Tax Policy and the Dividend Puzzle

61 Pages Posted: 5 Jul 2004 Last revised: 14 Oct 2008

See all articles by B. Douglas Bernheim

B. Douglas Bernheim

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 1990


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.

Suggested Citation

Bernheim, B. Douglas, Tax Policy and the Dividend Puzzle (September 1990). NBER Working Paper No. w3434. Available at SSRN:

B. Douglas Bernheim (Contact Author)

Stanford University - Department of Economics ( email )

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