"If dividends were a deductible expense, firms would be strongly motivated to pay out all their profits as dividends, since retained earnings would be subject to the corporate tax. Firms that did not pay dividends would be viewed unfavorably by investors who feared that the earnings are inflated and that the cash does not exist. The payment of cash dividends would therefore add significant credibility to management's earnings reports.

Allowing dividend deductibility would also eliminate the incentive for management to take on large amounts of debt and risk bankruptcy just to gain the deduction for interest costs. Furthermore stock options would become much less valuable under our proposal since most of the stock return would be paid in dividends and not through capital gains. This will lead management to grant shares instead of options to employees, which will lead to more accurate income statements and a better alignment of management with shareholders interests."

I don't really know enough about this to endorse it, but it sounds like a good idea. I think investment would be a lot healthier if it was about profits and not capital gains. Look for MS and Buffet to oppose this.

Knowledge@Wharton - Allow corporations to expense dividend payments.