Subject: RE: a stocks and dividends question
From: "Benjamin J. Tilly " <>
Date: Fri, 10 Jan 2003 22:27:51 +0500

"Jerry Dwyer" <> wrote:
> ---------- Original Message ----------------------------------
> From: "Larry M. Augustin" <>
> Reply-To: <>
> Date: Fri, 10 Jan 2003 06:39:23 -0800
> >
> >The key point in this thread (and I would agree) is that taxing dividends
> >differently distorts corporate behavior by discouraging dividends.

Is there just one key point?  Another key point is that whatever the
rhetoric, this proposal is mainly about finding another way to
flatten the tax structure in a way amenable to people of Bush'
socioeconomic status.

> Another way of saying it is that, given the progressive structure
> of the personal income tax, the best solution ignoring
> tax-enforcement problems would be to impute all corporate net
> income to the stockholders and let stockholders pay personal
> income tax on that imputed net income. Costs of collecting the tax
> can make it cheaper for the IRS to collect the tax from the
> corporation instead of individuals, which creates the present
> proposal.

In an ideal world this might make sense, but note that it means that
stockholders would pay tax on the income of the company, and not
just that portion paid out in dividends.

However I am not so sure that I agree with the theory in practice.
As it stands I believe that if I own a personal business, turn it
into a corporation, continue to own the corporation, and accept
dividends from my corporation, then I pay extra tax.  Once for the
corporation turning a profit, once for the dividend.  On the surface
this is unfair, OTOH the extra tax can be seen as society's way of
charging me for the various legal advantages of the corporate
structure.  Seen in that light the deal is not so bad - so much so
that intelligent businessmen routinely accept the bargain!

So what is the pressing need to sweeten the bargain further?

> The current situation involves relatively high tax rates on
> corporate income distributed as dividends. The corporate income
> tax rate is not all that different than the higher rates for
> individuals. The corporate tax rate plus the federal personal tax
> rate is very high indeed -- on the order of 70 percent. Some of
> this can be avoided by not paying dividends and buying back stock.
> Investors then can sell some of their stock to collect cash and
> pay a 20 percent tax rate. It's even better than that to use a
> buyback because the stockhoder gets to decide when to "realize"
> the income and pay the tax. The capital-gains tax need not be paid
> until the stockholder wants the funds. Personal income tax is paid
> when a dividend is received (even if it is reinvested in the
> company by buying more stock).

What you are saying would be more reasonable if large corporations
did not routinely manage to manipulate their income in such a way
that they don't generally pay tax.  So we are trading an ideal idea
of collecting income tax from the centralized corporation for a
practical reality of collecting no income tax at all.  No wonder
large stockholders like this idea!

> Dividends appear almost dollar for dollar in stock prices. When a
> dividend "occurs", i.e. the stockholder as of that minute will
> receive a check and later holders will not, the price falls by
> about the amount of the dividend. Sometimes prices rise or fall
> later, which does not affect the argument. The stockholder can
> sell right before the dividend and get a higher price or the
> stockholder can sell right after the dividend and get the dividend
> and a price lower by the amount of the dividend.
This is true.  And using this we can put an estimate on the value of
this change to the stock market.

Dividends are charged at, according to other claims in this thread,
an actual tax rate of around 40%.  In reality the wealthiest
stockholders have various ways to avoid being taxed what you would
think they should be, and of course much stock is owned in various
tax-free pension plans, so it is somewhat lower than this.  But we
know that stock buybacks are taxed at a capital gains rate of 20%,
and since presumably well-informed companies sometimes use one and
sometimes use the other, I will assume that 20% is a reasonable
figure for what actual shareholders pay in tax on money returned to

The present value of a stock to me, the stock holder, is the sum of
the present values of the revenue streams that I expect to get.  The
present value of the revenue stream is the value I get then, divided
by what I could earn with safe investments, modified with an
additional factor for my personal attitude towards risk.  Note that
the value I get then depends on the tax rate.  If I eliminate a
20% tax, I get 25% more on each payment.  And if each future payment
in that revenue stream increases by 25%, then the present value of
that revenue stream increases by 25%.  (I am - obviously - ignoring
the second-order effects of how this tax change changes the future
prospects of companies to make money.  I am, shall we say, somewhat
less convinced of the overall benefit here than current Republican
wisdom would hold.  Money cycled through the government still cycles
through the economy as a whole...)

Therefore if investors are rational, they should realize that this
change means a 25% increase in the present value of what they expect
to get from stocks relative to any other kind of investment.  This
increase will not, of course, hit all on the day that the bill is
signed.  It will fluctuate in and out as the market reassesses the
likelyhood of getting the bill through.  And fluctuate some more as
other events hit the market.  But 25% is OK for a back of the
envelope estimate of what this means.

To get a dollar estimate all that I need is the total market value
of the US equities market.  I don't know where to get that, but
according to the S&P 1500
is 87% of the total equity markets, and according to the total market
value of that 87% is 9,135 billion.  So the total market value of
the US equities market is on the order of 10,500 billion, making
my back of the envelope estimate for the current value of wealth
redistribution this year from this tax change at around 2,625
billion.  And the total wealth being redistributed is certainly NOT
evenly distributed through our society...

Now whether this is a good or bad thing depends upon ones political
and economic views.  The people receiving this wealth would have you
believe (and often believe themselves) that this redistribution from
estimated future government taxes to current stockholders will
result in great wealth creation to the benefit of all.  Of course
the same has been said for each of many tax cuts in the last few
decades.  And the end result of this appears to be that the median
family makes about what it used to make, but has both parents
working, and buys goods and services (eg prepared food) that used to
be produced at home.  This decrease in average lifestyle has been
accompanied by a huge stratification between the rich and everyone
else.  (A stratification which my family has, on the whole, done
fairly well from.)

Of course there are many, many factors that feed into this trend.
However at some point I personally start to wonder whether or not
coincidence might have alternate explanations...

And that is quite enough politics on fsb from me for at least the
next month.

Apologies for the rant,

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