Want To Argue About Capital Gains And Dividend Tax Rates? Who Doesn't?

by: YCharts

by Dee Gill

It's widely acceptable tax policy in the U.S., that the person who collects $60,000 by investing in Apple (NASDAQ:AAPL) stock gets to keep more of that money than the person who earns $60,000 trucking groceries to Safeway. There are lots of logical reasons given for this discrepancy, but it's getting harder to find evidence to back them up.

This is important to most investors because Congress will need some reasons to prevent investor taxes from going up at the end of year. Those notorious and wide ranging automatic tax hikes - the so-called "fiscal cliff" triggers -- include moving the maximum rate on capital gains from 15% to 20% and dividend taxes from 15% to 39.6%. Oh sure, some politicians vow to prevent those particular rate increases, and everyone agrees that lower taxes all around would be ideal. But we all know how naïve it is to equate promises with reality when Congressional action is necessary. In the days and nights of budget negotiations to come, investor money will look awfully tempting to both sides of a revenue-challenged, budget-balancing government.

^INX Chart

^INX data by YCharts

Historically, the best argument against raising investor taxes has been the assumption that doing so would cause investors to invest less, which would lead to less capital for businesses to build and to employ, and ultimately, to lower economic growth. But the latest attempts to prove out this cause-and-effect relationship aren't going well for investor advocates.

Earlier this year, economist Len Burman studied 45 years of capital gains tax rates and economic growth and found no correlation, ever, between the two, even when giving growth a five-year lag time. The Congressional Research Service, a non-partisan group under the Library of Congress, came to a similar conclusion in a different study released in September.

Burman has famously worked with liberals and conservatives alike for decades, and he presented his data in September to a joint Congressional committee assigned to the debate. While other economists there requested his data, none have yet come forward with evidence that lower capital gains taxes boost economies. Perhaps they're holding fire until the real debate gets underway post election. But it can't help the low-tax case that economic growth was strong in the higher-tax Clinton years and did this in the post-Bush-era tax cuts:

US Real GDP Growth Chart

US Real GDP Growth data by YCharts

The case for saving dividends from tax hikes looks a little weak too, as noted here. Dividends can make easy tax targets because unlike capital gains, which can come from non-market investments like the sale of a family business, it's hard to argue that one put a lot of sweat equity into building dividend income. Senior citizens are the best defense again higher dividend taxes because they depend more heavily on dividend stocks for income and vote more often. But the latest research indicates that tax rate hikes on dividends would not likely make those stocks less attractive to income seekers, seniors or not.

Dividend recipients, of course, have enjoyed the low tax rates. S&P's Howard Silverblatt estimates that investors have pocketed an extra $358 billion since the rate was lowered in 2003, as YCharts' Carla Fried reported here recently.

Dividend stocks -- think Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), General Mills (NYSE:GIS), Intel (NASDAQ:INTC), Microsoft (NASDAQ:MSFT) -- move with the market, move on each company's results and on perceived prospects. Will they move on a change on tax policy? We'll have to see.

JNJ Chart

JNJ data by YCharts

JNJ Dividend Chart

JNJ Dividend data by YCharts

In reality, the economy, like the markets, is vulnerable to so many factors that proving out the importance of any one of them, like tax rates, is all but impossible. A pre-VP candidate Paul Ryan gave the best analogy in September when faced with an historic tax rate/economic growth chart that made no sense as proof for a correlating relationship. "Just as the Keynesians say the economy would have been worse without the stimulus . . . . the flip side is true from our perspective," Ryan told the New York Times. In other words, he contends, that nasty recession would have been worse without those Bush tax cuts. Just try and prove that one.

All of those arguments are just philosophical asides unless lower investor tax rates actual cause people to invest more. But there's less money in the S&P 500 today and fewer investors in equities generally than when rates were higher in the early 2000s. The portion of Americans invested in the stock market was about 53% in April, down from about 65% in 2007. That's the lowest level since Gallup started asking in 1998.

So how would today's investors react to sharply higher investment taxes? They'd invest. Because no one thinks it's easier to drive a truck.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.