NCPA - National Center for Policy Analysis

Another Look at Stock Dividends

August 13, 2002

Economists have been paying increasing attention to the role of dividends -- or, rather, the lack thereof -- in promoting excessive stock options, as well as the problem of double taxation of dividends. It has recently been proposed that taxes be removed when they are imposed at the corporate level and when they are levied on dividends at the personal level.

But some economists argue that this goes too far. They argue that solely granting dividends deductibility from the corporate income tax, while continuing to impose them at the personal level, will remove many the pernicious incentives that have recently become so evident in corporate governance.

  • If dividends were a deductible expense, firms would be strongly motivated to pay out all their profits as dividends -- since retained earnings would be subject to the corporate tax.
  • The payment of cash dividends would add significant credibility to management's earnings reports.
  • It would also eliminate the incentive for management to take on large amounts of debt and risk bankruptcy just to gain the deduction for interest costs.
  • It would halt the increasing number of firms that seek to incorporate outside the U.S. for tax avoidance reasons.

The tremendous increase in dividend payouts would provide investors with billions of dollars of extra dividends to reinvest.

In 2001 corporations paid taxes of $151 billion, or 7.6% of the federal budget. If dividends were deductible, a large part of that revenue would disappear as firms reduce their tax by paying dividends. But the decrease in corporate tax revenue would largely be made up by the increase of personal taxes on dividends.

Source: Paul Gompers (Harvard Business School), Andrew Metrick and Jeremy Siegel (both at the Wharton School), "This Tax Cut Will Pay Dividends," Wall Street Journal, August 13, 2002.

 

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