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Taxation, Investment and Asset Pricing

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  • Marika Santoro

    (Congressional Budget Office)

  • Chao Wei

    (George Washington University)

Abstract

This paper studies the impact of dividend and corporate income taxes on investment and asset returns in a stochastic general equilibrium model. Under the "new" view of dividend taxation (e.g. Poterba and Summers, 1985), proportional dividend taxes do not distort investment decisions, and thus have no impact on asset returns. By contrast, we find that corporate income taxes introduce additional tax-related risk factors into the economy by distorting investment decisions. We uncover a mechanism through which corporate taxes amplify the responses of consumption and investment to technology shocks, and consequently lead to a lower risk-free interest rate and a higher equity premium. This amplification mechanism is the strongest when there exists a strong preference for consumption smoothing and high costs of adjusting the capital stock. (Copyright: Elsevier)

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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 14 (2011)
Issue (Month): 3 (July)
Pages: 443-454

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Handle: RePEc:red:issued:09-164

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Related research

Keywords: Dividend taxes; Corporate taxes; Risk-free rate; Equity premium; Amplification mechanism;

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References

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  1. Jeremy Greenwood & Gregory W. Huffman, 1991. "Tax analysis in a real business cycle model: on measuring Harberger triangles and Okun gaps," Staff Report, Federal Reserve Bank of Minneapolis 138, Federal Reserve Bank of Minneapolis.
  2. François Gourio & Jianjun Miao, 2008. "Firm Heterogeneity and the Long-Run Effects of Dividend Tax Reform," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics wp2008-002, Boston University - Department of Economics.
  3. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(2), pages 257-275, April.
  4. James M. Poterba & Lawrence H. Summers, 1985. "The Economic Effects of Dividend Taxation," NBER Working Papers 1353, National Bureau of Economic Research, Inc.
  5. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 91(1), pages 149-166, March.
  6. Danthine, Jean-Pierre & Donaldson, John B., 1985. "A note on the effects of capital income taxation on the dynamics of a competitive economy," Journal of Public Economics, Elsevier, Elsevier, vol. 28(2), pages 255-265, November.
  7. Chang, Ly-June, 1995. "Business cycles with distorting taxes and disaggregated capital markets," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 19(5-7), pages 985-1009.
  8. Roger H. Gordon & John D. Wilson, 1986. "Measuring the Efficiency Cost of Taxing Risky Capital Income," NBER Working Papers 1992, National Bureau of Economic Research, Inc.
  9. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 75, pages 321.
  10. Lai, Tsong-Yue, 1989. "An Equilibrium Model of Asset Pricing with Progressive Personal Taxes," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 24(01), pages 117-127, March.
  11. Hassett, Kevin A. & Hubbard, R. Glenn, 2002. "Tax policy and business investment," Handbook of Public Economics, Elsevier, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 20, pages 1293-1343 Elsevier.
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Cited by:
  1. Francois Gourio, 2012. "Credit risk and disaster risk," Working Paper Series, Federal Reserve Bank of Chicago WP-2012-07, Federal Reserve Bank of Chicago.
  2. Anagnostopoulos, Alexis & Cárceles-Poveda, Eva & Lin, Danmo, 2012. "Dividend and capital gains taxation under incomplete markets," Journal of Monetary Economics, Elsevier, Elsevier, vol. 59(7), pages 599-611.
  3. Marika Santoro & Chao Wei, 2011. "The Welfare Cost of Capital Taxation: An Asset Market Approach (Working Paper 2011-03)," Working Papers, Congressional Budget Office 41152, Congressional Budget Office.
  4. Gourio, François, 2012. "Macroeconomic implications of time-varying risk premia," Working Paper Series, European Central Bank 1463, European Central Bank.
  5. Peter A. Schmid, 2013. "The destabilizing effect of company income taxation," Society and Economy, Akadémiai Kiadó, Hungary, Akadémiai Kiadó, Hungary, vol. 35(3), pages 365-388, September.
  6. Santoro, Marika & Wei, Chao, 2013. "The marginal welfare cost of capital taxation: Discounting matters," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(4), pages 897-909.

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