"We fail to find much, if any, imprint of the dividend tax cut news on
the value of the aggregate stock market," the economists -- Gene Amromin,
Paul Harrison, Nellie Liang and Steve Sharpe -- wrote in a paper they presented
in October.By KAREN RICHARDSON
Staff Reporter of THE WALL STREET JOURNAL
December 6, 2005; Page C3
When President Bush slashed the tax on dividends in 2003, supporters hailed the move as a way to stimulate the economy and boost the stock market.
At least for the stock-market part of that plan, the jury is still out. A group of Federal Reserve Board economists concludes that the tax cut, which slashed the dividend-income tax on stocks to 15% from about 30%-38%, was a dud when it came to boosting the stock market when it was announced and passed in 2003 -- a time period, they say, that the stock market should have reacted most strongly.
Nor did the tax cut lead to a significant increase in the amount of money companies paid out to investors as a proportion of their earnings, the study adds.
"We fail to find much, if any, imprint of the dividend tax cut news on
the value of the aggregate stock market," the economists -- Gene Amromin,
Paul Harrison, Nellie Liang and Steve Sharpe -- wrote in a paper they presented
in October.
Administration supporters point to the 2003 tax cuts on dividend income and long-term capital gains (also reduced to about 15% from about 20%) as successful centerpieces of President Bush's economic policy. White House officials already are lobbying for an extension of the tax cut, which expires in 2008. The White House budget office, in a memo to the Senate in November, said the extensions are "necessary to provide certainty for investors and business and are essential to sustaining long-term economic growth."
The Fed economists' paper compares U.S. stock-market returns with those of European stocks over various "key periods" in 2003. The economists tracked stock performance during a few days in early January, after the Bush administration officially announced the tax-cut proposal, and two weeks in the latter half of May, when the tax bill was being discussed in the Senate and was eventually signed into law by the president May 28.
While those "event windows" are small, they are sufficient to capture the stock market's reaction to news of the tax cuts, the economists say. "The markets should have absorbed the tax-cut news within a month, if not a week or a few days, afterward, since markets are somewhat efficient in responding to news," says co-author Mr. Sharpe.
Theoretically, U.S. stocks should have performed better than European stocks because U.S. investors, who hold far more U.S. stocks than European stocks, would benefit from the tax cut and presumably drive up stock prices with their new expected windfall. Instead, the economists found that the S&P Euro 350, which covers about 70% of Europe's market capitalization, performed similarly to or better than U.S. stocks tracked in the S&P 500.
The authors assumed that the anxiety of the impending war in Iraq was the main influence on all stock markets around the world over those periods. So by comparing European stocks with U.S. stocks, they aimed to control for major world events. Thus, "any effect of the dividend tax should have resulted in a differential in performance," according to Mr. Sharpe.
Still, the economists didn't address other factors that might have contributed to a rise in European stocks or a drop in the U.S. market during the review periods.
For example, in the U.S., a stock-market rally in early January that some observers at the time said might have been driven by the tax-cut news ended after a few days when aluminum giant and Dow Jones Industrial Average component Alcoa Inc. reported bearish fourth-quarter results. Also, a terrorist bombing in Saudi Arabia in mid-May rattled the U.S., along with concerns about the weak dollar. Meanwhile, some Europe firms were reporting strong earnings.
While more companies paid out dividends in 2003, they didn't increase their average total payouts to shareholders as much as they have in the past. The authors found that 66% of S&P 1500 firms increased their total payouts to shareholders that year -- through some combination of dividend payouts and share-repurchase programs -- compared with the average of 89% that did so in the period of 1993 to 2002.
"The dividend tax cut did prompt a substitution from repurchases to dividends, but the effect on total payouts was much more muted," the authors conclude.
Other market observers see it differently. The dividend tax-cut has "definitely" helped to stimulate the stock market, and has contributed to the slow but steady increase of dividend payouts this year, says Howard Silverblatt, equity-market analyst at Standard & Poor's.
According to Mr. Silverblatt's research, the tax cuts on both dividends and long-term capital gains will result in individual investors saving a total of $114 billion from 2003 to 2008. "We believe a lot of that will filter back into the stock market," he says, pointing out that investors often reinvest their windfalls in other stocks.
Also, a Thomson Financial model shows that dividend tax cuts should theoretically result in higher stock-market returns each year, while, not surprisingly, higher tax rates should lower returns. However, Michael Thompson, director of research at Thomson Financial, cautions that attributing stock-market gains to one isolated factor risks being "intellectually dishonest."
Write to Karen Richardson at karen.richardson@awsj.com