Paying Dividends
Microsoft's announcement Tuesday of the largest dividend payout in history, $32 billion, followed by a 2% jump in its share price yesterday, is one of those headline-making events that illustrates a larger change. Reacting to last year's tax cut, American companies and investors are rediscovering the virtues of the dividend, which in turn is encouraging investment and powering economic growth.</br></br>The timing of the Microsoft decision tells us something. In paying out a hefty chunk of its cash hoard to shareholders in December, the company was clearly concerned with the possibility that John Kerry might be elected President and carry out his promise to return dividends to their former status as ordinary income (thus raising the dividend tax back to the nearly 40% Clinton-era top rate from today's 15%).</br></br>That sensitivity to change in the tax code jibes with statistics showing that other companies have also reacted to the new incentives. A new paper published by the National Bureau of Economic Research documents that the number of firms paying a regular dividend, which had declined steadily for the past two decades, started to rise precipitously last year. Authors Raj Chetty and Emmanuel Saez show that the aggregate level of dividends also jumped, as companies already paying them increased the amounts. The American Shareholders Association has noted the same phenomenon.</br></br>Why is this common sense observation significant? Well, the critics of the Bush dividend tax cut said it wouldn't happen. They argued that corporations don't consider the taxes that their investors face when making decisions about whether to retain earnings or pay them out. Furthermore, stock prices wouldn't be affected. There would thus be no net effect on the level of investment in the economy. The Bush Administration, in this view, was simply putting money into the pockets of the rich without any benefit to the wider economy.</br></br>Well, just as the rising level of dividends and Microsoft's behavior give the lie to this theory, it's worth noting that the stock market hit bottom in March 2003 and began to recover once the tax cut looked like a political certainty. It passed in May. Stock prices reflect the present value of future corporate earnings, and if investors are able to keep more of those earnings it's no surprise that they would value stocks more highly.