TCS Daily

Completing the Dividend Revolution

By Daniel Clifton - February 28, 2005 12:00 AM

In May 2003, President George W. Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA). The centerpiece of the plan was the slashing of the double tax placed on dividends and the equalizing of the dividend tax rate with the capital gains tax rate. The purpose of the plan was not just to lower the tax burden for investors every April 15th, but to re-encourage companies to pay dividends to their shareholders.

The lower tax rates have now been in place for 20 months and it is clear that companies have changed their behavior in response to the new tax law. 2004 was a record year for dividend shareholders, with more companies initiating and/or increasing dividends and shareholders recovering record amounts of cash. Last year's activity followed a very successful 2003, when companies immediately began returning cash to shareholders following the passage of JGTRRA. This year, dividend increases are running 12.5 percent ahead of 2004's pace, with more record dividend activity expected as the year progresses.

The large increases in dividend payments have forced the Congressional Budget Office (CBO) to admit that the original "cost" of the tax cut to the US Treasury will not be as great as previously anticipated. In fact, a large portion of the tax cut "cost" is actually being recouped from the resurgence of dividends and higher levels of economic growth. The best way to keep this growth moving forward is to make the tax cuts permanent, ensuring the completion of the dividend revolution.

Essentially, the tax cut has resulted in dividend activity in four stages. Stages one and two are now complete, and 2005 marked the beginning of stage three. But until the tax cuts are made permanent, stage four cannot not occur. It is vital that stage four does happen, however, as data showing the early success of the tax cut to date proves the argument that the dividend and capital gains tax reduction provisions should be made permanent.

Stage one of dividend activity was the immediate response following the tax cut as companies sought to readjust their payout policy with the new rates. In July 2003, a total of 179 companies increased their dividend, the most in one month since 1979. Among S&P 500 companies, 44 companies increased their dividends that month, which is nearly a three-fold increase from the 15 companies increasing their dividend in July 2002.

2003 also marked the largest one-year increase in dividend initiations on record as a net 19 companies on the S&P 500 began returning cash to shareholders through dividends. To place this number in context, the last time an increase had occurred was 1994, when there was only a net increase of one company. The largest previous increase over one year was five in 1989. Four times as many companies initiated a dividend in 2003.

Increasing dividend payments and record growth of dividend initiations translated into significantly more cash for shareholders. S&P 500 cash to dividend shareholders increased $12.8 billion in 2003, an 8.7 percent increase, which easily surpassed the historical annual average of 5.8 percent.

The solid performance of 2003 set the framework for 2004, which is stage two of dividend activity. With lower tax rates, the beginning of 2004 represented the first time many companies began to reexamine their dividend policy.

With a slower stock market (due in part to the presidential election and international uncertainty), companies opted to return cash through dividend initiations and increases. A net eight firms on the S&P 500 initiated dividends in 2004, marking the first time in 15 years that the number of companies on the Index paying a dividend increased two consecutive years. Clearly, the 25-year decline of dividend paying companies has been reversed.

Dividend increases also continued in 2004, outpacing 2003 by more than 10 percent. Total dividend increases for the index are now 55 percent higher than before the tax cut was put into place. As a result, shareholders received $20 billion more in 2004 than in the previous year: a record 12.7 percent increase. 2004 also experienced Microsoft's special dividend of $32 billion that was not included in these totals. Including this dividend in total distribution, $52 billion of additional cash went to shareholders in 2004. This is the equivalent of the increases for the years 1994 to 2002 combined.

With the election all but assuring the dividend tax cut provisions remain in place for another four years and companies maintaining sizable cash flows, dividends have soared in the first two months of 2005. Hence, 2005 will mark stage three in dividends, with companies and shareholders capitalizing on record cash flows. Companies began the year with a set of options for best utilizing their cash, such as pursuing mergers and acquisitions, stock repurchases, and dividend payments. Companies are now using a mix of these three strategies and dividend increases are up 12.5 percent over last year.

S&P is predicting 2005 to be a record year with another $22 billion of additional cash above the 2004 level going back to shareholders. Lehman Brothers estimates an even larger cash distribution of $50 billion. This 30 percent increase would occur while earnings are expected to increase by just 8 percent. Without question, the change in tax policy has removed the bias for firms to return cash to shareholders and it is clear they have responded.

The challenge now is for Congress to respond to this beneficial dividend activity by making the dividend and capital gains tax provisions permanent. And this will take dividend activity to its final stage. Markets respond favorably to certainty, and there is still uncertainty as to whether these provisions will remain after President Bush leaves office. By making the tax cut permanent, a large number of companies will move their special dividends to their annual dividend.

This move will fully complete the dividend revolution and lead to continued double digit growth of companies returning their cash back to their owners. And the sooner Congress acts, the better it will be for all American shareholders.

Daniel Clifton is executive director of the American Shareholders Association. He can be reached at


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