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What Obama's Budget Means for Investors

President Obama unveiled his 2013 budget proposal Monday, eliciting a chorus of cheers and jeers. Among other changes, the budget would raise rates on capital gains and dividends, close corporate loopholes, and create the Warren Buffett-inspired minimum tax on millionaires. Republicans, unsurprisingly, oppose much of the budget, and expressed their disapproval by calling it, "a recipe for a debt crisis and the decline of America."

With the president calling for changes in tax rates and new funding for certain industries, the budget, in whatever final form passes, is sure to have an effect on investors. Let's take a look at who benefits and who loses from the proposed budget.

Wealthy dividend investors
Individual dividend investors making more than $200,000 and couples earning over $250,000 would be big losers under the proposed budget. Right now, dividends are taxed at just 15%, the long-term capital gains rate, but the budget proposal would treat them as ordinary income. That would raise their effective tax rate to 43.4% on dividends, which includes a 3.8% surcharge to support the Affordable Care Act. Companies most likely to be affected would include high-dividend payer Frontier Communications (Nasdaq: FTR  ) , which pays a whopping dividend yield of 18.4%. Wealthy investors would see an additional 28.4% of that chunk of quarterly income disappearing under the Obama budget, which may lead them in search of other investment opportunities. AT&T, another high-yielding dividend stock, is already lobbying to maintain current dividend and capital gains rates.

For-profit education
As a college education has become vital for young people searching for a lasting career, the for-profit education sector has sprung up to meet the huge demand that traditional institutions could not. The Apollo Group's University of Phoenix, for example, serves more than 300,000 students, and budget constraints on community colleges have fueled for-profit colleges' incredible growth. However, the for-profits' expansion has slowed in recent years and the budget's proposal to provide $8 billion for community colleges should put a further dent into their profit-seeking competitors. The funding for the community colleges would help the schools partner with local businesses to provide students with job training skills.

Defense contractors
Republicans including John McCain have vilified Obama for not preventing automatic defense cuts that are set to go into effect as a result of the supercommittee's deal on the debt ceiling. However, defense contractors have not reacted the same way. Lockheed Martin stands to lose out on the purchase of 13 of its F-35 fighter jets, but the company said it understands the government's need to be fiscally responsible. Others in the industry have said the cuts in the Pentagon budget were relatively mild.

Corporate taxes
Republicans like to cite our 35% corporate tax rate as evidence of oppressive regulation and the need to cut taxes. In reality, the average tax rate that corporations pay has sunk to 12.1%, a 40-year low. The budget proposal seeks to close the tax loopholes that allow such a low effective rate, and lower the overall corporate tax rate.

This move would favor certain businesses, especially high-margin retailers and restaurants, which don't benefit from those loopholes and therefore pay the full 35% rate. For example, in their most recent quarters, Starbucks paid a 33% tax rate, Chipotle's (NYSE: CMG  ) was 38.3%, and lululemon athletica (Nasdaq: LULU  ) forked over 35.5% of its earnings. By contrast, a number of publicly traded companies actually received money from the government through tax incentives between 2008 and 2010. These included several utilities as well as industry giants like General Electric (NYSE: GE  ) and Verizon. The budget also has put subsidies for oil and gas and agricultural companies on the chopping block.

Transportation
Perhaps the biggest winner in the proposed budget is the nation's transportation network. The budget includes a total of $476 billion over the next six years and an additional $50 billion for the coming fiscal year. The extra money to help repair and build infrastructure like roads and bridges figures to be a boon for machinery maker Caterpillar (NYSE: CAT  ) . The company produces all manner of construction and road-building equipment and counts the government as a major customer.

Foolish takeaway
The final version of the budget will likely be some form of compromise between Republicans and the administration, but the proposals could mean an altered landscape for investors. Some other important changes in the budget include raising the capital gains rate on the highest income bracket to 20% from 15%, and eliminating the "carried interest" loophole that allows venture capital and private equity managers to pay the capital gains rate instead of having their salaries taxed as ordinary income.

Whatever the final federal budget, our experts have found two small companies with long-term government contracts that will help drive their future growth. Find out more about these potential multibaggers in the Fool's special free report: "Too Small to Fail: 2 Small Caps the Government Won't Let Go Broke." Just click right here to get your free copy.

Fool contributor Jeremy Bowman owns shares of Chipotle but holds no other positions in the above companies. The Motley Fool owns shares of lululemon athletica, Lockheed Martin, Starbucks, and Chipotle Mexican Grill. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill, Starbucks, and lululemon athletica, as well as writing covered calls in Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 16, 2012, at 12:57 PM, mrbillCZ wrote:

    so much for high dividend stocks as a safe haven? Including XOM, ADP, others?

  • Report this Comment On February 16, 2012, at 3:36 PM, DJDynamicNC wrote:

    "Republicans including John McCain have vilified Obama for not preventing automatic defense cuts that are set to go into effect as a result of the supercommittee's deal on the debt ceiling."

    It's funny, because they were the ones who insisted on the super committee in the first place - automatic budget cuts and all. The motivation was that they would force Obama to cut the deficit. Now that's happening, and they've changed their mind?

    How very unusual to completely contradict their own position mere months later. Nobody could have predicted this would happen.

  • Report this Comment On February 16, 2012, at 4:16 PM, keesluijt wrote:

    Hi,

    Just a question: what does the budget proposal mean for goreigners investing in American divident paying companies? I havent got a chance to read the proposal, but if the tax rate is to be increased,does this also count for people outside the US?

    For info: i hold a small portefio of div stocks in the US, under $75.000,- in value.

    Thanks for any info!

    Best

    Kees

  • Report this Comment On February 16, 2012, at 6:13 PM, seattle1115 wrote:

    "That would raise their effective tax rate to 43.4% on dividends...."

    I'm pretty sure that this is wrong. I'm pretty sure that's the top marginal rate, not the effective rate. The effective rate will be substantially lower (how much lower depends on income - specifically, how much income is subject to the top marginal rate).

  • Report this Comment On February 16, 2012, at 6:21 PM, TMFHobo wrote:

    @seattle1115:

    Good point. I meant the marginal rate I suppose. Though since it's now being lumped in with ordinary income, the dividend tax will essentially be applied at the marginal rate if you make over $250,000.

    @keesluijt: I'm no tax expert, but I believe individual taxpayers would only have to pay that if they're filing in the U.S. As a foreigner, I wouldn't think that would apply to you.

    -Jeremy Bowman

  • Report this Comment On February 16, 2012, at 6:27 PM, 1caflash wrote:

    Who knows what budget is finally approved? I have no Frontier Communications shares, but Management did what it Needed to help the Company go forward by cutting the Dividend. Solvency of the Business is much More Important than Shareholders fretting about the Yield. FTR's Board of Directors and CEO took the appropriate action. Shareholders should feel more calm; this puts FTR in a Stronger Position. CTL and HTCO are in my DRIP.

  • Report this Comment On February 17, 2012, at 9:53 AM, mdk0611 wrote:

    keesluijt - You'll have to check the applicable tax treaty. Rules vary.

    With respect to the budget, there will be no "final form" because a budget will never be passed. It will be another year of continuing resolutions.

    I recall Buffett saying in 2008 that the cap gains rate could go up to 20% without a significant impact on the economy and markets, but a bump to 28% would cause significant dislocation . At 24.3% (including the Obamacare tax) as of 1/1/13 we seem to be approaching danger territory. What I don't recall was any comment he made with respect to the rate on dividends. If his opinion is the same, a bump on the rate for dividends to 43.9% would be a disaster.

  • Report this Comment On February 19, 2012, at 9:04 PM, mjtri wrote:

    Regarding the comment "Republicans including John McCain have vilified Obama for not preventing automatic defense cuts...", you must be listening to the biased media too much. The Republicans were the ones to cut Obama's defense budget in the first place. Yes, some Republicans are against cutting the defense budget including McCain, but many want to cut spending across the board, particularly many of the Tea Party members.

  • Report this Comment On February 22, 2012, at 3:36 PM, keesluijt wrote:

    @TMFHobo and mdk0611,

    thanks for the info! I quess I'll just keep a look out at the developments for now.

    Anyway, a big increase as suggested would in my honest opinion be the end of dividend investing for most people, and a likewise sharp downturn in associated stock prices...

  • Report this Comment On February 22, 2012, at 3:57 PM, DJDynamicNC wrote:

    Not entirely likely, Keesluijt. Those who invest primarily in tax-sheltered Roth accounts would face no impact from enhanced dividend taxation.

    A concurrent increase in the capital gains tax would prevent a flight to riskier stocks to avoid the dividend tax, although I'm willing to accept arguments that 43% is a bit too high. I would expect companies to be less likely to bother increasing dividends in that case.

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Jeremy Bowman
TMFHobo

Fool since 2011. I write about consumer goods, the big picture, and whatever else piques my interest. Follow me on Twitter to see my latest articles, and for commentary on hot topics in retail and the broad market.

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