Many prov1s10ns of the U.S. tax code affect corporate decisions to pay out or retain earnings. Most studies of these effects have examined the effects of dividend and capital gains taxes on payouts. Relatively few studies have considered the effects of corporate taxes on retentions. In the early 1900s, the United States experimented with several corporate taxes on retentions. These taxes increased the price of corporate retentions, thereby encouraging corporate payouts. This paper studies the response of corporations to the most significant of these experiments the Undistributed Profits Tax of 1936-1938. While the U.S. no longer directly taxes corporate retentions, our study provides empirical results relevant to two recent policy debates. First, to the extent that corporate payouts did respond significantly to a change in the corporate price of retentions, we can learn more about the implicit prices corporations place on internal funds. These estimates enable us better understand the effects of government policies designed to encourage corporate reinvestment. Second, our study provides evidence relevant to several recent proposals designed to resolve managerial agency problems. These proposals require managers to payout their "free" cash flows as a way of committing not to waste financial capital. The Undistributed Profits Tax of 1936-1938 had a similar goal. Its maximum marginal tax rate of 27 percent on corporate retentions gave managers strong incentives to pay out retained earnings. We study the effects of the Undistributed Profits Tax on corporate payouts using a panel data set on 26 large petroleum companies. These data have a number of advantages, not the least of which is the relative homogeneity of petroleum firms' investment opportunities. We find that on average corporate payout policies did respond significantly to the surtax in 1936, the first year of the tax. There was much less of a response in 1937, and practically none in the last year, 1938. The smaller payouts in 1937 and 1938 suggest that managers were able to find margins other than dividends through which they could reduce their tax burden. These other margins included the short-term manipulation of expenses and delays in recognizing revenues. These responses suggest that managers place a relatively high valuation on internal versus external funds. They also suggest that proposals that would require managers to payout free cash flows must resolve an important incentive problem -- how to get managers to reveal fully what cash flows are "free." Finally, our results document the importance of recognizing behavioral responses to taxes. That is, firms may respond to changes in relative tax prices by finding other margins by which they can reduce their tax burdens.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Publisher Info
Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
3111.
Length: Date of creation: Sep 1989 Date of revision: Handle: RePEc:nbr:nberwo:3111
Note: ME Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A. Phone: 617-868-3900 Email: Web page: http://www.nber.org More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: ().
Related research
Keywords:
Other versions of this item:
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.: