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Tax Treatment of Dividends and Capital Gains and the Dividend Decision Under Dual Income Tax

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Author Info
Seppo Kari
Hanna Karikallio

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Abstract

The paper analyses efficiency aspects of a dual income tax system with a higher tax on capital gains than dividends. It argues that apart from the distortions to investments claimed in earlier literature, the system puts even more emphasis in creating incentives for entrepreneurs to participate in tax planning. The paper suggests that the owner of a closely held company can avoid all personal taxes on entrepreneurial income by two tax-planning strategies. The first is the avoidance of distributions, which would be taxed at the tax rate on labour income. These funds would instead be invested in the financial markets. The second strategy is a distribute-and-call-back policy, converting retained profits into new equity capital. Interestingly, the outcome is that investment in real capital is not distorted in the long-run equilibrium. Empirical evidence using micro data is also provided.

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Publisher Info
Paper provided by Government Institute for Economic Research (VATT) in its series VATT Discussion Papers with number 416.

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Date of creation: 05 Apr 2007
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Handle: RePEc:fer:dpaper:416

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Related research
Keywords: Dual income tax small business taxation income shifting

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Find related papers by JEL classification:
H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Seppo Kari & Vesa Kanniainen & Jouko Ylä-Liedenpohja, 2007. "Nordic Dual Income Taxation of Entrepreneurs," VATT Discussion Papers 415, Government Institute for Economic Research (VATT). [Downloadable!]
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  2. 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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  3. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Blackwell Publishing, vol. 58(2), pages 277-97, April. [Downloadable!] (restricted)
  4. Alstadsaeter, Annette, 2003. "The Dual Income Tax and Firms' Income Shifting through the Choice of Organizational Form and Real Capital Investments," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  5. 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!]
  6. Christian Keuschnigg & Martin D. Dietz, 2005. "A Growth Oriented Dual Income Tax," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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  7. 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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  8. Seppo Kari, 1999. "Dynamic Behaviour of the Firm Under Dual Income Taxation," VATT Research Reports 51, Government Institute for Economic Research (VATT). [Downloadable!]
  9. Tobias Lindhe & Jan Södersten & Ann Öberg, 2004. "Economic Effects of Taxing Different Organizational Forms under the Nordic Dual Income Tax," International Tax and Public Finance, Springer, vol. 11(4), pages 469-485, 08. [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Seppo Kari & Hanna Karikallio & Pirttilä & Jukka, 2007. "Anticipating Tax Changes: Evidence from the Finnish Corporate Income Tax Reform of 2005," VATT Discussion Papers 426, Government Institute for Economic Research (VATT). [Downloadable!]
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