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Tax Policy and the Dividend Puzzle

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  • B. Douglas Bernheim

Abstract

This paper offers a new explanation of the dividend puzzle, based upon a model in which firms attempt to signal profitability by distrubuting cash to shareholders. I assume that dividends and repurchases are identical, except that dividends are taxed more heavily. Nevertheless, I demonstrate that, under certain plausible conditions, corporations will pay dividends. Indeed, some firms will actually pay dividends, and then retrieve a portion of these payments by issuing new equity (perhaps through a dividend reinvestment plan), despite the fact that this appears to create gratuitous tax liabilities. In addition to providing an explanation for the dividend puzzle, I also derive a number of strong results concerning corporate payout decisions and government tax policy. Some of these results are surprising. For example, the relationship between repurchases and firm quality is hump-shaped. Moreover, despite the fact that a higher dividend tax rate depresses dividend payments, it does not affect either government revenue or welfare.

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  • B. Douglas Bernheim, 1990. "Tax Policy and the Dividend Puzzle," NBER Working Papers 3434, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3434
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