The Dividend Divide
As originally appearing in The Boston Business Journal

James T. Brett is the president and CEO of The New England Council

As members of the 111th Congress return to Washington following the historic 2010 midterm elections for their final lame-duck session, surely the economy is foremost on their minds. Few question that the economic downturn the United States has experienced over the past two years is the reason there will be so many new faces on Capitol Hill come January.

In New England, we’ve seen an uneven recovery from the recession, but there have been signs of improvement, as unemployment rates have very slowly declined and certain sectors have seen some growth. Investment in our region’s businesses is key to continued growth. However, if Congress does not act quickly, our fragile regional — and national — economic recovery faces a major disruption on Jan. 1, 2011, when the current capital gains and dividend tax rates are set to expire. Unless Congress takes action to extend the current rates, capital gains tax rates will increase from 15 percent to 20 percent, and the maximum tax rate for qualified dividends could nearly triple from 15 percent to 39.6 percent.

There is a significant economic benefit in maintaining current qualified dividend and capital gains tax rates, as both have a profound impact on investment behavior. Favorable tax rates encourage investment in companies that in turn grow, create jobs and drive economic expansion. Increasing those taxes could drive investors to the sidelines again, when they are just beginning to cautiously return to the market. Allowing tax rates to spike at the end of this year would severely hinder the economic improvements so painfully gained in the last 18 months. Of course, continuity and predictability in tax treatment helps facilitate economic growth regardless of the state of the economy. But to change tax treatment just at the point when the economic recovery has begun to take root simply does not make sense.

To exacerbate the problem posed by the expiring dividend and capital gains tax rates, if no congressional action is taken, dividends would be taxed at a substantially higher tax rate than capital gains, in effect penalizing companies that pay qualified dividends to shareholders. Currently, investors pay the same tax rate for income derived from long-term capital gains and qualified dividends. Parity between the two rates ensures that companies are making the best business decisions about whether to retain profits or pay out dividends, rather than making these decisions based on tax considerations. In addition to extending the current tax rates, Congress should enact legislation to continue this equity in tax treatment between capital gains and dividends.

It would be unfortunate if the expiration of the current capital gains and dividend tax rates were to slip through the cracks between the 111th and 112th sessions of Congress. It will be far less disruptive to deal with this tax issue proactively in 2010, and it would ensure that we have a tax climate in this country that encourages investment that will lead to job creation and spur economic recovery.

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