On January 7, 2003, President Bush proposed an economic growth package that included tax cuts totaling $674 billion over 10 years, not counting added interest costs. It would accelerate the tax rate cuts, the child credit (increased to $1,000), and the marriage penalty relief provisions of the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA). The centerpiece of the package was a proposal to eliminate the taxation of dividends paid on stock and mutual fund shares. This single proposal is now estimated by the Treasury Department to cost $360 billion over 10 years.
The Bush Administration has suggested that the repeal of the income tax on dividends would benefit retirees substantially. This Data Digest examines this claim using data on the distribution of dividend income among the age-50-and-older population, then discusses other aspects of the growth package, including its impact on the economy and its immediate and longer-term impact on the federal budget.
How Many People Have Dividend Income?
According to the National Income and Product Accounts, personal dividend income totaled $376 billion in 2000 (Park, 2002). But well under half of this amount is reported on tax returns, in part because half or more of dividends flow to tax-exempt sources like pension funds, 401(k) plans, and other non-profits (Gale, 2002).
Of the nearly $150 billion in dividends that were reported on tax returns in 2000, people aged 65 and older (hereafter "retirees") received a highly disproportionate share (48 percent). However, most people aged 65 or older will not benefit from the dividend tax repeal because most either pay no income taxes or have no dividend income (see Table 1).
The 16.7 million tax returns filed by persons aged 65 and older in 2000 represented about two-thirds (65 percent) of all persons in that age group (22.7 million individuals, calculated by counting twice those joint returns where both filers were aged 65 or older). The other 12.2 million of the 34.8 million persons aged 65 and older did not file returns generally because their incomes were too low. Moreover, only 80 percent of the returns filed (13.5 million) are taxable. Nearly 8.8 million of the 16.7 million returns (52.4 percent) filed by persons 65 and older reported dividend income. Because of joint returns where both spouses were 65 and older, these returns represented 12.2 million retirees (35 percent).
People aged 50-64 (hereafter "near-retirees") also received a disproportionate share (29 percent) of dividend income in 2000. Among near-retirees, 8.9 million returns (representing 13.4 million people) of 24.7 million tax returns filed (36.1 percent) had dividend income in 2000 (see Table 1). Returns with dividend income covered nearly one-third of near-retirees.
How Are Dividends Distributed?
Table 2 (below) shows how the 8.8 million retiree filers with dividend income were distributed in 2000. Among retirees, about three in 10 filers with less than $10,000 of income had dividend income, but more than nine in 10 in the $200,000-and-over income class did. Overall, 52.4 percent of retirees who filed returns had dividend income.
Among near-retirees, 15 percent in the low-income groups received dividend income, compared with 88 percent in the highest income class. Overall, 36 percent of near-retiree filers had dividend income (Table 3).
The totals in Tables 2 and 3 show that taxpayers aged 65 and older reported nearly $70 billion in dividend income, and 50-64-year-olds about $43 billion in dividends in 2000. Their combined total of $113 billion was 77 percent of the $147 billion in total dividend income reported by all taxpayers in 2000, although taxpayers aged 50 and older represented just over half (17.7 million) of the 34.1 million U.S. tax returns having dividend income.
What Share of Income Comes from Dividends?
Dividend income represented eight percent of total adjusted gross income (AGI) for retirees in 2000 (see Table 4). Dividends represented a fairly uniform percentage of income across income classes, although it was slightly higher for incomes above $100,000. Dividend income was less important to near-retirees (2.3 percent of income overall), ranging from 1.0 to 3.6 percent of AGI for people aged 50-64.
Dividend income was less important to near-retirees (2.3 percent of income overall), ranging from 1.0 to 3.6 percent of AGI for people aged 50-64.
What Share of Aggregate Dividend Income Is Received by Those Aged 50 and Older?
Of all dividend income reported by all taxpayers, 48 percent was accounted for by filers aged 65 and older, and 29 percent by those aged 50-64 (see Table 5). Dividend income was equally concentrated among persons 50 and older in each income class except for those earning less than $10,000. Although retirees had the larger share throughout the income distribution, in the highest income class retiree and near-retiree shares were almost evenly split.
How Concentrated Is Dividend Income among the Highest Income Classes?
Among taxpayers aged 50 and older, dividend income is heavily concentrated among those with incomes above $100,000, and even more so among those aged 50-64 than among those aged 65 and older (Table 6). More than half (56 percent) of all dividend income of retirees went to filers with incomes above $100,000. More than one-third (37.3 percent) went to filers with incomes in excess of $200,000. Dividend income was more concentrated among near-retirees, with nearly three quarters (72 percent) going to those with incomes greater than $100,000, and more than half (53.9 percent) going to those with incomes in excess of $200,000.
Of particular note is that, of all dividend income received in tax year 2000 ($147 billion), 48 percent ($70.3 billion) was received by tax filers aged 50 and older with incomes in excess of $100,000 (see Tables 2 and 3).
Retirees earning $100,000 and over received $39.2 billion (26.7 percent) of all dividend income, and near-retirees in that income range received another $31.1 billion (21.2 percent). These filers represented about 4 million (3.1 percent) of the 129 million filing units in the U.S., or about 3.1 percent.
The figures cited above come from IRS tabulations of tax returns, so we have good reason to trust their accuracy. However, they do not reveal the entire picture of who benefits because not all items reported as dividends to the IRS are actually dividends, and not all dividends will be tax-free under the president's proposal. The dividend amounts above are overestimated because the IRS requires distributions from mutual funds to be reported as dividends regardless of whether their underlying assets pay interest or dividends (Esenwein and Gravelle, 2003). In tax year 1999, an estimated $54 billion of the $129 billion in dividends reported in AGI (42 percent) was actually interest income, leaving a net total of $75 billion (58 percent) in actual dividends (Esenwein and Gravelle, 2003). For tax year 2000, the comparable figure for interest income reported as dividend income was $61.7 billion (Park, 2002), leaving a net of about $85 billion in actual dividends of $147 billion (58 percent).
In addition, there are some circumstances in which dividends will still be taxed under the new proposal, such as when a firm pays no federal taxes, or its dividends exceed its taxes paid. Therefore, a substantial percentage of the dividend income reported by retiree tax filers will not benefit from the dividend tax repeal, so their tax benefits will be smaller than the tables above suggest.
We cannot determine whether the dividend income from mutual funds that is actually interest income is distributed differently from the dividend totals reported above. However, we do know that taxable interest income is distributed more widely among the retiree population than is dividend income (see Table 7), and that it accounts for more of total AGI (about 12 percent) for filers aged 65 and older. Nearly nine in 10 elderly tax filers have taxable interest income, compared with just over half who have dividend income.
What Are the Impacts on Tax Burdens?
Both the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 and the president's new tax proposal conferred nearly half of their tax benefits on the top 5 percent of the income distribution. EGTRRA and the growth package provided 47 percent and 48 of their tax benefits, respectively, to the top 5 percent of taxpayers, and 38 percent and 32 percent respectively to the top 1 percent of taxpayers (Citizens for Tax Justice, 2001; 2003). By comparison, the top 5 percent of taxpayers pay less than 40 percent of all federal taxes, and the top 1 percent pay only about 23 percent of all federal taxes (Congressional Budget Office, 2001).
Some advocates for EGTRRA and for the president's new tax proposal reasoned that tilting the distribution of tax benefits toward higher income classes was warranted by the disproportionate share of income taxes paid by very-high-income people. For example, those in the top income quintile (fifth) in 1979 paid 66 percent of all federal income taxes. By 1997, they paid 78 percent of income taxes (CBO, 2001). The top income quintile paid a disproportionate share (relative to its numbers) of income in taxes for two reasons. First, this group received a disproportionate share of total income (46 percent in 1979 and 53 percent in 1997), so that even a proportional tax would result in the top fifth paying a disproportionate share of taxes relative to their numbers. Second, because we have a moderately progressive income tax, those at the top pay a higher proportion of their income in taxes than those in the middle or at the bottom. It is worth noting, though, that even after taxes, the income distribution has become more unequal-the income share of the top fifth has actually grown larger over time, from 40 percent of all income in 1979 to 50 percent in 1997.
The argument that the affluent pay a disproportionate share of taxes also tends to focus only on income taxes and ignores social insurance taxes, which are the second most important federal revenue source and higher than income taxes for the bottom four income quintiles of the population (CBO, 2001). In fact, although the top income fifth has the highest effective income tax rate of all taxpayers, it has the lowest effective social insurance tax rate (CBO, 2001).
A comprehensive Congressional Budget Office (CBO) report on trends in tax burdens over the previous two decades showed that effective tax rates (taxes paid as a percentage of income) fell for every income quintile, or fifth, of the U.S. population between 1979 and 1997 (2001).
Furthermore, although tax shares for the top fifth increased from 57 to 65 percent between 1979 and 1997 (14 percent), their pre-tax income increased by more than 50 percent between those two years, while the pre-tax income of the bottom fifth declined by 4 percent. No other income fifth increased by more than 15 percent. Thus, the higher effective tax rate paid by the highest fifth of income earners has not diminished the income advantage they have over the rest of the population. On the contrary, in spite of the progressive income tax, that advantage has increased rather than decreased over the past two decades.
What Are the Impacts on the Economy?
Leading fiscal experts agree that the tax bill will provide little economic stimulus in the short run and will magnify long-term fiscal problems (Gale, 2003; Esenwein and Gravelle, 2003). The main arguments for the bill as stimulus are that accelerating the lower EGTRRA tax rates may spur consumption and that the dividend tax repeal may increase consumption indirectly by raising stock prices, thereby encouraging people to spend more.
Even if withholding tables were altered to expedite the tax reduction, the likely lags in enactment and implementation will probably diminish its impact. In addition, accelerating the lower EGTRRA tax rates will benefit primarily the most affluent, who are more likely to save than consume the added income. The dividend tax repeal will have a small direct impact on income, because, as noted earlier, only about $85 billion (less than 1 percent of GDP) in dividends is taxable on individual returns. If stock prices increase by 5 percent of market value (roughly $425 billion) and people consume only 3 to 5 percent of wealth (the most common estimates), then consumption will increase by between $13 and $21 billion, or up to 0.2 percent of GDP (Gale, 2003). The small amount of stimulus may account for the Bush Administration's more recent emphasis on the tax bill as a "growth package."
Impact on the Deficit
Since the publication of its January, 2001 baseline, the CBO has projected a steadily deteriorating budget forecast. In 2001, CBO forecast 10-year surpluses of $5.6 trillion. The enactment of EGTRRA and a recession-weakened economy, aggravated by the uncertainty caused by the September 11 catastrophe and corporate bankruptcies, shrank the 2002 10-year surplus forecast to $2.3 trillion. In CBO's latest report, the 10-year surplus is down to $1.3 trillion. The $4.3 trillion reversal was due entirely to the $3.1 trillion on-budget surplus turning into a $1.2 trillion on-budget deficit. In fact, the off-budget surplus outlook (mostly Social Security) has actually increased by $80 billion during that time.
These worsening deficit figures do not truly reflect the depth of the future fiscal problem, however, because CBO baselines reflect current law only. Table 8 only shows how quickly the fiscal situation has already deteriorated. The future looks much bleaker. CBO projected only a $157 billion deficit for 2004, but the president's own budget projects the highest federal deficit in U.S. history ($307 billion in 2004), and cumulative deficits of $1.4 trillion over 2004-08. The growth package, along with making EGTRRA permanent and the administration's other tax proposals, would cost $1.5 trillion through 2013. Interest costs would add another $360 billion to the deficit, for a total of nearly $1.9 trillion. Adding to this the original impacts of EGTRRA, the administration's tax cuts would increase deficits by $4.4 trillion through 2013 (Friedman, et al., 2003).
Even these figures do not tell the entire story. The administration has acknowledged that it intends to address the individual Alternative Minimum Tax after the next election, and doing so will cost an estimated $675 billion, including interest costs (Friedman, et al., 2003). The imponderable cost of a war with Iraq was not included in the president's budget, but his former chief economic advisor estimated it at $250 billion, which may be optimistic.
The administration's 2004 budget identifies the long-term costs of Social Security ($4.6 trillion) and Medicare ($13.3 trillion) as "the real fiscal danger." "The longer the delay in enacting reforms, the greater the danger, and the more drastic the remedies will have to be." Yet the administration's enacted, proposed, and promised tax cuts plus interest costs add more than $4 trillion to the debt in the short term, and risk creating long-term structural deficits as the boomers begin to retire.
Citizens for Tax Justice (2001). "Final Version of Bush Tax Plan Keeps High-End Tax Cuts, Adds to Long-Term Cost," May 26.
_____ (2003). "Most of Bush's Proposed New 2003 Tax Cuts Would Go to Top 10 Percent," January 7.
Congressional Budget Office (2003). The Budget and Economic Outlook: Fiscal Years 2004-13. Washington, DC: U.S. Government Printing Office.
_____ (2001). Effective Federal Tax Rates, 1979-97. Washington, DC: US Government Printing Office.
Esenwein, G. and Gravelle, J. (2003). "The Taxation of Dividend Income: An Overview and Economic Analysis of the Issues." Congressional Research Service.
Friedman, J., Kogan, R. and Kadochnikov, D. (2003). "Administration's Tax Cutting Agenda Would Cost $2.5 Trillion Through 2013," February 10.
Gale, W. (2003). "The President's Tax Proposal: First Impressions." Tax Notes, January 13.
_____. (2002). "About Half of Dividend Payments Do Not Face Double Taxation," Tax Notes, November 11.
Internal Revenue Service (2001). Special Tabulation of Tax Year 1998 Individual Complete Report res Statistics of Income Division, May.
Kogan, R. (2003). "Total Cost of Bush Growth Package Exceeds $900 Billion." January 9.
Office of Management and Budget (2003). The Budget of the United States Government, FY 2004, U.S. Government Printing Office.
Park, Thae S. (2002). "Comparison of BEA Estimates of Personal Income and IRS Estimates of Adjusted Gross Income." Survey of Current Business, November, pp. 13-20.
- The president's budget reestimated the package at $614 billion, $360 billion attributable to the dividend exclusion.
- The total package cost has been estimated at $925 billion over 10 years with interest (Kogan, 2003).
- In some cases it may be that they have substantial tax-exempt income, e.g., from municipal bonds.
- These 13.5 million returns represented 18.2 million retirees because close to 5 million returns are joint, with both filers aged 65 or older.
- See the last column of Table 2 for retiree dividends and Table 3 for near-retiree dividends. Total dividends were $147 billion. The Urban-Brookings Tax Policy Center has estimated that 63 percent of the tax benefits from the dividend exclusion would go to those aged 65 and older with incomes in excess of $100,000.
- The taxes which finance Social Security, Medicare, and unemployment insurance.
- Office of Management and Budget, 2003, p. 32.
Written by John Gist, AARP Public Policy Institute
May be copied only for noncommercial purposes and with attribution; permission required for all other purposes.
Public Policy Institute, AARP, 601 E Street, NW, Washington, DC 20049