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Dividend and Corporate Taxation in an Agency Model of the Firm

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  • Raj Chetty
  • Emmanuel Saez

Abstract

Recent evidence on the effect of dividend taxes on firm behavior is inconsistent with neoclassical theories of dividend and corporate taxation. We develop a simple agency model in which managers and shareholders have conflicting interests to explain the evidence. In this model, dividend taxation induces managers to undertake unproductive investments by retaining earnings, and creates a first-order deadweight cost. In contrast, corporate taxes do not distort the manager's payout decision and may only create second-order efficiency costs. Corporate income taxation may therefore be a more efficient way to generate revenue than dividend taxation, challenging existing intuitions based on neoclassical models. (JEL D21, G35, H25, H32)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/pol.2.3.1
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Economic Policy.

Volume (Year): 2 (2010)
Issue (Month): 3 (August)
Pages: 1-31

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Handle: RePEc:aea:aejpol:v:2:y:2010:i:3:p:1-31

Note: DOI: 10.1257/pol.2.3.1
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References

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  1. David S. Scharfstein & Jeremy C. Stein, 2000. "The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(6), pages 2537-2564, December.
  2. Jeffrey R. Brown & Nellie Liang & Scott Weisbenner, 2007. "Executive Financial Incentives and Payout Policy: Firm Responses to the 2003 Dividend Tax Cut," Journal of Finance, American Finance Association, vol. 62(4), pages 1935-1965, 08.
  3. Raghuram Rajan & Henry Servaes & Luigi Zingales, . "The Cost of Diversity: The Diversification Discount and Inefficient Investment," CRSP working papers 463, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  4. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 2000. "Agency Problems and Dividend Policies around the World," Journal of Finance, American Finance Association, vol. 55(1), pages 1-33, 02.
  5. Marianne Bertrand & Sendhil Mullainathan, 2003. "Enjoying the Quiet Life? Corporate Governance and Managerial Preferences," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 1043-1075, October.
  6. Hans-Werner Sinn, 1991. "The Vanishing Harberger Triangle," NBER Working Papers 3225, National Bureau of Economic Research, Inc.
  7. Fenn, George W. & Liang, Nellie, 2001. "Corporate payout policy and managerial stock incentives," Journal of Financial Economics, Elsevier, vol. 60(1), pages 45-72, April.
  8. Chirinko, Robert S, 1993. "Business Fixed Investment Spending: Modeling Strategies, Empirical Results, and Policy Implications," Journal of Economic Literature, American Economic Association, vol. 31(4), pages 1875-1911, December.
  9. Raj Chetty & Emmanuel Saez, 2005. "Dividend Taxes and Corporate Behavior: Evidence from the 2003 Dividend Tax Cut," The Quarterly Journal of Economics, MIT Press, vol. 120(3), pages 791-833, August.
  10. Roger Gordon & Martin Dietz, 2006. "Dividends and Taxes," NBER Working Papers 12292, National Bureau of Economic Research, Inc.
  11. Raj Chetty & Emmanuel Saez, 2007. "An Agency Theory of Dividend Taxation," NBER Working Papers 13538, National Bureau of Economic Research, Inc.
  12. Bradford, David F., 1981. "The incidence and allocation effects of a tax on corporate distributions," Journal of Public Economics, Elsevier, vol. 15(1), pages 1-22, February.
  13. Christie, William G & Nanda, Vikram, 1994. " Free Cash Flow, Shareholder Value, and the Undistributed Profits Tax of 1936 and 1937," Journal of Finance, American Finance Association, vol. 49(5), pages 1727-54, December.
  14. Lawrence H. Goulder & Roberton C. Williams III, 2003. "The Substantial Bias from Ignoring General Equilibrium Effects in Estimating Excess Burden, and a Practical Solution," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 898-927, August.
  15. Feldstein, Martin S, 1970. "Corporate Taxation and Dividend Behaviour," Review of Economic Studies, Wiley Blackwell, vol. 37(1), pages 57-72, January.
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Citations

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Cited by:
  1. Alexis Anagnostopoulos & Eva Carceles-Poveda, 2010. "Dividend and Capital Gains Taxation under Incomplete Markets," Department of Economics Working Papers 10-06, Stony Brook University, Department of Economics.
  2. Emmanuel Saez & Joel B. Slemrod & Seth H. Giertz, 2009. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," NBER Working Papers 15012, National Bureau of Economic Research, Inc.
  3. Koethenbuerger, Marko & Stimmelmayr, Michael, 2014. "Corporate deductibility provisions and managerial incentives," Journal of Public Economics, Elsevier, vol. 111(C), pages 120-130.
  4. Becker, Bo & Jacob, Marcus & Jacob, Martin, 2013. "Payout taxes and the allocation of investment," Journal of Financial Economics, Elsevier, vol. 107(1), pages 1-24.
  5. Christian Keuschnigg & Evelyn Ribi, 2013. "Profit taxes and financing constraints," International Tax and Public Finance, Springer, vol. 20(5), pages 808-826, October.
  6. Jesse Edgerton, 2012. "Investment, Accounting, and the Salience of the Corporate Income Tax," NBER Working Papers 18472, National Bureau of Economic Research, Inc.
  7. Seppo Kari & Jussi Laitila, 2012. "Non-linear dividend tax and dynamics of the firm," Working Papers 41, Government Institute for Economic Research Finland (VATT).
  8. Marko Köthenbürger & Michael Stimmelmayr, 2009. "Corporate Taxation and Corporate Governance," CESifo Working Paper Series 2881, CESifo Group Munich.
  9. Zhiguo He & Gregor Matvos, 2012. "Debt and Creative Destruction: Why Could Subsidizing Corporate Debt be Optimal?," NBER Working Papers 17920, National Bureau of Economic Research, Inc.
  10. Alzahrani, Mohammed & Lasfer, Meziane, 2012. "Investor protection, taxation, and dividends," Journal of Corporate Finance, Elsevier, vol. 18(4), pages 745-762.
  11. Jesse Edgerton, 2013. "Four facts about dividend payouts and the 2003 tax cut," International Tax and Public Finance, Springer, vol. 20(5), pages 769-784, October.

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