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No Dividend Cliff in Sight
By Meggan Walsh
January 11, 2013

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Washington’s last-minute agreement on a fiscal cliff deal concentrated primarily on tax policy — including a higher dividend tax rate for high-income investors. History has shown, however, that the tax treatment of dividends has not hindered the relative outperformance of dividend-paying stocks over the long term.


The fiscal cliff and dividend taxes

In 2012, the top tax rate on dividends was 15%. Following the fiscal cliff deal, the top rate is now 20% for individuals with income higher than $400,000 and families with income higher than $450,000. (This comes in addition to a new tax on investment income for individuals making more than $200,000 and families making more than $250,000 — a 3.8% levy to help fund the Patient Protection and Affordable Care Act.)

We do not believe this limited rate increase presents a long-term issue for dividend investors. We are optimistic about the future for dividend-paying stocks for several reasons:

- History. It’s important to remember that the top rate of 15% had only been in place for the past 10 years, after the Bush tax cuts in 2003. The outperformance of dividend-paying stocks dates much farther back. Over the past 40 years, dividend-paying stocks have outpaced non-payers by 7.1% on an annualized basis.1 For most of that time, dividends were taxed at rates much higher than 15% or 20%.

- Stewardship. Dividend-payers tend to be strong, well-managed businesses that are growing and returning capital to shareholders. That’s what really matters over the long term.

- Management reaction. When dividend taxes were lowered 10 years ago, it was done on a temporary basis. Corporate management teams assumed the tax cuts would be temporary and did not broadly change their capital allocation decisions. In fact, dividend-paying stocks did not see a large boost in outperformance following the Bush tax cuts. So, if the cuts were not seen as a positive in 2003, we don’t believe their expiration should be a meaningful headwind in 2013. 

- Limited impact. About half of equities in the US are owned in non-taxable accounts, so the tax rate is not of significance to those investors.

More work to be done

While the bill provided some clarity on tax issues, longer-term spending issues were left unaddressed. The bill left the door open for continued negotiations in the next few months:

- Across-the-board government spending cuts were postponed for two months, meaning that the newly elected 113th Congress, which convened Jan. 3, will soon be tasked with resolving this issue. All told, these cuts would total $1.2 trillion over nine years, with almost $110 billion of that scheduled for 2013.

- The US officially reached its legal borrowing limit on Dec. 31, although Treasury Secretary Timothy Geithner has said he can take additional measures to keep the US under its limit until about Feb. 28 — at which time Congress would have to vote to raise the $16.4 trillion debt ceiling. Many observers expect lawmakers to tie the debt ceiling negotiations to a broader conversation about government spending.2

Focusing on the risks and opportunities

Invesco is closely monitoring the effects of the fiscal cliff deal as well as the implications of Washington’s unresolved spending questions. We have 750-plus investment professionals who actively monitor both the risks and the opportunities that can arise from such significant events.

The manner in which Congress and the White House resolve these issues could have significant long-term consequences on the economy, the markets and investors around the globe. After the last round of debt ceiling discussions in 2011 ultimately led to an increase in the borrowing limit, Standard & Poor’s downgraded the US long-term credit rating partly because of the “prolonged controversy” surrounding the negotiations.

As a global asset manager, we hope that the newly elected Congress can address our longer-term issues in a way that upholds the efficacy of the US political process and our government’s ability to make sound economic decisions.

What’s in the Fiscal Cliff Deal?

Known as The American Taxpayer Relief Act of 2012, or H.R. 8, the bill addresses a range of issues. Among the highlights:

  • Federal income tax rates will rise to Clinton-era levels for individuals with income of more than $400,000 and families with income higher than $450,000. The top rate tax will increase to 39.6% from 35.0%.
  • The tax on capital gains and dividends will rise to 20% from its current level of 15% for individuals with income of more than $400,000 and families with income higher than $450,000.
  • The estate tax will rise to 40% from 35%, with a $5.12 million exemption indexed to inflation.
  • The income exemption levels for the Alternative Minimum Tax will be permanently adjusted for inflation.
  • The Earned Income Tax Credit, the Child Tax Credit and the American Opportunity Tax Credit will be extended for five years. 
  • The 2% payroll tax holiday will expire. Payroll taxes will rise from 4.2% to 6.2%.
  • Federal unemployment insurance will be extended another year. 
  • Limits on personal exemptions and many itemized deductions will kick in at $250,000 for individuals and $300,000 for families.
  • Several temporary business tax breaks will be extended for another year. 
  • Scheduled Medicare payment cuts to doctors will be avoided for a year.
  • A nine-month farm bill extension was included to avoid an expected sharp increase in milk prices. 

Source: Various media reports


1 Source: Ned Davis Research, Jan. 31, 1972, to Dec. 31, 2012

2 Source: CNN Money, “It’s Official: U.S. Hits Debt Ceiling,” Jan. 1, 2013, 9:52 a.m. ET

The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

This information is not intended to be legal or tax advice. Investors should seek advice from a tax professional.

Invesco Distributors, Inc. is the US distributor and Invesco Advisers, Inc. is a US investment adviser for Invesco Ltd. All entities are indirect, wholly owned subsidiaries of Invesco Ltd.



(c) Invesco


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