Investment Warrior Report Archive Article

The Plain Truth About Dividends

President Bush has proposed dropping the taxation of dividends paid to shareholders of stocks. Is this proposal one that only benefits the rich? Just what is a dividend anyway, and are there other far reaching benefits that such a tax cut would produce for the health of the economy? Just what is the Plain Truth of this issue?

Dividends are payouts from earnings that are paid in cash to shareholders of common stock. The ratio of this payment to the stock price is known as the Dividend Yield. Historically (since 1926) , nearly half of the total return of the stock market was from the dividend yield. This return has been as important as price appreciation. On average the dividend yield has approached 5% historically, with a yield as high as 7.5% in 1950. As recently as 1990, stocks were yielding 4% on the Dow Jones Industrial Average. Since 1990, yields have consistently dropped and are now historically low at approximately 1.5%. 

The main reason for the drop in dividends has been the pressure from shareholders to have the companies retain earnings and not pay a dividend because of the issue of taxation. Dividends are taxed as ordinary income. Capital appreciation is taxed only when realized, and can qualify for long term capital gains. Not only does the individual pay taxes on dividends, but the company itself has already paid taxes on the earnings as well. It is estimated that over 50% of paid out profits of US corporations are taxed, when figuring both the corporate and individual taxes paid. Hence the current argument and movement to drop the dividend tax and its inherent "double taxation". 

The benefits of dropping this tax are many. Because corporations are retaining earnings rather than paying dividends, they must reinvest the capital. Over expansion, and acquisitions outside of the key business core have been the norm, and the results many times are bad business decisions and a dilution from the companies key market niches. Furthermore, since dividends have to be paid in "cold hard cash", less accounting shenanigans concerning earnings can occur. The dividend yield would become a very accurate indicator of corporate health and value. 

Is the elimination of a dividend tax a windfall only for the so called rich? I find such statements ridiculous, especially in the light of the fact that more than half of American households are owners of stocks! An elimination of the dividend tax will help restore sound business practices, expansion and accounting integrity for American businesses, and would end an unfair double taxation on profits paid to shareholders, who represent more than 50% of American households.