Analysts: Down on utilities. Is the party over? That’s the tough question posed in a research note by Wachovia equity research analyst Samuel Brothwell.
What happens when the Bush tax cuts expire?
While putting my thoughts together for this editorial, I was tempted simply to re-publish the text from my October 2010 column, “ Dividend Debacle .” That piece could stand nicely in this space with just a few changes—namely, today we’re approaching a presidential election, not the mid-terms. But aside from that, Congress again is embroiled in another hyper-partisan food fight that threatens to blow up into a fiscal crisis. And once again dividend-paying companies like utilities are caught in the crossfire.
However, since 2010 two things have happened that alter the tax-policy calculus. First, the Occupy movement seized public attention away from the TEA Party’s fiscal-responsibility agenda and turned it toward the cause of economic fairness. Then, this year the Republican party chose for its presidential ticket Mitt Romney—historically a political moderate, yet vulnerable to being defined as a fat cat. With his equity-fund background; his wife’s multiple Cadillacs; and his dismissive remarks about a certain 47-percent of Americans, Romney arguably has put some members of Congress in a position where they can’t vote to extend the Bush-era tax cuts, even if they want to, because doing so would add ammunition to the class warfare that’s come to dominate the budget debate.
Where does that leave the utility industry? It leaves us facing the strong likelihood of a dividend tax increase, that’s where.
Cutting a Deal
In September, a joint tax committee brought together a bipartisan group of legislators to chart a path that would avoid the so-called “fiscal cliff”— i.e., the set of automatic federal spending cuts that would take effect if Congress fails to reach a budget compromise. Although nothing truly definitive emerged from those meetings, two general themes seemed to dominate, if we can trust the comments we heard from lawmakers in the days that followed. First, despite all the campaign-trail bluster, few in this Congress seem to have the stomach for another budget crisis. Party leaders are hinting toward a budget extension in the lame-duck session that would push the problem into the next term, perhaps packaged with a less-draconian substitute for the “sequester” contingency that Congress produced back in 2010. Second, unlike the last time, tax increases now are on the table—even for TEA Party Republicans like Sen. Jim DeMint (S.C.), who said in September, “We might as well cut a deal. If Republicans want to maintain the defense, we’re going to have to give tax increases to Obama.”
Such a deal could involve extending the Bush-era tax cuts into the middle of 2013, and then rolling them back, perhaps according to some progressive formula that favors lower- and middle-income taxpayers. Alternatively—although much less likely—Congress might let the tax cuts expire for investment income, in which case dividends and capital gains would cease to qualify for a special tax rate, and instead would be treated as ordinary income.
That’s bad news for utility investors, particularly those in the upper income brackets who will see the