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Tax treatment of dividends and capital gains and the dividend decision under dual income tax

  • Seppo Kari

    ()

  • Hanna Karikallio

    ()

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 microdata is also provided. Copyright Springer Science+Business Media, LLC 2007

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File URL: http://hdl.handle.net/10.1007/s10797-007-9026-z
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Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 14 (2007)
Issue (Month): 4 (August)
Pages: 427-456

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Handle: RePEc:kap:itaxpf:v:14:y:2007:i:4:p:427-456
Contact details of provider: Web page: http://www.springerlink.com/link.asp?id=102915

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  1. Sinn, Hans-Werner, 1991. "The vanishing harberger triangle," Munich Reprints in Economics 19842, University of Munich, Department of Economics.
  2. Erik Fjaerli & Diderik Lund, 2001. "The choice between owner's wages and dividends under the dual income tax," Finnish Economic Papers, Finnish Economic Association, vol. 14(2), pages 104-119, Autumn.
  3. Lindhe, T. & Sodersten, J. & Oberg, A., 2001. "Economic Effects of Taxing Closed Corporations under a Dual Income Tax," Papers 2001:16, Uppsala - Working Paper Series.
  4. Annette Alstadsæter, 2003. "The Dual Income Tax and Firms' Income Shifting through the Choice of Organizational Form and Real Capital Investments," CESifo Working Paper Series 1018, CESifo Group Munich.
  5. 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, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  6. repec:cup:cbooks:9780521331586 is not listed on IDEAS
  7. Tobias Lindhe & Jan Södersten & Ann �berg, 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.
  8. Seppo Kari, 1999. "Dynamic Behaviour of the Firm Under Dual Income Taxation," Research Reports 51, Government Institute for Economic Research Finland (VATT).
  9. Seppo Kari & Vesa Kanniainen & Jouko Ylä-Liedenpohja, 2007. "Nordic Dual Income Taxation of Entrepreneurs," Discussion Papers 415, Government Institute for Economic Research Finland (VATT).
  10. Roger H. Gordon & Joel Slemrod, 1998. "Are "Real" Responses to Taxes Simply Income Shifting Between Corporate and Personal Tax Bases?," NBER Working Papers 6576, National Bureau of Economic Research, Inc.
  11. Cnossen, Sijbren (ed.), 2000. "Taxing Capital Income in the European Union: Issues and Options for Reform," OUP Catalogue, Oxford University Press, number 9780198297833, March.
  12. Roger Gordon & Martin Dietz, 2006. "Dividends and Taxes," NBER Working Papers 12292, National Bureau of Economic Research, Inc.
  13. Vidar Christiansen, 2004. "Norwegian Income Tax Reforms," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 2(3), pages 09-14, October.
  14. Raj Chetty & Emmanuel Saez, 2004. "Dividend Taxes and Corporate Behavior: Evidence from the 2003 Dividend Tax Cut," NBER Working Papers 10841, National Bureau of Economic Research, Inc.
  15. Peter Sørensen, 2005. "Neutral Taxation of Shareholder Income," International Tax and Public Finance, Springer, vol. 12(6), pages 777-801, November.
  16. 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.
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