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Investment Incentives in Closely Held Corporations and Finland's 2005 Tax Reform

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Author Info
Seppo Kari
Hietala
Harri

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Abstract

This paper analyses the effects of the recent Finnish income tax reform on the behaviour of a closely held corporation (CHC) and its owners. The main elements of the reform are cuts in corporate and capital income tax rates and the replacement of the current full imputation system by a partial double taxation of distributed profits. Considerable exemptions are applied to relieve the taxation of dividends from CHCs. The analysis indicates that the change in the CHC?s cost of capital depends on the marginal tax rate (MTR) of the owner. In the case of a high-MTR entrepreneur, the cost of capital increases or is retained at the present level while at lower MTRs the cost of capital may well decrease. The latter observation is due to the increase in the tax rate gap between earned income and capital income. Thus the reform does not remove the earlier reported nonneutralities of the Finnish tax system. The reform also improves the position of wage income as a form of compensation. This will cushion the effect of the dividend tax changes on the CHC?s cost of capital.

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Paper provided by Government Institute for Economic Research (VATT) in its series VATT Discussion Papers with number 392.

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Date of creation: 04 May 2006
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Handle: RePEc:fer:dpaper:392

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Keywords: Capital income taxation dual income tax tax reform

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  1. Sinn, Hans-Werner, 1991. "The vanishing harberger triangle," Journal of Public Economics, Elsevier, vol. 45(3), pages 271-300, August. [Downloadable!] (restricted)
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  2. Bonds, Stephen R. & Devereux, Michael P., 1995. "On the design of a neutral business tax under uncertainty," Journal of Public Economics, Elsevier, vol. 58(1), pages 57-71, September. [Downloadable!] (restricted)
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  3. Erik Fjaerli & Diderik Lund, 2001. "The choice between owner's wages and dividends under the dual income tax," Finnish Economic Papers, Finnish Society for Economic Research, vol. 14(2), pages 104-119, Autumn. [Downloadable!]
  4. Paolo M. Panteghini, 2001. "Dual income taxation : the choice of the imputed rate of return," Finnish Economic Papers, Finnish Society for Economic Research, vol. 14(1), pages 5-13, Spring. [Downloadable!]
  5. Tobias Lindhe & Jan Södersten & Ann Öberg, 2004. "Economic Effects of Taxing Different Organizational Forms under the Nordic Dual Income Tax," Asia-Pacific Financial Markets, Springer, vol. 11(4), pages 469-485, August. [Downloadable!] (restricted)
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  6. Vesa Kanniainen & Seppo Kari & Jouko Ylä-Liedenpohja, 2005. "Nordic Dual Income Taxation of Entrepreneurs," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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  7. Seppo Kari, 1999. "Dynamic Behaviour of the Firm Under Dual Income Taxation," VATT Research Reports 51, Government Institute for Economic Research (VATT). [Downloadable!]
  8. Bond, Stephen R. & Devereux, Michael P., 2003. "Generalised R-based and S-based taxes under uncertainty," Journal of Public Economics, Elsevier, vol. 87(5-6), pages 1291-1311, May. [Downloadable!] (restricted)
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  9. Fane, G., 1987. "Neutral taxation under uncertainty," Journal of Public Economics, Elsevier, vol. 33(1), pages 95-105, June. [Downloadable!] (restricted)
  10. Auerbach, Alan J, 1979. "Wealth Maximization and the Cost of Capital," The Quarterly Journal of Economics, MIT Press, vol. 93(3), pages 433-46, August. [Downloadable!] (restricted)
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