Thursday, January 16, 2003

Remora

LI hopes the last post wasn't too obscure. We were simply speculating, in our dillantantish way, about what a cut in dividend taxes would mean in terms of changing the landscape of investment. The NYT carries a column on just that subject today, by Hal Varian. Varian starts out poorly, with the wrong set of figures:

"First, we really have become a nation of shareholders. According to "The Rise of the Equity Culture," a paper by the M.I.T. economist James Poterba, the number of individuals owning corporate stock has increased by nearly 60 percent in a decade, with about half of American households now owning stock, either directly or indirectly."



Well, if half of American households own some stock "directly or indirectly" -- indirect ownership, presumably, means that somebody bought it for them and is waiting until a major holiday to give it to them -- or maybe it means that the stock was bought whilst the homeowner was in a somnabulistic fugue -- in any case, these are not the important figures for the potential change to be wrought by the tax cut. While it is possible that small individual portfolios will shift towards stocks that pay dividends, the key stimulus to change for these individuals will continue to be stock price. The gain accrued by the increase of equity value will far exceed any gain from a dividend benefit. The question is, will the two coincide. And that question is not going to be answered by finding out whether Martha and George X , secretary and shoe salesman, are going to shift their one hundred shares of Home Depot stock to fifty of Sears for the nice dividend. No, the real question is whether those who hold a significant amount of stock -- that much smaller percent of stockholders who hold the gross majority of equity -- will also shift from non-dividend paying stocks to dividend paying stocks.

One way of understanding the difference in the figures is to use the difference in the payout from the dividend tax cut to map the concentrations of stockholding. The Brookings Institute has a nice little pdf paper up on the tax cut. Here's a quote from it, concerning ways of measuring the effect of the cut across income percentiles:

"A second measure is the distribution of the tax cut
across income classes. Table 1 shows that households
with income above $200,000 receive more than one third
of the entire tax cut in 2003. A third measure
reports the tax cuts in dollar terms, and is often the
most striking. Returns with income above $1 million
would receive an average tax cut of almost $89,000.
Those with income below $40,000 would receive an
average tax cut of $125 and those with income between
$40,000 and $75,000 receive an average tax cut of $703.
As the program becomes permanent, middle-class households would
lose much of their share of the tax cut with the resources
transferred to high-income groups."

Now, we admit that this is not a roadmap to market-maker heaven. To break up the stockholders into income percentile ignores the aggregation of stockholding effected by mutual funds. It ignores institutional investors. Etc. All those things that make up "indirect" holding. Still, we get better numbers by understanding that most of the holders of equity can be safely ignored. They are merely numerous. This isn't a one man, one vote proposition.

Varian is more up to speed when he considers the effect of the dividend cut on the total financial market. He points out that the cut would undercut the rationale for holding tax exempt government bonds:

"What about municipal bonds? Odds are we would see their prices fall, since dividend-paying stocks would be pretty close substitutes under the Bush proposal. This means the cost of borrowing for state and local governments will be driven up � particularly bad news given their precarious economic position.

"One way to estimate the likelihood of the Bush plan's passing is to watch the prices of municipal bonds over the next few months: the more likely the plan is to pass, the lower those prices are likely to go."

Great. LI hasn't gone into this at any length yet -- oh, the meat and texture of the Bush fiasco! -- but the spending part of the potential Bush budget -- especially the lack of any plan to help states coping with huge budget shortfalls -- is going to bite him in the ass, to use the vernacular.

But we want to concentrate on dividends themselves, right now. In the next post, let's talk about why companies pay out dividends at all.

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