McKinsey on Dividend Taxes

McKinsey is one of the top, many say the best, management consulting firms–hardly a left-wing industry. Among their various activities, they distribute a newsletter, The McKinsey Quarterly. In the latest issue, they have a short piece entitled Eliminating the double taxation of dividends is more notable for what it won’t do than for what it will (free registration required). This is an exressly non-political piece that speculates about the implications of eliminating the dividend tax from the management perspective. In my series on dividend taxes (see top left of the sidebar), I argued that eliminating dividend taxes would increase the pressure on managers to distribute funds to shareholders and this would be a good thing because the alternative to paying dividends is often money wasting mergers and acquisitions. Making reference to this theory, the McKinsey newsletter says

We doubt all this. The proposed tax cut, when viewed with an understanding of the shareholder makeup and share price movements of US companies, seems unlikely to have a significant or lasting effect on US share prices. Moreover, history and practice suggest that if the proposal becomes law, most US companies will not—and should not —change their dividend policies significantly.

What? Was Angry Bear wrong? No, not really, a little later in the story they explain why:

…But the proposed tax cut isn’t likely to have a major lasting effect on US share prices, primarily because the key investors who drive them are already exempt from taxes. [emphasis mine]


…tax-paying US individual shareholders own a minority of all US shares—28 percent in 2002, whereas tax-exempt US institutions and individuals who hold shares in tax-exempt accounts owned 61 percent. (The remainder was in foreign hands.) For the most part, tax-paying individual shareholders don’t drive share prices, whereas nontax-paying institutional investors do: the trading activity of a company’s top 40 to 100 investors—again, usually big institutional investors—accounts for 70 percent of its stock price movement.

The point: don’t believe that the dividend tax cut will fix your 401k or other retirement savings. Those funds are already tax exempt so there is no direct benefit. And if you thought that eliminating the dividend tax would lead to a stock market boom and reverse the losses you suffered from 2000-present, think again. And in this case, it’s not (just) me saying it, it’s a top management consulting firm. One more line from the newsletter report: “In the end, the proposed tax cut will not have a significant impact on the wealth of investors or the behavior of managers.”