**Your intuition is reasonable as a proposal for changing the law, but it is not how U.S. tax law treats dividend reinvestment.** In a taxable account, a DRIP is treated as two transactions: you receive a dividend, then use it to buy shares. Automating the purchase does not remove the taxable dividend. [IRS explanation](https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/stocks-options-splits-traders/stocks-options-splits-traders-2)

The important difference is who controls the money. When the company retains earnings, the money remains corporate property; you own shares whose value may increase. When it distributes a dividend, that money becomes yours to invest or spend. Buying shares with it—even immediately—is a new investment.

Your retained-earnings example is broadly right: if you bought a share for 25¢ and later sell it for 30¢, you ordinarily have a 5¢ capital gain. But retaining 5¢ does not guarantee a 5¢ price increase; the market also considers what management will do with the money.

To see why basis matters, assume your figures are **per share**, ignore fees and other price changes, and suppose the stock is worth 30¢ immediately before a 5¢ dividend:

| What happens | Your position afterward | Tax treatment |
|---|---|---|
| Company retains the cash | 100 shares worth $30 | Selling for $30 produces a $5 gain over your $25 basis |
| Company pays the dividend | 100 shares worth approximately $25, plus $5 cash | $5 dividend income |
| You reinvest at 25¢ | 120 shares worth $30 | $5 dividend income; total share basis becomes $30 |

In the reinvestment case, selling all 120 shares immediately for $30 produces **no additional capital gain**. Adding the reinvested $5 to basis prevents that same $5 from being taxed again. [IRS basis explanation](https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/stocks-options-splits-traders/stocks-options-splits-traders-3)

**Could Congress instead defer the tax until sale? Yes.** In this simple example, your proposal would make the retained-earnings and reinvestment outcomes similar. It could simplify recordkeeping for someone who reinvests everything and eventually sells everything together.

The policy tradeoff is that it would create a tax benefit for reinvesting dividends that cash recipients do not receive. It would also require boundaries: must you buy the same stock, use an official DRIP, or reinvest within a certain period? Why should an automatic purchase receive different treatment from receiving cash and manually buying identical shares? Those are policy arguments for the current approach, rather than claims that it is the only workable system.

Also, reinvestment does not necessarily mean the company keeps the cash. A plan may buy existing shares from other investors, in which case the cash goes to those sellers. If it buys newly issued shares, the company gets cash back, but ownership proportions can change because some shareholders reinvest and others take cash.

There is already a closer counterpart to your idea: **a generally nontaxable, proportionate stock dividend**. The company distributes additional shares without distributing cash, and the shareholder’s existing basis is spread across the shares. But offering shareholders a choice of cash or stock generally makes the stock distribution taxable. [26 U.S.C. §305](https://uscode.house.gov/view.xhtml?edition=prelim&req=granuleid%3AUSC-prelim-title26-section305)

Finally, tracking each reinvestment matters when you sell only some shares or when some shares have been held over a year and others have not. Brokers generally report basis for covered DRIP shares acquired starting in 2012, which reduces the manual work, although older holdings can remain troublesome. [IRS reporting rules](https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home)

One historical correction: qualified dividends can receive long-term capital-gains **rates**, but remain dividend income. That preferential treatment began in 2003, so it would not apply to your literal 2001 example. [IRS explanation](https://www.irs.gov/taxtopics/tc404), [2003 tax changes](https://www.eitc.irs.gov/pub/irs-prior/p553--2003.pdf)