Investors should watch out for dividend tax credit proposals in both the upcoming federal budget and accompanying provincial budgets, suggest economists at TD Bank.

The federal Liberals had proposed to lower the taxation of dividends to deal with the supposed income trust tax leakage problem. However, the idea has been in limbo since the government was defeated and few provinces have revealed whether they would play their part in lowering these taxes in their own budgets.

That said, the Conservatives have promised to follow through on the Liberal proposal. It remains to be seen what the provinces do. “While it is reasonable for the federal government to assume that the provinces, as partners in the personal and corporate income tax fields, will contribute to the cause of leveling the playing field for dividend-paying stocks and trusts, the provinces are under no obligation to do so,” TD Economics notes in a new report.

TD says that so far in this year’s budget season both B.C. and Manitoba have indicated that they will be raising their dividend tax credits. “They are, understandably, short on detail, pending legislation to be introduced by the federal government. However, in conceptual terms they seem to be striving to the same objective of the federal government, namely ending the double taxation of dividend income,” it says. “As such, provided the federal government follows through on its commitment we can expect that these provinces will raise the dividend tax credit rates to a level around their respective general corporate income tax rates.”

TD notes that Alberta’s budget will be on March 22, Quebec and Ontario March 23, New Brunswick March 28, and Newfoundland and Labrador March 30. “So budget watchers should keep their eyes on what is proposed for the provincial dividend tax credit rates,” it says. “Finally, all eyes will be on the federal government’s budget, likely in April. If all governments follow through with actions along the lines of the Liberal’s proposal of last November, dividends will become an even more attractive component of a wealth generation plan.”

“Smart investors have always understood the importance of re-investing dividends in longer-run wealth accumulation,” it says, noting that the American economist Jeremy Siegel found that in the U.S. Market, from 1871 through 2003, “97% of the total after-inflation accumulation from stocks comes from reinvesting dividends. Only 3% comes from capital gains.”

In Canada, the “compounded return from reinvested dividends accounted for more than 60% of the total return from the Toronto Stock Exchange Index over the past 48 years”

Along with the possibility of lower taxes, TD adds that dividends are becoming of even greater interest to investors for a couple of reasons. “First, with interest rates still relatively low, dividend yields alone rival the returns from fixed income products and that leaves completely aside the potential for capital gains on the underlying stocks. Second, flush with cash, many Canadian corporations have been increasing their dividend payments. The Toronto Stock Exchange reported 140 dividend increases in 2005. The previous high was 113 in 1995.”