NCPA - National Center for Policy Analysis


September 21, 2004

The Job Growth and Taxpayer Relief Reconciliation Act of 2003 (JGTRRA) substantially reduced the individual income tax burden on dividends. It also reduced tax rates on capital gains from the sale of corporate stock.

Before JGTRRA, an individual investor in the top federal income tax bracket received after-tax dividends equal to 61.5 percent of his pretax dividends. After-tax capital gains, by comparison, were at least 80 percent of the pretax gain.

Proponents of tax relief argued that lowering the dividend tax would raise corporate payout by reducing the cost of paying dividends and that would encourage investment. A new paper from the National Bureau of Economic Research analyzes the effects of the 2003 tax cut. The author finds that dividend payouts did increase:

  • The enactment of the 2003 tax cuts raises the after-tax value of dividends relative to capital gains by more than 5 percentage points.
  • The net increase in dividends paid by S&P 500 firms was 38.7 in 2003, but only 29.8 percent in 2002 and 30.2 percent in 2001.
  • Based on historical patterns of corporate behavior, he predicts that the tax cuts will ultimately increase dividends by almost 20 percent.

The author also suggests that the tax cuts should increase stock prices. If the stock market capitalized the dividend tax cut in the same way that it capitalized other earnings, the implied increase in stock market value would be approximately $690 billion, or roughly 6 percent of the $11.4 trillion aggregate value of U.S equities at the end of March 2003.

Source: Les Picker, "Taxation and Corporate Payout Policy," National Bureau of Economic Research, NBER Digest, May 2004. Based on: James Poterba, "Taxation and Corporate Payout Policy," National Bureau of Economic Research, Working Paper, No. 10321, February 2004.

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