Mark Brook, 43, the owner of a home-building supply company in Oceanside, New York, is ecstatic about the possibility that most taxes on dividends will be eliminated.
"There are taxes that are inherently stupid," he said. "The dividend tax is like the estate tax; it just doesn't make sense."
Last year, Brook said, he earned about US$40,000 in dividends on a portfolio of about US$1 million.
On the other hand, Judith Berger, 59, a middle school teacher in the nearby Long Island community of Rockville Center, said she does not expect to benefit from the proposal because she and her husband hold virtually all of their investments in tax-sheltered retirement accounts.
"Like most of the middle class, we invest through our jobs," she said. "So it doesn't really change our investing strategy."
While the main beneficiaries of elimination of taxes on dividends would be investors who hold stocks outside of retirement accounts, only about one-quarter of the adult population has such holdings , according to the Center for Economic and Policy Research in Washington. The wealthiest 1 percent of the population holds 53 percent of those stocks, the center said.
For wealthier investors, the dividend tax plan proposed by President Bush could have important implications. For people whose assets are mainly in retirement accounts, the issue is far less pressing, many financial advisers say.
Many financial planners are counseling their clients against making major portfolio changes based on assumptions about a tax proposal when details -- and the chances of passage -- are far from certain. But some portfolio managers say it is not too early to start re-examining investment choices.
Anna Dopkin, who manages the T. Rowe Price Growth and Income fund, said that with the tax proposal in mind, she is considering the purchase of stocks that could potentially increase their dividends, or begin paying them for the first time. These include Federated Department Stores of New York, and Altera, a semiconductor company based in San Jose, California; both now pay no dividends. The fund does not currently own either stock.
Stocks that now pay high yields may not turn out to be good investments, she said. "In most cases, these are riskier stocks," she said. "The payout ratios may be too high and they might have to cut their dividend."
Gary Schatsky, a New York City financial planner, said that while the tax plan might make dividend-paying stocks look more appealing as investments, they should not be directly compared with high-yielding assets like municipal bonds and real estate investment trusts, or REITs.
Dividends on REITs would not be tax-exempt under the Bush administration's proposal, but Schatsky said REITs are often bought as an alternative to bonds. Because of their rich yields, often 7 percent to 8 percent, REITs should be bought in retirement accounts, he said.
Long-term bond mutual funds, which had a big inflow of money last year, could be hit hard if the administration's proposal becomes law. While holders of individual bonds will recoup their principal if they hold the bonds to maturity, investors in bond funds could suffer an immediate capital loss because mutual funds are repriced daily.
Stock dividends earned by mutual funds would be tax-exempt under the proposal, but mutual fund shareholders might not gain much. Funds are required to pay out dividend income, but only after deducting operating expenses. The expenses of most funds effectively eliminate payments to investors; only 42 percent of domestic equity funds paid dividends last year, according to Morningstar Inc.
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