Working Paper: NBER ID: w13858
Authors: Anton Korinek; Joseph E. Stiglitz
Abstract: We analyze the effects of changes in dividend tax policy using a life-cycle model of the firm, in which new firms first access equity markets, then grow internally, and finally pay dividends when they have reached steady state. \n \nIn accordance with the traditional view of dividend taxation, new firms raise less equity and invest less the higher the level of dividend taxes. However, as postulated by the new view of dividend taxation, the dividend tax rate is irrelevant for the investment decisions of internally growing and mature firms. Since aggregate investment is dominated by these latter two categories, the level of dividend taxation as well as unanticipated changes in tax rates have only small effects on aggregate investment. \n \nAnticipated dividend tax changes, on the other hand, allow firms to engage in inter-temporal tax arbitrage so as to reduce investors' tax burden. This can significantly distort aggregate investment. Anticipated tax cuts (increases) delay (accelerate) firms' dividend payments, which leads them to hold higher (lower) cash balances and, for capital constrained firms, can significantly increase (decrease) aggregate investment for periods after the tax change. \n \nThe analysis of dividend taxation in a contestable democracy thus has to take into account future policy changes as well as expectations thereof. This can significantly alter the evaluation of any given dividend tax policy.
Keywords: dividend taxation; intertemporal tax arbitrage; firm behavior; lifecycle model
JEL Codes: G35; G38; H32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher dividend taxes (G35) | reduce the amount of equity raised by new firms (G32) |
| reduce the amount of equity raised by new firms (G32) | decrease their investment levels (G11) |
| anticipated dividend tax cuts (G35) | enable mature firms to engage in intertemporal tax arbitrage (H32) |
| enable mature firms to engage in intertemporal tax arbitrage (H32) | allow them to postpone dividend payments and increase cash reserves (G32) |
| allow them to postpone dividend payments and increase cash reserves (G32) | facilitate greater investment opportunities when they arise (O16) |
| anticipated tax increases (H29) | lead firms to accelerate dividend payments (G35) |
| lead firms to accelerate dividend payments (G35) | reduce cash balances and future investment capacity (G31) |
| unanticipated changes in dividend taxes (G35) | minimal effects on aggregate investment (E22) |
| anticipated changes in dividend taxes (G35) | significant distortions in investment behavior across the economy (H32) |