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This section of the article is great: > Over time, share repurchases became a substitute for dividends. Managers rationalized the practice by saying they were
by MrPowers 6y ago
This section of the article is great:
> Over time, share repurchases became a substitute for dividends. Managers rationalized the practice by saying they were doing shareholders a favor: Dividends were taxed as ordinary income, whereas capital gains were taxed much more lightly. Moreover, capital gains taxes weren’t payable until shares were sold, while taxes on dividends had to be paid annually. Assuming a share repurchase raised share prices by the same amount as would be the case if the money were paid out as a cash dividend, taxable shareholders would prefer share buybacks.
Dividends are taxed as ordinary income and the top marginal income tax rate was incredibly high at various points in history (94% in 1944 and more than 50% till 1986). Capital gains taxes are lower so the government has given corporations a massive incentive to pay less dividends.
The article is very critical of corporations, which is fine, but let's not forget about the bizarre incentives that governments give, for no apparent reason. "Managers rationalized the practice by saying they were doing shareholders a favor" could easily be rephrased as "Corporations were pressured to change shareholder payouts due to tax laws...".
Angelo Mozilo's story is a great example of misaligned incentives and minimal consequences: https://en.wikipedia.org/wiki/Angelo_Mozilo https://en.wikipedia.org/wiki/Angelo_Mozilo
Buffett has a great criticism of stock option compensation: https://www.nytimes.com/2002/03/11/business/stock-options-are-faulted-by-buffett.html https://www.nytimes.com/2002/03/11/business/stock-options-ar...
- zoolily 6y agoWhile unqualified dividends are taxed as ordinary income, qualified dividends are taxed at much lower rates. Qualification status basically requires you to have owned the stock for a couple months. You can see the details in layman's language at https://www.nerdwallet.com/blog/taxes/dividend-tax-rate/ https://www.nerdwallet.com/blog/taxes/dividend-tax-rate/
- MrPowers 6y agoThis is a great point, thanks for commenting. Still thing my main point stands, but more because capital gains taxes can be deferred. It's amazing how convoluted / confusing dividend taxation is.
- beezle 6y agoThat is not entirely true. For instance, from 1954 to 1967, the maximum capital gains tax rate was 25%, while marginal income rates were very high. Yet companies paid good dividends (prior to 1960 the market dividend yield was consistently above 3%) Also, much of the investment in the stock market is in non-taxable accounts and not subject to capital gains or ordinary income taxes until funds are paid out.
- bleepblorp 6y agoThere's a reason governments give out bizarre capital gains incentives: rich people bribe ('lobby') politicians for them. The truly rich receive most of their income through capital gains rather than wage labor, so when the rich lobby for tax cuts for themselves, they lobby for reductions in capital gains taxes.
- nickff 6y agoThe parent is talking about dividend vs capital gain taxation; your comment does not address this issue.
- zentiggr 6y agoGP's comment outlines a pretty solid driver for the CG taxes to be driven lower than dividend rates, so yeah, it does address it. If capital gains rates were required to be equal to the rates on dividends, the incentive toward buybacks and other earnings bypass measures would go away.
- cryptonector 6y agoMany companies pay no dividends and do no share buybacks. The explanation is simple: dividends are taxed every time and are taxed as income, while capital gains are only ever taxed when realized, so if you don't sell, there's no tax! To pay no tax, a capitalist simply pays themselves no income, not even dividends. What if they need cash, you ask? Easy peasy: just borrow against the capital holdings. How to service that debt, you ask? Easy too: just borrow more! As long as you don't consume too much of your capital, so that it continues to accumulate, you win the privilege of paying $0 in taxes. If your capital's value collapses, you'll have a problem (or, rather, your creditors will), so make sure that doesn't happen.
- lostmsu 6y agoI am not sure how does your borrowing scheme work. You have to service the loan after you got it, and to do that you have to sell some of your capital holdings and pay taxes.
- cryptonector 6y agoRe-read what I wrote. As long as your capital grows faster than your debt servicing requirements you can just keep borrowing against your capital.