are disrupted by the absence of signals dividend payments would normally provide. With the current policy debate on tax reform intensifying and the sunset of the 2001/2003 tax cuts at the end of 2012, Congress and the Administration will need to consider whether the tax rates on dividends and long-term capital gains should remain at their current levels or rise.
Recent tax and entitlement reform plans would also change the taxation of dividends and capital gains, as well as the corporate level tax, and in most cases leave the United States with integrated dividend and capital gains tax rates that are among the highest among developed nations. As the tax reform debate progresses, it is important to consider carefully the adverse economic consequences of high tax rates on dividends and capital gains.