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I am wondering what was the motivation to decouple taxation (USA) of short-term gains/income from dividends in 2003.

Before 2003, dividends were mostly taxed as current income, at a significantly higher tax rate compared to long-term capital gains. However, in 2003, the situation flipped with both capital gains and dividends being taxed at 15%. (I guess now as of 2021, the highest bracket is 20% for capital gains and dividends).

I got this question while I was reading "Unconventional Success: A Fundamental Approach for Personal Investment", by D. F. Swensen, where the following table is taken from:

Historical Federal Tax Rates 1980–2003

As I understand, the table assumes dividends to be qualified dividends which were introduced by Jobs and Growth Tax Relief Reconciliation Act of 2003, which is linked to a "bucket" of Bush tax cuts.

The general topic of tax cuts, in general, and Bush tax cuts, in particular, are a bit too broad—so, I want to be very specific. In my view, dividends are very similar to current income. I have a hard time justifying the taxation of dividends differently from regular income. I read the Why are dividends different from property income like rent?, and while it was interesting and insightful, I am coming more from a taxation point of view (and that question did not have a clear consensus anyway).

So, I wonder, what were (and, I guess, still are) the main motivations for "relaxed" taxation on qualified dividends? Why they are tax-differentiated from current income?

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Congress and the President want to change how an item of income was taxed. This would change how people invest their money.

All tax changes boil down to one of three reasons:

  • Bring in additional income to the government.
  • Reward people who have a specific type of income/expense
  • Punish people who have a specific type of income/expense.

If I drop a tax rate, that rewards a group of people. If I make something deductible that wasn't before, then I reward a group of people. If I do the opposite things, I punish others.

In the Bush tax cuts the Congress and the President changed items in the tax code to do exactly that. People who have income from dividends and capital gains were seen as people who had investments that lead to additional jobs. So reward them so they funnel more money into those types of investments.

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  • Instead of reward and punish I would say motivate and deter, since the idea is to change behaviour to get more of what the government wants and less of what it doesn't. Sep 6 at 12:58

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