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Non-linear dividend tax and dynamics of the firm

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  • Seppo Kari
  • Jussi Laitila

Abstract

This paper analyses the implications of a non-linear dividend tax in a life-cycle model of the firm. In the model new firms first enter markets, then grow, financing from retained earnings and finally distribute their profits in the steady state. We find that under a non-linear tax the owners prefer a smooth flow of dividends, which encourages the firms to start distributions right from the beginning. This slows down investments and leads to delayed growth of production. There is, however, an opposing effect resulting from an increase in the start-up size of the firm, which speeds growth. Simulations nevertheless show that a revenue-neutral switch from a linear to a progressive tax exacerbates production losses. We further find that this distortion can be substantially reduced by carrying forward unused tax allowances with interest.

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Bibliographic Info

Paper provided by Government Institute for Economic Research Finland (VATT) in its series Working Papers with number 41.

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Date of creation: 07 Dec 2012
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Handle: RePEc:fer:wpaper:41

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Keywords: dividend tax; progressive tax; nucleus theory; firm behavior;

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  1. Fran�ois Gourio & Jianjun Miao, 2010. "Firm Heterogeneity and the Long-Run Effects of Dividend Tax Reform," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 131-68, January.
  2. Sinn, Hans-Werner, 1991. "The vanishing harberger triangle," Munich Reprints in Economics 19842, University of Munich, Department of Economics.
  3. Jeffrey R. Brown & Nellie Liang & Scott Weisbenner, 2006. "Executive financial incentives and payout policy: firm responses to the 2003 dividend tax cut," Finance and Economics Discussion Series 2006-14, Board of Governors of the Federal Reserve System (U.S.).
  4. Stephen Bond & Alexander Klemm & Michael B. Devereux, 2007. "The Effects of Dividend Taxes on Equity Prices: A Re-examination of the 1997 U.K. Tax Reform," IMF Working Papers 07/204, International Monetary Fund.
  5. Chetty, Raj & Saez, Emmanuel, 2004. "Dividend Taxes and Corporate Behaviour: Evidence from the 2003 Dividend Tax Cut," CEPR Discussion Papers 4722, C.E.P.R. Discussion Papers.
  6. Hans-Werner Sinn, 1991. "Taxation and the Cost of Capital: The "Old" View, the "New" View and Another View," NBER Working Papers 3501, National Bureau of Economic Research, Inc.
  7. Seppo Kari & Hanna Karikallio & Jukka Pirttilä, 2008. "Anticipating Tax Change: Evidence from the Finnish Corporate Income Tax Reform of 2005," CESifo Working Paper Series 2201, CESifo Group Munich.
  8. Bo Becker & Marcus Jacob & Martin Jacob, 2011. "Payout Taxes and the Allocation of Investment," NBER Working Papers 17481, National Bureau of Economic Research, Inc.
  9. Martin D. Dietz, 2004. "Dividend and Capital Gains Taxation in a Cross-Section of Firms," Public Economics 0405004, EconWPA.
  10. Annette Alstadsæter & Erik Fjærli, 2009. "Neutral taxation of shareholder income? Corporate responses to an announced dividend tax," International Tax and Public Finance, Springer, vol. 16(4), pages 571-604, August.
  11. Anton Korinek & Joseph E. Stiglitz, 2008. "Dividend Taxation and Intertemporal Tax Arbitrage," NBER Working Papers 13858, 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. Raj Chetty & Emmanuel Saez, 2010. "Dividend and Corporate Taxation in an Agency Model of the Firm," American Economic Journal: Economic Policy, American Economic Association, vol. 2(3), pages 1-31, August.
  14. Alan J. Auerbach, 1980. "Wealth Maximization and the Cost of Capital," NBER Working Papers 0254, National Bureau of Economic Research, Inc.
  15. Roger Gordon & Martin Dietz, 2006. "Dividends and Taxes," NBER Working Papers 12292, National Bureau of Economic Research, Inc.
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