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Dividend Taxes, Corporate Investment, and "Q"

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  • James M. Poterba
  • Lawrence H. Summers

Abstract

Taxes on corporate distributions have traditionally been regarded as a "double tax" on corporate income. This view implies that while the total effective tax rate on corporate source income affects real economic decisions, the distribution of this tax burden between the shareholders and the corporation is irrelevant. Recent research has suggested an alter- native to this traditional view. One explanation of why firms in the U.S. pay dividends in spite of the heavy tax liabilities associated with this form of distribution is that the stock market capitalizes the tax payments associated with corporate distributions. This capitalization leaves investors indifferent at the margin between corporations paying our dividends and retaining earnings. This alternative view holds that while changes in the dividend tax rate will affect shareholder wealth, they will have no impact on corporate investment decisions. This paper develops econometric tests which distinguish between these two views of dividend taxation. By extending Tobin's "q" theory of investment to incorporate taxes at both the corporate and personal levels, the implications of each view for corporate investment decisions can be derived. The competing views may be tested by comparing the performance of investment equations estimates under each theory's predict ions. British time series data are particularly appropriate for testing hypotheses about dividend taxes because of the substantial postwar variation in effective tax rates on corporate distributions. The econometric results suggest that dividend taxes have important effects on investment decisions.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0829.

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Date of creation: Dec 1981
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Publication status: published as Poterba, James M. and Lawrence H. Summers. "Dividend Taxes, Corporate Investment, and 'Q'." Journal of Public Economics, Vol. 22, (1983), pp. 135-167.
Handle: RePEc:nbr:nberwo:0829

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  1. Engle, Robert F, 1974. "Band Spectrum Regression," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(1), pages 1-11, February.
  2. Oulton, Nicholas, 1978. "Explaining aggregate investment in Britain : The importance of Tobin's Q," Economics Letters, Elsevier, vol. 1(3), pages 253-257.
  3. King, M A, 1971. "Corporate Taxation and Dividend Behaviour-A Comment," Review of Economic Studies, Wiley Blackwell, vol. 38(115), pages 377-80, July.
  4. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  5. Feldstein, Martin & Green, Jerry, 1983. "Why Do Companies Pay Dividends?," American Economic Review, American Economic Association, vol. 73(1), pages 17-30, March.
  6. Pesaran, M H & Deaton, Angus S, 1978. "Testing Non-Nested Nonlinear Regression Models," Econometrica, Econometric Society, vol. 46(3), pages 677-94, May.
  7. Pesaran, M H, 1974. "On the General Problem of Model Selection," Review of Economic Studies, Wiley Blackwell, vol. 41(2), pages 153-71, April.
  8. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  9. Rothschild, Michael, 1971. "On the Cost of Adjustment," The Quarterly Journal of Economics, MIT Press, vol. 85(4), pages 605-22, November.
  10. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  11. Michael Salinger & Lawrence H. Summers, 1983. "Tax Reform and Corporate Investment: A Microeconometric Simulation Study," NBER Chapters, in: Behavioral Simulation Methods in Tax Policy Analysis, pages 247-288 National Bureau of Economic Research, Inc.
  12. Auerbach, Alan J., 1979. "Share valuation and corporate equity policy," Journal of Public Economics, Elsevier, vol. 11(3), pages 291-305, June.
  13. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers 0349, National Bureau of Economic Research, Inc.
  14. Engle, Robert F & Foley, Duncan K, 1975. "An Asset Price Model of Aggregate Investment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 16(3), pages 625-47, October.
  15. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
  16. Amemiya, Takeshi, 1974. "The nonlinear two-stage least-squares estimator," Journal of Econometrics, Elsevier, vol. 2(2), pages 105-110, July.
  17. Feldstein, Martin S, 1970. "Corporate Taxation and Dividend Behaviour," Review of Economic Studies, Wiley Blackwell, vol. 37(1), pages 57-72, January.
  18. Zellner, Arnold, 1981. "Posterior odds ratios for regression hypotheses : General considerations and some specific results," Journal of Econometrics, Elsevier, vol. 16(1), pages 151-152, May.
  19. Fair, Ray C, 1970. "The Estimation of Simultaneous Equation Models with Lagged Endogenous Variables and First Order Serially Correlated Errors," Econometrica, Econometric Society, vol. 38(3), pages 507-16, May.
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