A current problem is this:
Corporate profits are taxed at 35%.
Dividends are almost always paid out of this profit.
So, if the company makes $1, the government takes $0.35. When they pay a dividend, (a company like Home Depot pays 25% of it's profits back as a dividend) they pay out .25*.65 or $.16.
Then, the government taxes that $.16 at ordinary income tax rate, generally 24% and upwards of 37% in the high tax bracket depending on the year.
So of a $1 worth of profits, the company keeps $0.49, the government gets $0.41, and investor gets $.10.
Yuck. Under the current system, dividends are pathetic.
Why dividends are a good thing:
#1) When investing money, you want a return. It's best if it is tangible. I put in a dollar and get some money back each quarter.
#2) You can't fake cash. Enron, Tyco, Worldcom can fake earnings left and right as long as it's on paper. However, if dividend paying companies are en vouge, the companies that can't afford to pay cash are penalized since they don't have real earnings.
#3) Dividends reduce the growth rate of a company. By having (demand curve) to pay out money to the investors, that is money that can't be invested back into the business. Capitalism functions best with competition. CostCo/Wal-mart battles are good for the consumer. If dividends are out of style, companies are encouraged to grow their business as fast as possible rather than return money to shareholders.
#4) Dividends are paid in cash. When you receive a dividend check, it is just like a paycheck and you get it four times a year. That is four opportunities to make purchases either of new stock or buying consumer products.
-------- Business Theory on why Taxation is Bad -----
When you decide to start a business, you weigh your risk against your benefits.
The risk free rate of return is a T-Bill currently at 4% (tax free at the state level).
Now, as your risk (chance of business failing) goes up, so does your expected rate of return.
The current accepted level is if you invest a dollar in a business (your own, or in the stock market) you should get $1.12 a year later.
Taxation, though changes that return rate considerably. Since a corporation must pay 35% (current) income tax, that rate of return must move higher already. So, the business doesn't have to make $0.12 on that dollar, they have to make $0.18!
Let's follow a dollar track in today's environment.
I make $1,000. The Feds take 17% for income taxes, and 15% for SS and Medicare. I'm down to $680. Assuming I'm in California, I lose another 9.3% in state tax. $590. I buy an entertainment center at Ethan Allan (as if I could get one for that cheap) and you have to tack on another 8.5%. so I'm down to $505.
BAM! 50% of my money is gone and I didn't even pay propery taxes.
Here is where it gets worse.
Ethan Allen's profit margin is 9.5%. so they made $50. The other $450 went to the govt (corporate taxes $30), $225 to whomever made the furniture (where the US takes 35% of their profit), payroll (the feds and state take another 40%), and assorted other costs of running a business (lights, rent, etc).
So, the government doesn't just take 50% of your money, they also take 50% of what you spend, drastically lowering the real value of money.
Now, you might argue that they spend all that they get, which is not only true, it is overly true, because they SPEND more than they make. However, I think you'll find very few people that believe that the government is more effecient than individuals or corporations so they waste a ton of money in the process.