Payout policy and taxes The mi

Payout policy and taxes The middle-of-the-road party holds that payout policy doesn’t matter because the supply of high-, medium-, and low-payout stocks has already adjusted to satisfy investors’ demands. Investors who like generous dividends hold stocks that give them all the dividends that they want. Investors who want capital gains see ample low-payout stocks to choose from. Thus, high-payout firms cannot gain by transforming to low-payout firms, or vice versa.

Suppose the government reduces the tax rate on dividends but not on capital gains. Suppose that before this change the supply of dividends matched investor needs. How would you expect the tax change to affect the total cash dividends paid by U.S. corporations and the proportion of high-versus low-payout companies? Would payout policy still be irrelevant after any dividend supply adjustments are completed? Explain.

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