**Your intuition supports a reasonable tax-policy proposal. Under current U.S. law, though, reinvesting a dividend generally creates two transactions: taxable dividend income, followed by a purchase of additional shares.** In a taxable account, automatic reinvestment does not defer the dividend tax. [IRS explanation](https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/stocks-options-splits-traders/stocks-options-splits-traders-2)

The main benefit you are proposing is **tax deferral**. Qualified dividends already receive the same federal tax rates as long-term capital gains, subject to eligibility and holding-period requirements. The difference is that dividends are taxed when paid, while appreciation generally is taxed when you sell. One historical detail: qualified-dividend treatment began in 2003, so it would not apply to your literal 2001 example. [IRS dividend guidance](https://www.irs.gov/taxtopics/tc404), [2003 Publication 550](https://www.irs.gov/pub/irs-prior/p550--2003.pdf)

Taking your amounts as *per share*, you initially invested $25 and subsequently received a $5 dividend. Assuming ordinary purchases at market value and ignoring fees:

| Event | Current tax treatment |
|---|---|
| Buy the original 100 shares | $25 cost basis |
| Receive and reinvest the $5 dividend | Report $5 of dividend income; the additional shares have $5 basis |
| Later sell all shares for $40 | $10 capital gain: $40 proceeds minus $30 total basis |

**Adding reinvested dividends to basis prevents the same dollars from being taxed twice.** Using only your original $25 basis would produce a $15 gain, even though you already reported $5 as dividend income. [IRS basis explanation](https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/stocks-options-splits-traders/stocks-options-splits-traders-3)

Under your proposed system, the $5 would escape tax when reinvested, the total basis would remain $25, and selling everything for $40 would produce a $15 capital gain. That is a coherent alternative.

Your comparison with retained earnings also makes sense economically, with some qualifications. Cash retained by the company can support a higher share value, although the market need not value every retained dollar at exactly one dollar. If the additional cash raises your eventual sale proceeds by $5, your gain rises by $5.

A DRIP’s mechanics can differ. When it purchases existing shares on the market, the company has paid out cash and you have used your dividend to buy another investor’s shares. If the company issues new shares, the money can return to the company, but the share count and ownership percentages change. In an idealized case where everyone reinvests proportionally, the result can closely resemble retaining the cash.

So why retain the current rule? The policy tradeoff is between simpler accounting for reinvestment and consistent treatment of dividend income:

- **Equal treatment of purchases.** Taking a cash dividend and buying shares manually has the same tax consequences as an automatic purchase. Exempting reinvestment would require deciding which purchases qualify.
- **Tax timing and revenue.** Your proposal lets shareholders defer tax by choosing reinvestment, potentially for decades. That changes the tax burden as well as the paperwork.
- **Rules for accessing the money.** A deferral system would need rules for partial sales and distributions. Allowing immediate access would end the deferral; restricting access would add complexity.

Those are policy considerations, not proof that the existing system is best.

Finally, the bookkeeping burden can be smaller than it sounds. If you sell everything and all the shares qualify for long-term treatment, total adjusted basis may suffice for the gain calculation. Separate purchase records matter especially for partial sales and different holding periods. Brokers generally report basis for covered DRIP shares acquired beginning in 2012, and eligible DRIP holdings can use an average-basis method. Older holdings can still require reconstruction. [IRS broker-reporting guidance](https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/stocks-options-splits-traders), [Publication 550](https://www.irs.gov/publications/p550)

Your proposal could simplify a buy-and-hold investor’s accounting. Adopting it would also create a new tax-deferral benefit that Congress would have to define.