The Effect of Dividends on Consumption

Abstract:     
Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while naive "spend income, not principal" mental accounting rules and other economic frictions can cause investors to have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. Further analysis suggests that while several factors may be at work, mental accounting is perhaps the most credible single explanation for the results. Finally, our results imply some estimates of the effects of the 2003 dividend tax cut on aggregate consumption.

Keywords: dividend, consumption, tax cut, CEX, mental accounting

JEL Classification: D12, D91, H31, G35, H24

Accepted Paper Series