Retirees Beware: Don't Worry About the British -- 2013 is Coming

The easy money policy of the federal reserve and the 15 percent tax rate on qualified dividends have encouraged retirees to reorient their nest eggs away from certificates of deposit, Treasuries, and money market funds to dividend-paying stocks and mutual funds. According to the Internal Revenue Service, 43 percent of taxpayers age 65 or older reported qualified dividend income amounting to nearly half of the qualified dividend income reported by all taxpayers. By contrast, 46 percent of taxpayers age 65 or older reported net capital gains amounting to 30.5 percent of the net capital gains reported by all taxpayers. But 2013 is coming and, unless Congress extends the current rates or reaches an agreement on tax reform, dividends will be taxed as ordinary income at a marginal rate as high as 39.6 percent. The 15 percent tax on most net long-term capital gains is also going to rise by a third to 20 percent. For those whose modified adjusted gross income exceeds a certain amount, there will be a 3.8 percent medicare tax on their net capital gain income and dividend income (and interest income as well as other investment income), bring the highest marginal rate to 43.4 percent. In this article, we propose a compromise for both dividends and capital gains. Instead of taxing dividends as ordinary income and most long-term capital gains at a flat 20 percent rate, our compromise would apply a progressive tax rate schedule to both. We would aggregate all net capital gains and qualified dividends into a single figure, which for convenience we refer to as aggregated dividends and net capital gains or ADCG for short. We don’t propose an exact progressive rate schedule for ADCG. Congress would decide that. A possible schedule would reach the 30 percent marginal rate on $1,000,000 of ADCG and above, and might take the following form: 15 percent on the first $250,000, 20 percent on the next $250,000, 25 percent on the next $500,000, and 30 percent on $1,000,000 and above. The proposed compromise would provide a higher tax rate on the ADCG of the very wealthy while applying a 15 percent rate for those whose ADCG is more modest. We believe that this simple compromise would satisfy those who want the super-rich to pay higher taxes and also satisfy a quite different constituency: retirees who worked for a living, saved as much of their after-tax dollars as they could, and invested their nest eggs in dividend-paying stocks or mutual funds. Our proposal for a progressive-rate system for ADCG, ranging from 15 percent to 30 percent, appears to us to be a sensible compromise. We hope that it appears sensible to Congress, sensible enough to make the compromise permanent, so that small investors who are saving for retirement and those who have already retired will not constantly be in doubt about the future taxation of their nest eggs.