A New Analysis of the Effect of Dividend Tax Policy on the Relationship between Dividend and Treasury Yields

We investigate the relationship between relationship between U.S. Treasury bill yields and the dividend yield of the S&P 500 in the period before and after the passage of the Jobs Growth Tax Relief Reconciliation Act (JGTRRA) in 2003. The results suggest that there is an upward pressure on the Treasury yields when capital gains are tax-favored over dividends. An increase in the portion of stock returns attributable to capital gains makes an equity portfolio more tax-efficient, placing upward pressure on competing Treasury bill yields. Our results are robust to a battery of additional tests, including the level of stock prices. These analyses provide new insights into the complex relationship between investment returns and tax rates on interest, dividends and capital gains, and suggest a public policy favoring dividend tax cuts may have the inadvertent effect of increasing the cost of debt