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Is capital gains income?

February 2, 2005

Tags Money and BanksValue and Exchange

The recent report on personal income and spending showed a full 3.7% increase in personal income and an even greater increase in disposable income , raising the savings rate to 3.4%. But this sharp increase was mostly due to the temporary factor of Microsofts extra dividend of over $30 billion (Excluding that the increase was only 0.5%, lower than the increase in spending). The January report is likely is therefore likely to show a sharp decline in personal income and savings and sometimes later this year the taxes paid on that dividend will reduce disposable personal income in absolute numbers. But the interesting issue here is: did this dividend really make Microsoft's shareholders richer?

Indirectly, it will likely do so as the shareholders will probably use them in a more productive way than Microsoft with its excess cash holdings could have done. But setting aside the issue of who will use the money more efficiently, is the payment of dividends really something which directly make its shareholders richer? No, not really I would argue as the decrease in Microsoft's cash reserves will lower the value of their shares with roughly the same amount. This brings to mind the issue that some people who has a bullish outlook on the economy have raised, that the official personal savings rate underestimates the true savings rate becaude it does not include capital gains.

It seems to me that they actually are right-but only partially. We must here differentiate between capital gains based on a increase in the underlying value of assets (for example increases in corporate profits) and capital gains based on asset price inflation. The former should be included since this means that the value of their assets increases without reducing the purchasing power of the buyers, but as the latter merely means transfer of value from buyers to sellers it should not be included. Moreover, to the extent that the increase in real value are based on expectations of future earnings it should not be included either as this means that income flows from future years are withdrawn. Therefore it would make more sense to only include current retained earnings.

Of course, dividends unlike capital gains means a cash-flow transfer from the corporate sector to the household sector so if the purpose of this statistic is to measure cash-flow then it might seem correct anyway. But if cash-flow were what we wanted to measure then we should also include stock-repurchase programs and at the same time deduct the cash-flow to corporations generated by new issuance of stocks. If on the other hand we were out to measure the amount of real savings that households do then we should really merge it with the corporate sector (Or the part of the corporate sector owned directly or indirectly by domestic households) and add net profits as a form of implicit household income. Then it would not really matter whether earnings are retained or payed out in dividends.

It should finally be noted though that such a measure would not really change the overall picture of a too low savings rate in the U.S. economy as it would merely. mean a statistical transfer of corporate savings to the household sector. And the national savings rate is very low both in comparison with the past and in comparison with other countries.

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