I have an economist friend who always roots for the stock market to decline even though all of his financial wealth is invested in stocks. He is not a masochist. He just recognizes that his income when he retires will heavily depend on dividends paid by the stocks that he owns. When share prices decline, he reasons, future dividends are effectively on sale, and his savings today buys a better retirement.

While the upside-down thinking might be unique to my friend, retirees around the nation have relied on dividend-paying equities for many years. While dividends can accumulate in tax-deferred retirement accounts during an individual’s working life, many people find that a significant share of their income when they retire is in the form of taxable dividends. Until recently, the tax bite associated with those dividends was steep. Those in the top income tax brackets paid about 40 cents federal tax for every dollar of dividends received, while individuals in the lowest tax bracket paid about 15 cents federal tax on the dollar.

This year the tax law changed significantly. Economists have taken to calling the new dividend tax plan the “5-15” plan. The name refers to the two tax rates that apply to dividend income under the new law. Individuals in the top income tax brackets now must pay only 15 percent tax on their dividends, whereas low-income individuals who pay 15 percent tax (or less) on their labor income now pay only 5 percent tax on their dividends. The changes add up to a significant amount of change. A retired individual with total income of $35,000 who receives $5000 in dividends has seen his tax on those dividends decline from $750 under the old law to only $250 today.

Big savings like that help explain the political popularity of dividend tax reductions. They also are the foundation of the economic benefits believed to accompany dividend tax relief. The basic idea is simple. Investors purchase assets because of their interest in their total after-tax return. For assets like dividend-paying stocks and interest-paying bonds, the after-tax cash flow from the asset is a key determinant of investor return. When dividend taxes are high, the flow of capital into the corporate sector is discouraged, and economic growth undercut. If the tax on a dividend is reduced, then the asset is worth more to the investor, the flow of dollars into equities increased, and equity prices increase as well.

Such linkages may seem like wishful thinking, but a simple analogy can highlight how powerful the logic really is. Suppose, that a firm announces that its profits have surprisingly increased by 10 percent and that it expects the higher level to persist for some time. After reading such news in the paper, you might not be surprised to read that the firm’s share price increased by 10 percent as well. Similarly, if policymakers reduce that tax on corporate dividends so that investors can keep 10 cents more of every dollar of dividend, you might also not be surprised if share prices surged. A dividend tax cut is like happy news about profits.

Given this intuition it should not be surprising to hear that economic models of dividend tax changes predicted that share prices would surge if taxes were reduced, and that is exactly what occurred. Sometimes the obvious things really happen. And that is not the end of the good news. Our best models also suggested that dividend tax reductions would lead to growth in real activity in the corporate sector, as businesses looked for places to put the newfound equity cash to good use. The latest economic data suggest that the corporate turnaround is under way as well.

When this year began, the U.S. has the second highest combined tax rate on dividends among all OECD countries. After the change, we are back in the middle of the pack. Back in January, our corporate and manufacturing sectors were still struggling to recover from the recent recession and economists were warning of a dreaded “double dip.” Such concerns are now a distant memory. In several years, tax reductions will almost surely receive their share of the credit, when the academic literature identifies sources of the resurgence of economic growth. Which means that just about everyone should be pleased with the tax changes that occurred this year. Everyone, that is, except for my economist friend. He was very annoyed about the dividend tax cuts and seems to be getting angrier every day.

Kevin A. Hassett is a resident scholar at AEI.