Chaos by Incentives – Part 3

Thesis: Corporations would be better managed, have higher and more stable growth, the jobs of employees would be more secure, and overall shareholder returns would be higher if corporate dividends were tax-free and capital gains were taxed at a flat rate of 20% regardless of income.

Dividend paying companies are more stable. They have less volatile share prices and less fickle shareholders. Research has shown that on average they also deliver higher overall returns than non-dividend paying companies. What’s not to like?

Well, for one thing, fast growing companies need all the cash they can get to finance organic growth. That’s fine as long as they recognize the approaching end of their fast growth phase and begin the transition to paying dividends.

For another thing, the tax code favors capital gains over dividends even now that both dividends and capital gains are taxed at 15%. Dividends are paid from after tax net income and are immediately received by the shareholder as taxable income. Whereas when the company reinvests its net income the investment becomes either a deductible expense or a depreciable capital investment.

Despite the continuing double taxation of dividends when the 2003 tax cuts reduced the dividend tax rate to 15% many companies started paying dividends for the first time.

Tax policy should favor dividends over capital gains in order to encourage corporate stability, prudent management, organic growth, and productive investment. Dividends should be tax free to shareholders without punishing capital gains.

A 0% tax rate on dividends and a 20% rate on capital gains would set off a wave shareholder demands for more companies to pay dividends and the naturally accompanying corporate stability.

Links to Other Posts in the Special Report: "Chaos By Incentives"