More of this Feature • Part 1: The Dividend Tax Cut - Bush's Plan • Part 2: The Dividend Tax Cut - Substitution of Bonds for Stocks • Part 3: The Dividend Tax Cut - How Does This Effect Interest Rates? • Part 4: The Dividend Tax Cut - How Does Interest Rate Increases from Bonds Effect You? • Part 5: The Dividend Tax Cut - The Supply Side • Part 6: The Dividend Tax Cut - Have Your Say

Related Resources • Bush Offers Dividend Tax Cut Plan • Dividend Tax Cut and Economic Stimulus Plan • White House Release - Dividend Tax Cut and Economic Stimulus Package • Tax Policy Center - Information on Dividend Tax Cut

This rise in interest rates will not be limited to just bonds. Banks and other financial institutions use their customers’ deposits to either buy bonds or to loan to other customers in the form of mortgages, car loans, and business loans. These loans usually carry an interest rate of Prime + X%, where X is a number based on the likelihood the borrower will go bankrupt and default on the loan. The more likely the lender is to default on the loan, the higher X is: this is why Bill Gates gets a better rate on his mortgage than you do.

Since interest rates tend to be calculated based on Prime and the likelihood of the borrower to go bankrupt, there is a perfect relation between them and the prime rate. The prime rate is the interest rate at which banks lend money for a short-specified term to large corporations that have little chance of going bankrupt in the near future. These loans are, in reality, bonds, since the large corporations have to pay them back at a specified date, and the banks can sell these loans to other banks or institutions if they wish.

Thus, if the demand for bonds decreases and causes a rise in the interest rate on bonds, the prime rate will increase (because it is as an interest rate on a bond), and cause the rate of interest to rise on all loans.

Next page > Part 5: The Supply Side > Page 1, 2, 3, 4, 5, 6.