The Heritage Foundation

WebMemo #207 on Taxes

February 14, 2003

February 14, 2003 | WebMemo on Taxes

Bush Plan Boosts Stock Market, Helps Recover Losses

The 84 million Americans who own equities have suffered steep losses over the last few years.  The Dow Jones Industrial Average fell 7.1 percent from December of 2000 to December of 2001, and another 16.8 percent from December of 2001 to December of 2002.  For these two years combined, the Dow has dropped just over 22 percent.[1] One good way to reverse this trend would be to eliminate the double tax on dividends.

Many economists have noted that eliminating this double tax is likely to boost the stock market, helping people recover much or even all of their recent losses ? even if the stockholders don?t currently pay taxes on dividends (such as IRA holders).  This means that Americans who assume they will have to delay their retirement because of their shrinking IRA or pension fund could see their retirement plans become real again.  Here?s a sample of what these economists are saying:

  • Lynn Reaser, an economist with Banc of America Capital Management, predicts eliminating the double tax on dividends could boost the stock market by as much 10 percent.[2]
  • White House economist R. Glenn Hubbard estimates that repealing the double tax could increase equity values by up to 20 percent.[3]
  • Some observers focus on the all-important psychology of Wall Street: "A cut in dividend taxes ? could help to lift some of the gloom on Wall Street," says Greg Valliere at Schwab Washington Research. "It would be quite positive, quite quickly for the stock market."[4]

A 10 percent increase in stock values, due to the dividend tax repeal, would enable the average stockholder to recoup 45 percent of the typical portfolio decline during 2002.  A 20 percent recovery in values would mean the average portfolio would recover 75 percent of the 2002 loss, and just over 57 percent of the losses from the last two years.[5]

 In other words, one of the most positive and immediate actions that Congress and the President could take to restore investor confidence and portfolio value is eliminating the double taxation of dividends.

 
Footnotes

[1] Grace Toto, ?Monthly Statistical Review,? Securities Industry Association Report, Vol. IV, No. 1, January 31, 2003.

[2] ?Can a Dividend Tax Cut Juice Growth??, January 3, 2003, at http://www.businessweek.com:/print/bwdaily/
dnflash/jan2003/nf2003013_6478.htm?pi
  

[3]Same source as number 1.

[4] Mary Thompson, ?Dividend Tax Cut Would Bolster Wall Street,? January 6, 2003, at http://moneycentral.msn.com/content/CNBCTV/
Articles/TVReports/P37293.asp
.

[5] These estimates assume the typical portfolio is invested 50% in a diversified mix of equities, 30% in Aaa rated corporate bonds, and 20% in short-term securities. The return used for the corporate bond portion of this portfolio was the Moody?s Aaa corporate bond annual return as of February 13, 2003, 5.99%. The return used for the short-term securities portion was the rate on a 10 year U.S. Treasury security as of December 2002, 4%.  The above estimates assume that the corporate bond and Treasury returns will remain unchanged from these levels.  These estimates are for illustrative purposes only and should not be used to make investment decisions.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies