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

The Bush Administration hopes that by eliminating the dividend tax, investors will be encouraged to buy more stocks. This, they believe, will cause a rise in the value of the market. The main question is: where will investors find the money to buy more stocks? Incomes are not likely to increase a lot in the short-term. Thus, if investors are buying more stocks, they must, necessarily, be buying less of something else. It is likely that consumers will buy less of the good that is the closest substitute to stocks, and for most consumers that good is bonds.

Bonds are, in essence, a loan taken out by a government or corporation, with the promise to pay back, to holder of the bond, a fixed amount at a later date. Bonds are a close substitute for stocks, because the two goods share many attractive qualities. Both stocks and bonds tend to appreciate in value over time. Also, unlike investments like real estate and collectibles, both bonds and stocks are liquid assets, meaning it is easy and inexpensive to find a buyer anytime one wishes to sell. There are millions of brokers and organizations that will gladly buy your bond at market rates; finding a buyer for your rare beanie baby collection would be much more difficult.

Since bonds and stocks are substitutes, and the dividend tax cut will make owning stocks more desirable and bonds would become less desirable to investors. Bonds would be purchased in smaller quantities. Economic theory, as well as common sense, dictates that when demand for a good falls, the price of that good will fall as well. So the dividend tax, while having the intended effect of a rise in the price of stocks, will see a corresponding fall in the price of bonds.

Next page > Part 3: How Does This Effect Interest Rates? > Page 1, 2, 3, 4, 5. 6.