In reality though, the price of the dividend does not make the stock drop by an equal amount.
[citation needed]
Perhaps you mean that the price drop is not always
visible because it's obscured by other market noise? But it's there.
http://groupssa.com/ex-dividendstockpriceadjustment.htmlIf the value of a position of stock A goes up 100% after 10 years without dividends.
If the value of a position of stock B goes up 100% after 10 years with dividends
The value of A and B both start and end at the same value.
So comparing A with B, the amount of taxes owed when selling all of the position is significantly less for B than A, because you have been paying for the dividends with taxes along way with B.
Sure, you'll pay less tax (zero) with B than A during your final transaction, but so what? You'll end up with more total money with A, which is what people actually care about.
We'll assume that in both cases, you initially pay $10k for 1000 shares of each company at $10/share. Both companies produce the same profit, and repeat it every year, allowing for a $1000 dividend payout to you. We'll further assume that both companies' value changes only by their book value, and broader economic factors or "market sentiment" have no effect on their share prices. We'll also assume capital gains and dividend taxes are an equal 20%.
In B, each year the share price rises from $10 to $11, recognizing the growing cash surplus. Then they pay you a $1000 dividend, the share price drops to $10, and you purchase 100 new shares at $10/share. You pay your $200 dividend tax with external income. By the end of 10 years, you'll have 2000 shares @ $10, which you can sell for $20k. You pay zero capital gains tax, because there were no capital gains.
Ending value: $20000In A, each year the share price rises $1 over the previous year, recognizing the growing cash surplus. They hold onto their cash, so over the years the share price continues to rise. The $200 of external income that you used in B to pay your dividend tax in this case can be used to buy $200 worth of Company A shares at the current share price, every year. By the end of 10 years, you'll have 1134 shares (1000 original plus 134 from the yearly purchases), and since the share price is now $20, total value is $22675. Your cost basis is $12000, so you'll pay 20% capital gains tax on the difference, for a tax bill of $2135.
Ending value: $20540Essentially this is just illustrating the basic principle that a dollar today is more valuable than a dollar tomorrow, and thus, it's best to defer any taxes for as long as possible. Dividend-paying stocks prevent you from making that deferral.
This is increased if there will be a tax change in the future (I think there will be) that increases the tax rate.
Sure, if you assume the capital gains rate increases to something greater than 25% in year 10, while leaving the dividend rate unaffected all of the previous years, then A would win. But that's a really specific and odd assumption. And to be logically consistent with your belief, then you'd want to be regularly selling your stock positions, paying your capital gains taxes at their current "low" rates, and repurchasing them with a higher cost basis in order to reduce your future tax liability. Are you doing that?