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

So far we have just examined changes in demand, but we know that two factors always affect price: demand and supply. What effect will the elimination of dividend taxation have on the supply of stocks and bonds? We know that consumers are now willing to pay more for stocks, and less for bonds. Corporations obtain funds for new projects by either selling bonds or by issuing new stock. Since selling stocks is now more lucrative than issuing bonds, because of the relative change in prices, we should see more companies selling stocks, and fewer companies issuing bonds. Since the supply of bonds by corporations is decreasing, we should see the price of these bonds increase. So this will mitigate the fall in bond prices caused by changes in demand. In theory, it is possible for the supply effect to outweigh the demand effect; this would happen if there were large enough reductions in the amount of bonds issued. This would cause an overall rise in bond prices, and a lowering in interest rates. This is exactly the opposite of what I've been arguing so far. However, a dramatic fall in the amount of bonds issued is highly unlikely for two reasons. The first is that companies usually prefer to sell bonds instead of issuing new stocks. This is due to the fact that when a company sells stock, it is diluting the ownership of the company. If a company issues too much stock, there is the risk that the a single investor or group of investors will be able to buy enough stock in the company to take it over, which is called a hostile takeover. Because of this, a big rush of new stock issues is unlikely.

The second reason this is unlikely is that corporations are not the only entities that sell bonds. The federal government, along with state and municipal governments and public utilities all issue bonds for their funding needs. Most governments are currently running into budgetary crunches and many are running deficits for the first time in years. The federal government will be forced to run a deficit due to increases in spending and declining revenues due to this tax cut. To finance these deficits, governments will be forced to issue more bonds. Because the number of government issued bonds will increase, we should not expect to see a dramatic drop in the total overall value of bonds issued.

Next page > Part 6: Have Your Say > Page 1, 2, 3, 4, 5, 6.