President Obama's "Budget Blueprint" proposes to raise the tax
rate on dividends and capital gains from 15 percent to 20
percent. This tax hike would hit senior citizens
particularly hard, as it would depress the value of stocks held in
many types of retirement savings plans they rely on for income to
supplement their Social Security benefits.
These plans include 401(k)s, 403(b)s, IRAs, and self-directed
state, local, and federal government employee retirement funds. As
of December 31, 2008, these plans invested $4.4 trillion in
stocks--just over of 54 percent of all their assets.
A Steep Decline
Capital gains and dividends taxes decrease stock prices in two
ways: They reduce the after-tax value of the dividends and capital
gains earned by stocks, and they increase the cost of capital for
businesses, thereby reducing future business profitability.
To determine how much Obama's proposed tax hike would reduce the
value of retirement savings plans, the value in current dollars of
the yearly revenue raised by the tax increase (as shown in the
Budget Blueprint) is discounted by the latest available
price-to-earning ratio of the S&P 500 to calculate the
aggregate decline in stock prices. This is a widely accepted
According to this calculation, the tax hike would cause stock
prices to drop almost $93 billion. As the percentage of all stocks
held in retirement savings plans is approximately 30 percent, nearly
one-third of the decline in stock prices would fall on stocks owned
through these plans. This works out to $27 billion of lost value
for current and future retirees unnecessarily redistributed to
Congress. That works out to $434 of lost retirement savings for
Seniors' Income Would Fall
The $27 billion of lost wealth would lower the incomes of
seniors dependent on retirement savings plans. Seniors sell stocks
held in these funds after they retire to pay for their living
expenses, including basics such as housing, food and medical care.
When the stocks they sell decline in value, seniors have less money
to pay their bills, and their budgets are squeezed tighter.
Seniors dependent on retirement savings plans already
experienced a precipitous decline in purchasing power due to the
current recession. From the end of 2007 to the end of 2008, they
lost more than $2.6 trillion of value--more than 24 percent of
their total worth--because of the decline in stock prices.
Seniors may not see these values return to near previous highs
any time soon because of the ongoing economic and financial crisis.
These seniors are forced to live on less for the foreseeable future
as a result. A tax hike on dividends and capital gains would
further depress retirement savings plan values and the purchasing
power of seniors' money.
Unlike the decline in stock values due to the recession, the
stock price decline caused by the dividend and capital gains tax
hike is irrecoverable because the additional tax lowers stock
prices permanently--or at least until the tax hike is reversed. On
the other hand, the lost value from the stock market decline will
reverse as economic conditions improve.
Do Not Punish Seniors
Seniors have already paid a steep price in their retirement
income during this recession. Rather than causing further damage,
Congress and the President should leave the tax rate on dividends
and capital gains at current levels. Even better, they should
follow the opposite course and lower these taxes. Cutting
the dividend and capital gains taxes would raise stock prices,
thereby raising the incomes of seniors, and it would reduce the tax
disincentive facing business investment, thereby accelerating the
recovery--a double bonus for the ailing economy.
Dubay is a Senior Analyst in Tax Policy in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage
James Poterba, "Corporate Payout Policy," American Economic
Review, Vol. 94, No.2 (May 2004), pp.171-175, at http://jstor.org/
stable/3592877 (March 6, 2009); United States Department
of Treasury, "Report of the Department of the Treasury on the
Economic Effects of Cutting Dividend and Capital Gains Taxes in
2003," March 14, 2006, p. 9, at http://www.treas.gov/press/releases/reports/report%20on%20econ
%20of%20cap%20gains%20%20dividends%203.14.06.pdf (March 6,
Federal Reserve Board, "Flow of Funds Accounts
of the United States," pp. 75-76.