NCPA - National Center for Policy Analysis

Paying Attention to Stock Dividends

September 3, 2002

Many younger investors have never thought about dividends. Rather, they've fixated on capital appreciation of their stock holdings. Dividends largely fell out of fashion because of double taxation -- because corporate profits are taxed first at the corporate level, and taxed again at the individual level, when they are distributed as dividends.

But dividends constitute a contract between a company and its shareholders in which the company promises to share part of its earnings -- year in and year out -- with the shareholders. Especially following doubts about the kind of reported "earnings" that drove stock prices during the 1990s, dividends restore public confidence in stocks. There is now a push to change the tax code to once again encourage declarations of dividends through removal of double taxation.

  • Over the past several years, average dividend yields have fallen from around 5 or 6 percent to 2 percent or less -- and many stocks pay no dividends at all.
  • But dividends can be taxed by up to nearly 40 percent -- while the capital gains rate is only 20 percent.
  • Thus a share buy-back by a company -- which increases capital gains -- is a better deal for shareholders than a dividend.
  • That is why stock options became so profitable to corporate executives and encouraged them to do everything possible to drive up the stock price.

Putting all the emphasis on stock appreciation encourages the excesses in terms of earnings and stock options that have become apparent.

The disappearance of dividends has also created special problems for retirees who must live on income from their investments.

All of these considerations argue for the elimination of double taxation, observers say.

Source: Daniel Yergin, "An Appreciation of the Dear Old Dividend," Washington Post, September 1, 2002.

 

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