Do companies invest more after shareholder tax cuts?

This paper investigates changes in firm spending following changes in shareholder taxes. We show that firms with less elastic demand for equity capital will expand operations less than other firms following shareholder tax cuts. Since financial constraint is a factor that diminishes a firm¡¯s demand elasticity for capital, we predict that financially constrained firms expand less than other companies following shareholder tax reductions. Using a difference-in-differences approach, we find that financially constrained companies increased their capital expenditures and acquisitions less than other firms did, following the two most recent U.S. reductions in shareholder taxes. The effects appear stronger when capital gains taxes alone were cut (1997) than when both capital gains and dividend taxes were reduced (2003). To our knowledge, these findings provide the first evidence of differential effects on the direct link between corporate spending and the shareholder taxes that its owners face.