April 25, 2008
Economic policies may determine the presidential election. Utilities are particularly interested in preserving the current dividend tax rate -- something that they say encourages more investment in their enterprises.
A 15 percent tax on dividends is not just good for utilities but is also healthy for the economy. Proponents say the policy helps attract the capital needed to improve infrastructure while also contributing to full employment. Such incentives furthermore encourage savings and reduce the need to acquire excessive debt that could drag businesses down during economically distressing times.
In 2003, President Bush pushed through his tax package that included lowering the rates for dividends payments from a maximum of 28 percent to 15 percent. Those tax reductions are scheduled to expire year-end 2010. Besides trying to increase investment in corporate America, the president also sought to minimize the effect of "double taxation." That is, company earnings are taxed not only at the corporate level but also when they are distributed to shareholders as dividends.
Utilities have benefited from that policy. An increase in tax rates would force many older shareholders who need stable incomes to consider owning alternative investments such as bonds. Companies such as Centerpoint Energy, Exelon and TXU raised their dividends after the tax breaks were enacted. According to a study just released by Ernst & Young, U.S. electric and gas utilities paid $16.3 billion in 2005. But they increased those payments to $17.7 billion in 2006.
"Lower tax rates on dividends have helped to increase the above-average share appreciation of utility stocks during the past three years, which reduces the cost of capital for the major transmission and distribution system upgrades, environmental and energy-efficiency improvements, and new capital needs the industry is facing," says the firm.
The study, based on IRS data from 2004 tax returns -- the latest year for which such information is available -- shows that 64 percent of federal tax returns with qualified dividends from direct ownership of utility shares were owned by those 65 or older. It also says that 68 percent of those returns were filed by those making less than $75,000 a year and that 42 percent were filed by those with incomes less than $25,000 a year.
The discussion is part of a broader one that centers on whether to extend the entire Bush tax package enacted in both 2001 and 2003. If the full package were to remain in place, the Congressional Budget Office says that it would cost $1.8 trillion over the next 10 years. Besides reducing the dividend tax, Bush also cut corporate and personal tax rates as well as long-term capital gains taxes from 20 percent to 15 percent. The rules require tax cuts and spending increases to be paid through government cuts or tax hikes.
Competing Interests
The presumptive Republican nominee, John McCain, has vowed to preserve the favorable tax treatment given to dividend payments -- a shift away from his original position taken when the original vote was taken. Republicans, generally, have made the extension of the tax cuts a fundamental theme in the election, saying that if the Democrats get in office it would result in huge tax increases and economic peril.
But the two remaining Democratic contenders have said that their goal is to bring tax fairness to the system. Instead of giving breaks to the "rich," they would increase spending on social programs to help the less fortunate. To fund this, the Democrats would likely raise the marginal rates of those earning $200,000 or more as well as hike taxes on dividends and capital gains received by "average" taxpayers.
"Americans know there is a difference between keeping taxes as low as possible on the middle class, and giving away the bank to the wealthiest Americans," says Bill Burton, a spokesman for Barack Obama, in a New York Times story. "If President Bush's tax cuts are extended, the wealthiest 1 percent will save more than the bottom 80 percent combined, at a cost of $1 trillion over 10 years."
While the fate of the entire tax package enacted in the early Bush years is unknown, supporters of the favorable rates provided for dividends and capital gains on the sale of stocks are rounding up support now. A president who would support an extension needs to win a majority of votes in Congress whereas one that does not can just let the breaks expire by remaining on the sidelines.
In any event, the discussion should not be relegated to class warfare. After reviewing the tax policies of the 30 industrial countries of the Organization for Economic Cooperation and Development, the Cato Institute found that 27 of them now provide full or partial relief from double dividend taxation. It says that such assistance is typically done through an individual tax credit or a reduction in the tax rate on dividends.
Utilities, of course, want to attract shareholders by providing higher dividend payments. But they also know that if forced to issue less stock, they would then take on more debt. Highly leveraged balance sheets, in turn, can lead bankruptcies during hard times.
"This is why we are urging Congress to take early action to extend or make permanent the lower rate on dividends -- so that Americans can be assured of keeping more of their dividend income," says Tom Skains, chief executive of Piedmont Natural Gas.
The presidential candidates will weigh in. Utilities, which are planning to spend billions on new projects, are taking a keen interest. But they are joined by companies and shareholders of all stripes, who not only want to minimize their taxes but who also say that such policies stimulate economic growth. Ultimately, it becomes a balancing act between the need to attract investors and the desire to provide other essential services.
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Ken Silverstein EnergyBiz Insider Editor-in-Chief
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