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

  • Harri Hietala

    ()

    (Department of Economics, University of Helsinki and HECER, Finland)

  • Seppo Kari

    ()

    (Government Institute for Economic Research, Finland)

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 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 non-neutralities 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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Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

Volume (Year): 19 (2006)
Issue (Month): 2 (Autumn)
Pages: 41-47

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Handle: RePEc:fep:journl:v:19:y:2006:i:2:p:41-47
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  1. Paolo M. Panteghini, 2001. "Dual income taxation : the choice of the imputed rate of return," Finnish Economic Papers, Finnish Economic Association, vol. 14(1), pages 5-13, Spring.
  2. Seppo Kari & Vesa Kanniainen & Jouko Ylä-Liedenpohja, 2007. "Nordic Dual Income Taxation of Entrepreneurs," Discussion Papers 415, Government Institute for Economic Research Finland (VATT).
  3. Seppo Kari, 1999. "Dynamic Behaviour of the Firm Under Dual Income Taxation," Research Reports 51, Government Institute for Economic Research Finland (VATT).
  4. Steve Bond & Michael Devereux, 1999. "Generalised R-based and S-based taxes under uncertainty," IFS Working Papers W99/09, Institute for Fiscal Studies.
  5. Fane, G., 1987. "Neutral taxation under uncertainty," Journal of Public Economics, Elsevier, vol. 33(1), pages 95-105, June.
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