In our last article, "The Rich Will Not Abandon Dividends," a battle of opinions about who makes how much and who pays how much is evolving in the comments stream. That sort of argument, which comes more from bias than basis, is not backed by fact on either side - just opinions, planted by political sound bites from both sides of the argument.
Another recent article "2013 Dividend Tax Impact" discussed the return impact of a couple of plausible 2013 tax regimes, the comment stream of which made the need for further discussion with "The Rich Will Not Abandon Dividends."
We'd like to conclude our discussion of the 2013 tax regime, whatever it may turn out to be, with just plain cold hard facts, that might be the basis of arguments about policy that are arbitrated by information more than opinion or ideology.
Whatever is ultimately decided will move markets one way or the other. Right now markets are treading water, with some strong daily moves up and down, when politicians express optimism or pessimism about a deal, even though the nature of the deal is totally unknown.
We as citizens need more in the way of comprehensive, objective data to know what is really going on; and as investors need better contextual information to help us form rational guesses about what may or may not happen.
Most people who think about the deficit problem know that we can't solve it on the backs of the rich alone. Whether you feel the rich are good or bad, fair or unfair, greedy or reasonable, our overall structural government spending, which is unlikely to be unwound any time soon, is such that broader tax participation will be required. Let's look at some data in this article that supports that view.
The budget and tax problems in the United States and Europe and Japan are probably an argument for more equity exposure to emerging economies (directly or indirectly) in the long-term (e.g. EEM versus SPY or EFA); a greater shift from taxable bonds to tax-exempt bonds, if they survive the tax code changes (e.g. MUB versus LQD); and greater appeal of partially tax sheltered investments, such as equity REITs and pipeline MLPs, assuming they don't get whacked in the tax code changes (e.g. VNQ or AMLP).
Capital Gains Not the Answer For Many Retirees
Capital gains will become theoretically more attractive than dividends, but the predictability of capital gains is far less than dividend cash flow, which is an important negative for retirees attempting to create a fairly predictable and growing income stream. Regular withdrawals from highly volatile assets is basically suicidal.
Bond interest does not grow, and rates are miserably low, with real prospects for capital losses when rates eventually rise.
Dividend stocks still have their role in certain types of portfolios for which there are scant income and growth alternatives.
Data Versus Sound Bites
Wanting more facts in context, and wanting less in the way of Democrat and Republican propaganda talking points, we have analyzed the 2009 tax statistics from the IRS (last published data available) - download full data from the IRS.
Here are 2009 facts that we think you will find useful to know from that IRS data (also shown in the table image below):
- of the 140.5 million tax filings, 41.7% have no tax due
- 1/3 of filers reported less than $20,000 AGI
- 2/3 of filers reported less than $50,000 AGI
- 97% of filers reported less than $200,000 AGI
- 99.5% of filers reported less than $500,000 AGI
The group that paid the most taxes (24.5% of all taxes) was in the $100,000 to less than $200,000 bracket, and generated 26.9% of taxable income, but consists of only 9.6% of filers. Their average tax rate was 16.25%. They are where the most money was earned and from which the most tax revenue was derived.
The second largest tax payments came from the $200,000 to less than $500,000 taxable income bracket. However, they earned only 14.8% of total taxable income. They paid 20.4% of total taxes, and had an average tax rate of 24.5%.
There were three important brackets on the periphery of the $100,000 to less than $500,000 taxable income range. They were:
- the $50,000 to less than $75,000 tier (who generated 5.1% of all taxable income, and paid 9% of all taxes, at an average tax rate of 10.8%)
- the $75.000 to less than $100,000 tier (who generated 5.7% of all taxable income, and paid 9.3% of all taxes, at an average tax rate of 12.0%)
- the $500,000 to less than $1,000,000 tier (who earned 5.8% of all taxable income, and paid 9.3% of all taxes, at an average tax rate of 28.7%)
The real workhorses for the IRS are the 16.7 million tax filers (11.9% of total filers) who reported between $100,000 and $500,000, having paid 44.9% of all taxes, at average federal income tax rates from about 16% to about 25%
The Fiscal Cliff And New Tax Rates Not Sufficient
We believe that it is fairly widely understood by those with a head for numbers and a modicum of curiosity that there is not enough tax potential among the upper income groups to solve the federal budget problem.
The budgeted 2013 federal deficit is about $900 billion. How much of that would have been covered by the tax increase to 39.6% on top earners?
Unfortunately, the IRS data breaks at $200,000 then $500,000, so we have to bracket the numbers. Here they are, based on 2009 data:
- The $500K+ filers reported $907 billion in AGI, and paid $258 billion in taxes at an average rate of 28.44%. At 39.6%, they would have paid an additional $101.2 billion (about 11%) of the budgeted 2013 deficit.
- The $200K+ filers reported $1.626 trillion in AGI, and paid $434.3 billion in taxes at an average rate of 27.61%. At 39.6%, they would have paid an additional $209.5 billion (about 23%) of the budgeted 2013 deficit. Remember a substantial number of those in this category are not scheduled to be taxed at the 39.6% rate.
Based on 2009 data, the potential to close the federal budget deficit with the tax increase to 39.6% on those in the $250,000 couples/ $200,000 singles categories is broadly in the 11% to less than 23% range.
Not expecting Congress to get the other 89% to 77% from expenditure changes, we face broader participation in tax increases, and extended periods of deficit.
Alan Greenspan says we can run a perpetual 3% of GDP budget deficit. Maybe so, maybe not; but the political talk about fixing problems with taxes as proposed is in the realm of the unreal.
We certainly don't want to pay more taxes, and are definitely in the smaller government camp, but that counts for little. Taxes now or later are destined to go higher for more than just the rich.
Disclosure: QVM has no positions in any mentioned security as of the creation date of this article (December 8, 2012). We certify that except as cited herein, this is our work product. We received no compensation or other inducement from any party to produce this article, but are compensated retroactively by Seeking Alpha based on readership of this specific article.
General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.