As members of the 111th Congress return to Washington following the historic mid-term elections for their final lame-duck session, surely the economy is forefront on their minds. Few question that the economic downturn the United States has experienced over the past two years is the reason that there will be so many new faces on Capitol Hill come January.
Here in New England, we've seen an uneven recovery to 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 if the current capital gains and dividend tax rates are allowed 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 dividend tax rates could nearly triple from 15 percent to 39.6 percent.
There is a significant economic benefit to 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 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.
Furthermore, we cannot overlook the fact that in the 21st century, American companies must compete in an increasingly global market. Increasing the tax rates on capital gains and qualified dividends undermines America's ability to maintain its position as a worldwide economic leader. The last two years presented ample challenges to this nation's economic viability on the world stage.
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. Doing so would not only encourage good business practices, but would also encourage investors of all types to invest in our economic recovery going forward.
Yet another argument in favor of extending the current qualified dividend tax rate is the impact any change could have on senior citizens. According to an analysis of 2005 IRS Statistics by the Heritage Foundation, seniors are far more likely than other investor groups to own stocks which pay dividends, and in 2010, seniors are almost twice as likely to report dividend income on their tax returns. In fact, here in Connecticut, 65.7 percent of seniors own stocks which pay dividends. Because seniors have a shorter investment horizon, their need for cash tends to be higher, and dividends supplying regular income are an important part of many retiree investment portfolios. Any tax rate change that disadvantages dividend payments will have a disproportionate impact on our region's seniors.
There is of course limited time for Congress to address a long list of important legislative priorities before a new Congress is convened in 2011. 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 will ensure that we have a tax climate in this country that encourages investment that will lead to job creation and spur economic recovery.
James T. Brett is the president and CEO of The New England Council, the nation's oldest regional business organization.