Politics & Policy

The Dividend Revolution

This Bush incentive will change business and investing as we know it.

President Bush’s plan to abolish the double tax on dividends can rescue the stock market and investor wealth, liberate shareholder rights and democratize corporate governance, spark a new economic cycle of expansion and prosperity, and fund the war on terror. All this? Yes indeed.

Dividends paid to shareholders slowed markedly during the last two decades, in part because of the double tax on dividends. After peaking at a 14% annual rate in 1980, dividend growth has slowed to only 4% today.

However, between 1980 and 2000, stock-market indexes grew by leaps and bounds. The S&P 500 experienced a price appreciation of 870% in this period, while the S&P dividend yield dropped from 5% to 1%. This was the age of capital gains — the emphasis was securely on corporate earnings forecasts and stock-price appreciation rather than dividend payouts to investors.

It was a nice period, to be sure. The cap-gains era had a splendid final run, right up to the tech crash of 2000. But ever since, stock markets have been unable to get out of their rut.

Today, demoralized investors have given up hope that there will ever be additional capital gains — or increases in the value of their investments — from a steady rise in the stock market. Earnings forecasts have been devalued to the point of worthlessness. Just as the euphoric wave of optimism went too far in the last decade, the recent wave of pessimism has gotten way out of hand, producing the current psychology of suspicion, cynicism, and disbelief.

But all this will change with the dividend incentive provided by President Bush. Shareholders will now clamor for tax-free dividend payouts, and to a great extent CEOs will be forced to deliver rising dividends to attract shareholder interest.

Investors, meanwhile, will take their tax-free dividend checks to the bank. This is real money, and it will become the new currency of investing. Old capital will be unlocked and new money will be unleashed. As investors keep more of their shareholder stake and the federal government keeps less, resources for investment — as well as the animal spirits of investors — will be resurrected. Moribund markets for venture capital and initial public offerings will also reawaken. New risks, ventures, equipment, buildings, and jobs will lead a new cycle of expansion and prosperity.

Corporate ethics will be resurrected, too. In far too many cases modern CEOs have behaved like dictatorial Napoleons rather than democratic Jeffersons. Instead of sending a larger chunk of earnings back to the shareholders, imperial CEOs have hoarded cash for nonsensical acquisitions.

Sometimes, these self-appointed empire-builders put their hands in the cookie jar, stealing shareholder returns. Along the way they took on huge debt burdens that later crippled operations or led to bankruptcy. Capital losses, not gains, were the result.

In this sense President Bush has emerged as a shareholder-emancipating leader. By taxing corporate profits only once by abolishing the tax on investor dividends, he will liberate shareholder rights and bring democracy and accountability to the corporate suite.

Ironically, tax-free dividends for investors will also resurrect stock prices, and hence capital gains. But share prices will rise the old fashioned way. For most of the past two centuries, according to Professor Jeremy Siegel of the University of Pennsylvania, rising dividend yields were the principal driver of 7% long-run stock-market returns. There’s no reason to believe this won’t happen again.

Right now, roughly 85 million Americans own stock. This isn’t a country-club revolution, it is a Main Street phenomenon, and it will be super-charged by the return of serious dividends. A full 45% of dividend recipients today make less than $50,000 a year, and two-thirds make under $100,000. So Bush’s plan is hardly a tax-break-for-the-rich scheme, as Democrats now call it. More, the overall Bush tax-cut plan directly benefits a wide spectrum of wage earners. A family of four making $40,000 a year gets a $1,100 tax break under this plan, virtually wiping out their yearly tax burden.

The increase of secure dividend payouts will also draw more people to the stock market. This will raise stock values and halt the debilitating bear market of the past three years. As more investors receive bigger dividends, stock prices will be stimulated upward. It follows that the federal government will receive more revenue from the taxes it collects on capital gains and corporate profits.

We saw a similar situation a few years back. Between 1997 and 2000, as the marginal tax rate on cap-gains descended from 28% to 20%, cap-gains tax collections increased $60 billion — a doubling. Today, that $60 billion figure would finance the anticipated war in Iraq, according to OMB director Mitch Daniels.

In view of all this, Congress simply cannot afford to reject President Bush’s tax-free dividend revolution. The biggest risk, and the harshest penalty, will accrue to those elected officials who choose to do nothing.

Mr. Kudlow is CEO of Kudlow & Co.


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