These increases are due to (1) increased rates on dividends for taxpayers in the top income tax bracket enacted as part of the American Taxpayer Relief Act (ATRA; P.L. 112-240 ); and (2) a 3.8% tax on net investment income, including dividends, for taxpayers with modified adjusted gross income above certain thresholds. Before 2003, dividends were treated as ordinary income for tax purposes. Hence, as Congress evaluates tax reform options, changes to the tax treatment of dividends may be considered. In the context of a base-broadening, rate-reducing tax reform, increasing tax rates on qualified dividends is one option for raising revenue that could be used to reduce marginal tax rates. Taxing dividends as ordinary income could raise revenues sufficient to offset a 1.3% reduction in individual income tax rates, meaning the top tax rate could be reduced by roughly 0.5 percentage points, from 39.6% to approximately 39.1%. A rough static estimate suggests that taxing dividends at ordinary rates could allow corporate tax rates to be reduced by roughly 4.6%, allowing for a revenue-neutral reduction in statutory corporate rates from 35.0% to an estimated 33.2%. While many economists believe that taxes on dividends discourage investment and distort the allocation of capital in the economy, there is an alternative view in which changes in dividend tax policy do not affect investment incentives. Traditional concerns about the excess taxation of capital income include the distortion in favor of investments outside the corporate sector, the favorable treatment of debt versus equity within the corporate sector, and the differential treatment of dividends and capital gains, which favors retentions in the corporation. In addition, these open economy issues may be one consideration for evaluating various integration proposals discussed subsequently. When taxes on dividends were reduced in 2003, some predicted that the reduced tax rates on dividends would increase the price of U.S. traded equities. Economic Stimulus

Dividend tax relief might also be considered as a tool for economic stimulus. Debt-financing also tends to be tax-favored, as interest payments are deductible. Further reducing taxes on dividends or integrating the corporate and individual income tax systems could reduce federal revenues. Thus, policy options that reduce taxes on dividends, considered in isolation, would tend to reduce the progressivity of the overall tax system. With more than half of dividends paid not being taxed at the individual level, a substantial portion of capital income is taxed only once, at the corporate level. Shareholder (Imputation) Credit

Integration of the corporate and individual tax systems can also be achieved by granting a credit at the individual level for taxes paid at the corporate level. A dividend exclusion was also considered in 2003. Some have suggested taxing dividends at ordinary rate at the individual level, using the revenues to reduce corporate tax rates. Even if the revenues were used to decrease corporate tax rates, progressivity would likely increase. House Ways and Means Committee Chairman Dave Camp has proposed taxing dividends as ordinary income as part of the Tax Reform Act of 2014. For single individuals, the dividend exclusion was increased from $100 to $200. Under the Jobs and Growth Tax Reconciliation Act of 2003 (JGTRRA; P.L. Appendix C. Taxation of Dividends in OECD Countries
With the reduced tax rates on dividends enacted in 2003, the U.S. moved from having a "classical" system, where dividends were taxed at the same rate as other types of capital income (e.g., interest), to a "modified classical" system, where dividends are taxed at the shareholder level, but at reduced rates. On average, combined (corporate and individual) statutory tax rates on dividends have decreased in OECD countries over the past decade.
The tax treatment of dividends has changed numerous times over the past century. Most recently, the American Taxpayer Relief Act (ATRA; P.L. 112-240) increased the tax rate on dividends, from 15% to 20%, for taxpayers in the top income tax bracket. The change was effective for 2013. Also effective in 2013 is the 3.8% tax on net investment income for taxpayers with modified adjusted gross income above certain thresholds ($200,000 for single, $250,000 for married filing jointly).
Further increases in the tax rate on dividends may be considered as part of a base-broadening, rate-reducing tax reform. Rough estimates suggest that taxing dividends as ordinary income could raise enough in revenue to offset a 1.3% reduction in individual income tax rates, which would reduce the top marginal rate from 39.6% to roughly 39.1%. If the revenues were instead used to reduce corporate rates, the corporate tax rate could be reduced by roughly 4.6%, from 35% to roughly 33.2%. House Ways and Means Committee Chairman Dave Camp's tax reform discussion draft, the Tax Reform Act of 2014, proposes that dividends be taxed as ordinary income, but provides an exclusion of 40% for dividend and capital gain income.
Before 2003, dividends were taxed as ordinary income. The tax rate on dividends was reduced as part of the Jobs and Growth Tax Reconciliation Act of 2003 (JGTRRA; P.L. 108-27). Tax rates on dividends were reduced in 2003 to address some of the economic distortions that result from taxing dividends at both the corporate and individual level. Taxation of dividends in both the individual and corporate income tax systems leads to a preference for non-corporate as opposed to corporate investment. Taxation of dividends at both the corporate and individual levels also creates a bias in favor of debt-financed investments, where interest payments are deductible.
The reduced tax rate on dividends at the individual level reduces, but does not eliminate, tax-induced distortions in the allocation of capital. Integrating the corporate and individual tax systems, such that capital income is taxed only once, could further improve the allocation of capital in the economy. Rather than increasing taxes on dividends in a base-broadening tax reform, integration may be considered as an option for reducing tax-induced economic distortions. Options for integration include shareholder imputation credits (individual-level credits for corporate taxes paid), a dividends paid deduction, or a dividend exclusion. A trade-off to consider with integration proposals is the budget impact. If integration policies are deficit financed, higher interest rates could crowd out economic growth.
Open-economy considerations, in a globalized economy with trade, might also motivate changes in the tax treatment of dividends. Taxing dividends at ordinary rates at the individual level, using the additional revenues to reduce corporate rates, could encourage capital investment in the domestic corporate sector.
Increasing taxes on dividends at the individual level would likely increase the progressivity of the U.S. tax system. Correspondingly, a decrease in taxes on dividends would tend to decrease the progressivity of the overall tax system. Ultimately, any change in dividend tax policy is likely to have economic, distributional, and revenue consequences. The trade-offs between these various objectives are something to be considered by policymakers.