Why would ending the double tax on dividends encourage economic
growth and thereby benefit most Americans?
To understand why, it is helpful to imagine being a corporate
manager. Before investing in buildings, equipment and machinery,
managers estimate their expected profits using a concept known as
the "hurdle rate." How exactly does this work?
To estimate a project's return (or profit), managers compare the
amount of money they expect the project to bring in to the cost of
the funds (the capital) needed to undertake it. To be profitable,
therefore, the project's rate of return must be greater than the
firm's cost of capital. Otherwise, the project would be expected to
lose money and, as a result, not be carried out.
The firm's cost of capital, therefore, is the hurdle rate - the
cost that must be exceeded for a project to be profitable. The
hurdle rate can also be thought of as the minimum profit the firm
has to return to its investors. When a project's rate of return is
greater than the firm's cost of capital, it clears the hurdle rate;
the project will be undertaken because it is profitable. This is
why dividend taxes are so damaging. Dividends represent a part of
the firm's cost of capital. When investors buy stock, they expect
to receive dividends.
dividends that have to be paid to investors, therefore, represent a
part of the firm's cost of capital. Consequently, lowering the tax
on dividends will make it easier for managers to return money to
investors because it lowers the cost of doing business and
undertaking new activities.
cost of capital falls, business managers will increase their firm's
investment in equipment and buildings. Increasing investment
frequently results in new jobs, and these new jobs and the new
purchases of business mean higher incomes for many more people than
those who work directly for the business manager. Over time, these
effects of lowering the cost of capital through ending the double
tax on dividends leads to higher economic growth and widespread