I've been writing about finance on a regular basis since 2000, yet it took me until this week to get clear in my own mind the significance of the questions: do stock prices fall in value in response to a forthcoming dividend payment? and its related question: if so, why? There is a lot of material about which I am still very naive, I concede.
If I had been asked, I might have remembered some long-distant lesson about two guys whose names each begin with the letter "M," and the notion that dividend policy, in an efficient market, is neutral as to the value of a stock. So I would have denied that any move at all could be predicted with any degree of confidence.
That may still be the "right answer," but I now believe I understand that there is a controversy here, and why. Figuring it out involved wrestling with vocabulary and chronology. My understanding is that the usual process is this: a company will say that it will pay dividends this quarter, and it will set a "record date" in the near future, and a "payment date" about a week after that. The payments will go out to everyone who owns the company's stock -- who is a "holder of record," as of the record date. Hence the term.
But to make things more complicated, two days before the record date comes what is called the ex-dividend date. This exists because it can take a couple of days for a stock transaction to settle: for the necessary paperwork to get done between the time somebody shouts "sold" on a trading floor on your behalf and the time you are in deed a owner of record. Thus, before the ex-dividend date the stock was trading "with the dividend," -- part of what you were purchasing in buying it was the expectationof that dividend. On and after that date, the stock is trading "ex" the dividend.
Intuitively, then, one would expect stocks to increase in value at the time of the announcement and drop in value again on the ex-dividend date. As of the announcement, the stock carries with it the promise of a near-immediate cash rebate, whereas after the ex-dividend day, the stock no longer carries the expectation of a cash payment that it had carried the day before. Why, then, wouldn't it be worth a bit more after the one development and a but less after the other?
But the money doesn't come out of nowhere. The market at the time of the announcement understands that by these cash payments the company will be depriving itself of that amount of cash, and losing the opportunity to re-invest it in something productive. Further (and this was the key to the Miller-Modigliani argument to which I alluded above) the market is indifferent between an increase in the value of the stock by one dollar on the one hand and the pay-off of $1 as a dividend on the other. So these announcements don't seem to produce any increase in value.
There is an arbitrage argument for the irrelevance of the ex-dividend date, too. After the declaration date, everyone in the market knows when the dividend will be paid, and when the ex-dividend date arrives. If this situation were sufficient to create a price drop, then a lot of speculators would rush in a short sell the stock in the days leading up to the ex-dividend day, betting on that price drop. Their short sales would cause the price to fall earlier than that date, perhaps as soon as the day after the announcement. The date itself, then, would be an irrelevance.
The situation is complicated by the issue of taxation. Dividends are taxed more than are capital gains, a fact that may make some investors and traders less willing to buy a stock that has announced a dividend in that run-up to the ex-dividend day than they would otherwise be, and might thus reduce the extent of the drop, if any, on that day.
Theories notwithstanding, there is evidence that there is a decline ceteris paribus on or around the ex-dividend date.
Is the decline equal to the full value of the dividend to be paid, perhaps with some modification for tax considerations? That is another question, and not one I yet want to try to tackle.
Showing posts with label capital gains. Show all posts
Showing posts with label capital gains. Show all posts
17 September 2011
26 June 2010
Victory for a Loophole
Capital Gains treatment for "carried interest" now seems likely to survive this session of Congress.
As regular readers of this blog know, I am against cap gains treatment in this area. It is a paradigm of a an inequitable tax loophole.
There is room for reasonable argument about what exactly ought to be done to close this loophole, but that it ought to be closed, nobody who has viewed the situation in a dispassionate way seems to doubt.
Yet year after year, Congress has proven incapable of acting.
As to this year specifically: under the bill approved by the House of Representatives on May 28, 2010, the American Jobs and Closing Tax Loopholes Act of 2010 (H.R. 4213), 75 percent of carried interest will be taxed as ordinary income beginning in 2013. The remaining 25 percent will continue to be taxed as capital gains. During the transition period until 2013, under this bill, 50 percent will be taxed as capital gains, 50 percent as ordinary income.
That was a detail within a big bill with other motives. The overriding purpose of the bill was to extend unemployment benefits further. Republicans didn't like that and demanded budget neutrality -- i.e. assurances the bill would not contribute to the deficit. That set off the search for loopholes to close and, in fixing upon the cap gains treatment of carried interest, the legislative draftsmen found a good one.
On Tuesday, June 8, the Senate Finance Committee, chaired by Max Baucus (D-Mont.) amended the House bill in the form of a substitute. There were some important changes, including some in the provisions dealing with carried interest, but nothing a conference committee couldn't have patched up.
It now appears that there won't be a conference, because the bill can't get through the Senate. The Republicans (with just one Democratic ally, and one Independent ally) have successfully filibustered the unemployment extension there. The provisions closing the loophole weren't the reason for the filibuster, so far as I can tell, but they are casulaties nonetheless.
As regular readers of this blog know, I am against cap gains treatment in this area. It is a paradigm of a an inequitable tax loophole.
There is room for reasonable argument about what exactly ought to be done to close this loophole, but that it ought to be closed, nobody who has viewed the situation in a dispassionate way seems to doubt.
Yet year after year, Congress has proven incapable of acting.
As to this year specifically: under the bill approved by the House of Representatives on May 28, 2010, the American Jobs and Closing Tax Loopholes Act of 2010 (H.R. 4213), 75 percent of carried interest will be taxed as ordinary income beginning in 2013. The remaining 25 percent will continue to be taxed as capital gains. During the transition period until 2013, under this bill, 50 percent will be taxed as capital gains, 50 percent as ordinary income.
That was a detail within a big bill with other motives. The overriding purpose of the bill was to extend unemployment benefits further. Republicans didn't like that and demanded budget neutrality -- i.e. assurances the bill would not contribute to the deficit. That set off the search for loopholes to close and, in fixing upon the cap gains treatment of carried interest, the legislative draftsmen found a good one.
On Tuesday, June 8, the Senate Finance Committee, chaired by Max Baucus (D-Mont.) amended the House bill in the form of a substitute. There were some important changes, including some in the provisions dealing with carried interest, but nothing a conference committee couldn't have patched up.
It now appears that there won't be a conference, because the bill can't get through the Senate. The Republicans (with just one Democratic ally, and one Independent ally) have successfully filibustered the unemployment extension there. The provisions closing the loophole weren't the reason for the filibuster, so far as I can tell, but they are casulaties nonetheless.
13 October 2007
Yes, Close the Loophole
I don't believe in taxation in general. I don't believe in sovereignty or government either. All that is implied in the label "anarcho-capitalist" which is part of the mission statement of this blog.
Ordinarily, then, I wouldn't get involved in debates over particular tax proposals up or down. It is my mission as an anarcho-cap to think out of precisely that box.
Still, I have seen (relatively) strong and weak arguments made in "within the box" terms, in debates especially over what does or doesn't count as a capital gain. I know the difference -- between strong and weak that is -- and some of the arguments made to defend tax loopholes, made to defend in particular favorable capital-gains like treatment for some very ordinary-income type cash receipts (by the managers of hedge and private equity funds) are painfully weak.
I keep hearing and reading these bad arguments for how compensation for that particular sort of well-remunerated employment should really be considered capital gains because it takes place within the context of a limited partnership and the managers have their own money involved so its only fair to be nice to them and we don't want to wage class warfare by calling compensation by its right name. It is painful to watch it, but I do my duty.
On September 8, on this blog, away from the obligations of employment and propriety, I discussed the general considerations governing why capital gains are generally treated favorably in the first place. All I'll say today in expansion upon that is: Leges non verbis, sed rebus, sunt impositae.
Or, in humbler non-Latin terms, I reminded of the story about Abraham Lincoln in which he asked a cabinet member, "how many legs does a dog have if we call a tail a leg?"
"Well, sir, then it would have five."
"No. It would have four. Calling a tail a leg won't make it a leg."
Income is income, and income earned by managerial effort is "ordinary income" for which the law prescribes a rate. Calling it capital gains for various spurious reasons ought to stop. Or ought to be seen for what it is by the general run of folks who can't benefit by such trickery, in the hope that seeing what is underway here will diminish their attachment to the myth of sovereignty and will help hasten the day of anarcho-capitalism.
Ordinarily, then, I wouldn't get involved in debates over particular tax proposals up or down. It is my mission as an anarcho-cap to think out of precisely that box.
Still, I have seen (relatively) strong and weak arguments made in "within the box" terms, in debates especially over what does or doesn't count as a capital gain. I know the difference -- between strong and weak that is -- and some of the arguments made to defend tax loopholes, made to defend in particular favorable capital-gains like treatment for some very ordinary-income type cash receipts (by the managers of hedge and private equity funds) are painfully weak.
I keep hearing and reading these bad arguments for how compensation for that particular sort of well-remunerated employment should really be considered capital gains because it takes place within the context of a limited partnership and the managers have their own money involved so its only fair to be nice to them and we don't want to wage class warfare by calling compensation by its right name. It is painful to watch it, but I do my duty.
On September 8, on this blog, away from the obligations of employment and propriety, I discussed the general considerations governing why capital gains are generally treated favorably in the first place. All I'll say today in expansion upon that is: Leges non verbis, sed rebus, sunt impositae.
Or, in humbler non-Latin terms, I reminded of the story about Abraham Lincoln in which he asked a cabinet member, "how many legs does a dog have if we call a tail a leg?"
"Well, sir, then it would have five."
"No. It would have four. Calling a tail a leg won't make it a leg."
Income is income, and income earned by managerial effort is "ordinary income" for which the law prescribes a rate. Calling it capital gains for various spurious reasons ought to stop. Or ought to be seen for what it is by the general run of folks who can't benefit by such trickery, in the hope that seeing what is underway here will diminish their attachment to the myth of sovereignty and will help hasten the day of anarcho-capitalism.
08 September 2007
Capital Gains
What is a "capital gain"? and why is it taxed at a rate lower than than of ordinary income?
The textbook answer to the first of those questions: a capital gain is the amount by which proceeds from the sale of an asset exceed the original cost.
Further, there is at least one obvious and intuitive reason for treating capital gains differently. The income from the sale of an asset that a taxpayer has held for several years realizes the accretion of value over each of those years, whereas his/her salary, wages, tips etc.(paradigms of "ordinary income") represent the return on labor expended in the taxable year involved. This means that if the income from the sale of a house were taxed as ordinary income the year of the sale, the homeowner would experience an enormous hit that year. This is called the "bunching effect," i.e. taxable events from several years bunched into the year of realization. That, in turn, would freeze up assets -- everyone would become afraid to sell anything valuable for fear of the tax hit -- with disastrous economic effect.
So far, so good. But there are also short-term intra-year capital gains. Why aren't they taxed as ordinary income? Suppose I bought a house in February 2006 for purpose of flipping it. Did so in April 2006. Why shouldn't my profit be treated as ordinary income? The best argument against doing so is that there would still be a "lock-in effect" even without any bunching. We (policy makers or others putting ourselves in their shoes) want people to be able to flip house, because they contribute to the liquidity of the marketplace -- to the ease with which non-speculators too can find something to buy or sell when the time is right.
But the intuitive appeal of that argument is weaker, it would seem, than the appeal of the bunching argument for longer-term investments.
And since we're thinking about it ... there might be better ways of dealing with the "bunching effect" in the case of long term investments too. Conceivably, the accretion of value to my house could be taxed each year as it happens, so that the final sale would have no or only a very slight significance for tax purposes. (Yes, there would be obvious practical difficulties there.)
Aside from the bunching and lock-in effects, the only significant remaining argument for differential treatment of capital gains is this: taxing such gains discourages investment or (what is the same) discourages savings, encouraging immediate consumption and indebtedness.
Does it, though? The late Milton Friedman always used to maintain that fiscal policy is much less efficacious at shaping behavior than policy-makers flatter themselves it is. I wonder about this one.
Also, there seem to be a number of areas defined by law as "capital gains" arbitrarily, or simply as a response to lobbying power and cronyism, where the definition isn't warranted by any of these arguments. But more of that another time perhaps.
The textbook answer to the first of those questions: a capital gain is the amount by which proceeds from the sale of an asset exceed the original cost.
Further, there is at least one obvious and intuitive reason for treating capital gains differently. The income from the sale of an asset that a taxpayer has held for several years realizes the accretion of value over each of those years, whereas his/her salary, wages, tips etc.(paradigms of "ordinary income") represent the return on labor expended in the taxable year involved. This means that if the income from the sale of a house were taxed as ordinary income the year of the sale, the homeowner would experience an enormous hit that year. This is called the "bunching effect," i.e. taxable events from several years bunched into the year of realization. That, in turn, would freeze up assets -- everyone would become afraid to sell anything valuable for fear of the tax hit -- with disastrous economic effect.
So far, so good. But there are also short-term intra-year capital gains. Why aren't they taxed as ordinary income? Suppose I bought a house in February 2006 for purpose of flipping it. Did so in April 2006. Why shouldn't my profit be treated as ordinary income? The best argument against doing so is that there would still be a "lock-in effect" even without any bunching. We (policy makers or others putting ourselves in their shoes) want people to be able to flip house, because they contribute to the liquidity of the marketplace -- to the ease with which non-speculators too can find something to buy or sell when the time is right.
But the intuitive appeal of that argument is weaker, it would seem, than the appeal of the bunching argument for longer-term investments.
And since we're thinking about it ... there might be better ways of dealing with the "bunching effect" in the case of long term investments too. Conceivably, the accretion of value to my house could be taxed each year as it happens, so that the final sale would have no or only a very slight significance for tax purposes. (Yes, there would be obvious practical difficulties there.)
Aside from the bunching and lock-in effects, the only significant remaining argument for differential treatment of capital gains is this: taxing such gains discourages investment or (what is the same) discourages savings, encouraging immediate consumption and indebtedness.
Does it, though? The late Milton Friedman always used to maintain that fiscal policy is much less efficacious at shaping behavior than policy-makers flatter themselves it is. I wonder about this one.
Also, there seem to be a number of areas defined by law as "capital gains" arbitrarily, or simply as a response to lobbying power and cronyism, where the definition isn't warranted by any of these arguments. But more of that another time perhaps.
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