Benefits of Eliminating Double Taxation of Dividends
January 10, 2003
The current tax treatment of dividends has had two undesirable effects, economists point out.
- First, it has encouraged a dangerous build up of debt at the expense of equity financing.
- Because interest is tax deductible to businesses, the cost of debt financing is made artificially low relative to equity financing -- and firms are encouraged to adopt a leveraged capital structure.
- And these high debt levels make the economy less stable.
Second, the tax system has encouraged a dramatic change in corporate dividend behavior.
- To the extent that stocks are held outside of tax-advantaged retirement plans, dividends are taxed at regular income-tax rates, while capital gains are taxed at much lower rates if realized.
- More important, the tax on unrealized capital gains is deferred and can be eliminated completely if stocks are bequeathed to one's heirs.
- Members of employee stock-option programs do not receive credit for dividends paid -- but do benefit if funds are used to buy back shares creating capital gains.
The system creates distortions, not the least of which is to give corporate managers an incentive to retain earnings.
By eliminating the personal income tax on dividends, the tax system will become more even-handed in the treatment of debt and equity. It would also lead to a powerful rally in stock prices and do much to lift the uncertainty of both consumers and corporate managers.
Source: Burton G. Malkiel (Princeton University), "The Dividend Bounce," Wall Street Journal, January 9, 2003.
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