President Bush’s new economic stimulus proposals include one
stunner: the total elimination of shareholder tax obligations on
dividend payments received from stock investments. It’s a typically
bold Bush stroke, and one hopes it will pass Congress without being
watered down to a 50 percent cut. Eliminating the tax on dividends
does something decisive. It effectively creates an entirely new
asset class.
Clearly, the administration believes this cut will have several
important effects: It will make stock prices go up, as
dividend-bearing stocks become more valuable to own. It will
incentivize companies that do not pay dividends to consider paying
them. It will reduce the tendency of corporate management to retain
earnings, and often to spend those retained earnings unwisely. (To
paraphrase a close associate of mine, giving a CEO money is like
giving an alcoholic a drink.)
Further, it will encourage people to buy and hold
dividend-paying stocks as income vehicles. It may tend to
discourage selling those stocks, and thus dampen (to an extent)
stock market volatility. It will revitalize a large category of
mutual funds — growth and income funds and equity income funds —
that have been languishing.
That’s the administration’s take. Critics say companies don’t
like to pay dividends, and won’t, in any case. Democrats point out
that most people own stocks in tax-qualified plans, so tax-free
dividends are irrelevant — and that, as a result, most of the
benefits will go to “the wealthiest one percent of Americans.”
Corporate finance experts don’t seem to like dividends much anyway,
particularly for growth companies. Dividends, they say, are
appropriate to old line, mature companies, whose growth rates have
“regressed to a mean” (that means when companies get really big,
their growth rates slow down). To the extent that the new tax law
tempts growth companies into paying dividends, it will do those
companies a disservice, since they are better off retaining and
reinvesting earnings.
Stock market history seems to be on the administration’s side.
Historic stock indexes show that, from 1900 to 2000, about
two-thirds of the average annual total return on U.S. stocks came
from reinvested dividends. And, after a falloff in the number of
companies paying dividends through the 1990s, there is some
indication that dividends are coming back into favor. A December
2002 article in Fortune magazine tipped investors that
dividends might be the driving factor in the next major investing
trend, and pointed out that some hallmark growth companies (FedEx,
Outback Steakhouse) had recently declared dividends.
Mr. Bush may be getting out in front of a nascent trend, always
a good thing.
Further, far from being a “break for the rich,” dividends have
always been a terrific tool for the little guy. Today’s popular
“DRIP” programs — dividend re- investment plans, offered by
hundreds of companies — allow investors to buy stock, even a few
shares at a time, completely free of commissions, then re-invest
the dividends automatically in more stock. And the Democrats’
objection about most people owning stock in already tax-exempt
plans falls apart as the population matures. Qualified plan holders
are required to take their money out by age 67 and a half. What do
you do with it then? The Bush plan creates an attractive new,
tax-free income vehicle for distributed senior savings.
Finally, look at the landmarks of recent financial history.
Every tax cut has led to tremendous market gains, every one: The
creation of the IRA, the creation of the 401(k), the Tax Reform Act
of 1984. Indeed, the lesson of the IRA and the 401(k) is that a new
tax-free investing vehicle makes an impact perhaps ten times as big
as politicians think it will.
People like tax-advantaged investing vehicles. Lots and lots of
people like them. Enough to turn an economy completely around?
It has happened before. My guess is, it will happen again.
