John Templeton’s objective to maximize total real return after taxes is an
essential investment strategy. And stocks are very well suited to this
purpose. In contrast to fixed-income investments, both the capital gains
and now the dividends are treated favorably by the U.S. tax code. So in
addition to having superior before-tax returns, stockholders often hold
an even larger after-tax advantage over bondholders.
HISTORICAL TAXES ON INCOME AND CAPITAL GAINS
Figure 5-1a plots the marginal tax rate on dividend and interest income
for investors at three income levels: the highest tax bracket, the tax rate
for real 2006 income of $150,000, and the tax rate for real income of
$50,000. The tax rates on capital gains are shown in Figure 5-1b.
Until the dividend tax rate reductions were put into effect in 2003,
the tax rates on dividend and interest income were identical, although in
the past, small amounts of dividends were often exempt from tax. From
1930 to 2003 the capital gains tax rate was generally below the dividend
tax rate; then in 2003 the tax rates on qualified dividends and capital
gains were made equal. A history of the tax code applicable to stock in-
vestors is provided in the appendix at the end of this chapter.
A TOTAL AFTER-TAX RETURNS INDEX
A total real returns index for stocks, bonds, bills, and gold is presented in
Figure 1-4 in Chapter 1. The effect of taxes on these returns is shown in
Figure 5-2.
■The upper line of the stock range equals the before-tax real stock
returns shown in Figure 1-4. These returns would be applicable
to tax-exempt individuals or institutions.
■The lower line of the stock range in Figure 5-2 assumes that in-
vestors pay the highest tax rate on dividend, interest, and capi-
tal gains income, with no deferral of capital gains taxes.
■The shaded area shows the range of total real returns from the
lowest- to the highest-taxed investor.These calculations include only federal taxes; no state, local, or es-
tate taxes are considered.
The difference between the before- and after-tax total returns is
striking. Total before-tax real stock returns accumulate to $755,163,
while after-tax accumulation for someone in the highest bracket is about
$30,018—less than 5 percent of the before-tax accumulation. Similar
66 PART 1 The Verdict of History