The Effect of the 2003 Dividend Preference on Portfolio Allocation of Stock

Abstract

Based on standard economic theory, individuals allocate their portfolios in a tax-efficient manner between tax-deferred accounts (or TDAs) and fully taxable accounts when they place a higher percentage of their highly taxed assets in tax preferred accounts. Setting aside complications arising from liquidity preferences, as well the endogeneity between tax characteristics and the cash flow, we might generally expect that, if the tax rate on dividends is reduced, the percentage of stock held within such accounts will decrease. Similarly, we might expect that that amount of stock held within a tax-deferred account as compared to the total within and without of such accounts might decrease as well. The paper explores whether the enactment of the 2003 dividend preference resulted in tax-efficient changes to portfolio composition with respect to the allocation of stock to tax-deferred accounts. Empirical results based on OLS and Tobit analysis suggest that the portion of tax-deferred accounts allocated to stock decreased following the enactment of the dividend preference; moreover, the allocation of stock within and without such accounts also appeared to change significantly.