The Dividend Tax Cut: The Right Questions - The American Spectator | USA News and Politics
The Dividend Tax Cut: The Right Questions
by

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.

Sign up to receive our latest updates! Register


By submitting this form, you are consenting to receive marketing emails from: The American Spectator, 122 S Royal Street, Alexandria, VA, 22314, http://spectator.org. You can revoke your consent to receive emails at any time by using the SafeUnsubscribe® link, found at the bottom of every email. Emails are serviced by Constant Contact

Be a Free Market Loving Patriot. Subscribe Today!