John Locke Update / Research Newsletter (Archive)

Investing with an ever-changing tax

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Hello, my name is Sarah Curry, and I’m the new Director of Fiscal Policy at the John Locke Foundation.  I have a background in banking and investments as well as some first hand experience in our North Carolina legislature.  I hope you find these newsletters informative, as I will try to relate them to everyday financial concerns and questions.  I want to begin by tackling some of the discussions you might have heard over the last couple of weeks relating to our government’s solution for the fiscal cliff and what effects it will have on us in this new year.

It’s 2013 and most of us have made some sort of New Year’s resolutions.  Year after year we hear the most popular New Year’s resolution in America is to lose weight or exercise more.  I decided to look at the news outlets’ findings on this topic and I discovered in the top 10 list of resolutions is saving money.

As most of you know, capital gains and dividends are being taxed

differently in this new year than they were in 2012.

Capital gains and dividends



Short-term gains taxed as ordinary income.

Long-term gains taxed based on your top marginal income tax rate:

  • 0% if you’re in the 10% or 15% brackets.

  • 15% if you’re in the 25% bracket or higher.

"Qualifying" dividends (which generally include dividends paid on common stock, including stock of qualified foreign corporations, and certain preferred securities, subject to holding-period and hedging requirements) are taxed at the 0% and 15% levels (as with long-term capital gains) rather than as ordinary income.

Sources: IRS and The Tax Foundation

Short-term gains taxed as ordinary income.

Long-term gains taxed based on your top marginal income tax rate:

  • 0% if you’re in the 10% or 15% brackets.

  • 15% if you’re in the 25%, 28%, 33%, or 35% brackets.

  • 20% if you’re in the 39.6% bracket.

Qualifying dividends continue to be taxed at the same level as capital gains.

When people save money, they commonly do it either by investing in stock directly, by investing in retirement accounts such as IRAs or 401(k)s, and/or by putting it in their local banks savings account.  The earnings generated by any of these methods are called investment income and are subject to investment specific taxes such as the ones seen above.

Historically, the taxing of investments began with the passage of the 16th Amendment to the Constitution in 1913 which states: The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.  Although this allowed Congress to tax dividends as a form of income, dividends were exempt from taxation from 1913 to 1953 with the exception of a small four-year period from 1936 to 1939 when they were taxed at an individual’s income tax rate. 

Over the last 60 years dividends have been taxed at various rates, and are currently taxed at the same rate as capital gains.  As bleak as the media makes out our tax rate for capital gains to be, the truth is that it’s not that bad when you look at the historical rates.  The Tax Policy Center records data on this starting in 1954, where the maximum tax rate on long-term gains was 25%.  The highest US taxpayers have ever paid on capital gains was from 1976-1978 when the maximum rate was 39.875% and the lowest was in 2008-2009 at 15.35%.  This fluctuation of investment taxation levels leads Washington politicians to request higher tax rates for investment income when they see a budget deficit or any need for more income.

Looking to the IRS for investment income data, I found the number of returns with the value of investment income by state.  This data is from the 2010 tax year.  I have also included a color code; red for Republican and blue for Democrat voting states in both the 2008 and 2012 presidential elections. 

Notice Wyoming is ranked number one in the country for average investment income.  This is due to the large number of retired people in the exclusive Jackson Hole Ski Resort area.  The next highest-ranking states are Connecticut, New York, District of Columbia, Massachusetts, and Nevada with their average person’s investment income being well over $5,500 per year.  Many of the Democrats in Washington are spouting the idea of taxing investment income at higher rates.  Unfortunately the majority of investment income is found in democratic states, thus only encouraging the idea that it is OK to tax investment income at a higher rate.  North Carolina’s average investment income was $2,207 per person — ranked 43rd out of 51 (DC is included).

We know that, as a whole, investment income in America makes up a large percentage of our aging population’s income, and any tax rate changes on this will have major effects on their purchasing power.  The impact of such tax rate changes would vary drastically by state and by population demographics.  We can see from our data that states with higher investment incomes tend to be states with a higher percentage of retirees, such as Florida at $4,437 and ranked 10th in the US.  Before lawmakers could change tax rates on these financial vehicles, they would have to take into account how it would affect this demographic, since they would be less capable of weathering such a tax increase.

So for 2013 and beyond, keep investing in your retirement account of choice, whether it is a 401(k) or an IRA.  The benefit is that capital gains and dividend taxes won’t affect you because dividends, capital gains, and interest incur no tax liability while in those retirement accounts.  Happy investing!


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Sarah Curry is Director of Fiscal Policy Studies at the John Locke Foundation. Previously, she worked for the North Carolina State Senate as a research assistant for the chairs of the Senate Agricultural Committee and headed the research efforts for… ...

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