Next Up Previous Contents Index
Next: Is interest more Up: Pay dividends? Previous: Pay dividends?

Why not dividends?

Why on Earth should an investor object to receiving income from his stock? Let's review why dividends have fallen out of favour. First and foremost is the notorious ``double taxation of dividends'', a fixture of United States tax policy for decades. Dividends paid by a corporation to its shareholders are not deductible from the company's corporate income tax, whereas interest payments to bondholders are fully deductible. Dividends constitute taxable income for the recipient, so the original corporate earnings are taxed twice: first at the corporate tax rate before the dividend is paid, then again at the shareholder's tax rate.[Footnote]

Let's consider the ultimate disposition of a dollar of sales collected by a company. We'll assume the company pays a marginal tax rate (federal plus state) of 40% and that the investor holding the company's stock or bonds is an individual also taxed at a 40% marginal rate. If the company takes the dollar and reinvests it in the business by spending it, for example, on an expense item such as payroll or rent, the entire dollar is deductible and hence is applied to the benefit of the company. Of course the dollar, by being spent, is no longer a dollar of earnings reported by the company; publicly held companies expected to report rising earnings and stable margins must balance spending additional dollars against the earnings expectations of the market. Increasing spending also assumes that the expenditures will increase the value of the company. As we have seen, increased spending does not contribute to the position of a New Technological Corporation as reliably as for more capital-intensive businesses, except if the company can obtain a better market position by increasing marketing and sales expenditures.

Editor: John Walker