The Washington Times

OK, small investor, here’s the question you should be asking: Where’s my dividend? In good times, well-run corporations rack up substantial profits. You, the shareholder, are a part owner. Yet, if you’re expecting to see your proportionate share of the earnings from year to year, you are very likely to be disappointed.

The dividend yield on the S&P 500 in 2000 was a mere 1.1 percent, as portfolio manager Steve Stein has noted, and 65 percent of public companies pay no dividends at all. Instead of paying out to the owners, companies hold onto their earnings. The idea is that if they put those retained earnings to good use, the result will be an increase in the value of the company – in other words, the price of its stock will rise and owners will benefit that way.

But that’s not the real reason your grandma isn’t getting any income from the little nest egg she and gramps scrimped to put together. The real reason is taxes. Corporations pay taxes on earnings at a top rate of 35 percent. In 1999, there were about 4.9 million corporate returns in all, according to IRS figures. Net income for that year was $929 billion. Taxable income amounted to $694 billion. Corporations were due to pay $242 billion in taxes, about 35 percent, before taking the available credits, which reduced the amount to $193 billion – about 28 percent of taxable income, or just under 21 percent of net income.

The problem is what happens next: When companies pay dividends to their shareholders, the people who receive them pay tax on them at the top rate on their individual income tax returns. The highest such rate is 38.6 percent. If you’re paying at that rate and you look at a dollar a company you own a share in has made in net income, off comes 21 cents for corporate tax and then another 39 cents for individual income tax, or about 60 cents, leaving you with 40 cents. Looking at that tax bite, you might well be satisfied to let corporate management hold onto and reinvest 79 cents rather than pocket a mere 40 cents.

Would you do better investing 40 cents than the company would investing 79 cents? True, you have to wait for the success of corporate management’s investment decisions to be reflected in a higher stock price. But that’s worth the risk, isn’t it? It’s your dollar; why give an extra 39 cents of it to the government?

But wait. That top rate of 38.6 percent kicks in at a taxable income level of just over $300,000 for married taxpayers filing jointly in 2002. For taxpayers married filing jointly with incomes of $46,700 or less – grandma and gramps-range, maybe – the top rate is 15 percent. That dollar of earnings here translates into not a mere 40 cents in the hand of the taxpayer but 64 cents [the corporate tax is still 21 percent, but the individual rate added on is 15 percent, for a total of 36 cents out of the dollar].

So, would you rather have 64 cents of your own to invest or would you rather have the company invest 79 cents for you? That still gives the company an edge. But the difference is nowhere near so overwhelming.

And here’s another point about grandma and grandpa: They aren’t necessarily all that interested in the proposition that retained earnings result in a higher stock price in the long run. Their time horizon is likely to be a little shorter than that of a top-bracket taxpayer in his 40s. They might be thinking not in terms of reinvesting , but in terms of buying a little improvement in quality of life in the here and now.

The problem is that the calculation driving the top rate [as well as the 35 percent rate, the 30 percent rate and arguably the 27 percent rate, which kicks in over $46,700, the steepest rise in rates in the code] is the one that chiefly drives corporate decision-making. The logic there is overwhelming: It makes no sense not to forgo dividends and instead retain most if not all earnings. I don’t have figures at hand, but I imagine that by a good margin most shareholders are paying a top rate above 15 percent.

But not all. The upshot is that your grandma never sees a cent in dividend income. The double taxation of dividends, at the corporate and individual level, keeps money out of her pocketbook. The irony is that because the rich would pay high taxes on dividends, dividends do not get paid, so those less well-heeled – who would benefit more from receiving the same dollar in dividends, because they pay taxes at a lower rate, and who might have real use for the money – get nothing.

The problem with dividends is that they don’t get paid. It’s time to democratize corporate earnings by letting corporations deduct dividend payments.