Dividend Taxes and the Passage to Maturity

The new view holds that a dividend tax is capitalised and leaves the mature firm’s decisions undistorted, provided marginal investment is financed out of retained earnings. The firm reaches that regime by first withholding its earnings, and while it withholds them the dividend tax is not in force. This article places the two regimes inside a trade-off model with debt and endogenous default, so that maturity is an event the firm chooses and may never reach. The dividend tax does not reach the immature firm. It taxes the passage to maturity, and its whole content is one number, the value of a unit distributed relative to a unit retained. Lowering that number from unity to 0.60 lifts the expansion trigger by a factor of 3.4, cuts the probability of ever maturing from 59.8% to 23.7% and the value today of one unit paid at maturity by 90%. At the baseline a third of firms ever mature, and nine tenths of the firm’s discounted lifetime is spent in the regime in which the new view does not apply. The tax also creates the shield that pays for the passage: a firm that can recapitalise at maturity keeps maturing at dividend rates at which a firm that cannot borrow never does, provided the proceeds leave through repurchases rather than dividends. The firms that never mature are those whose expansion buys a small productivity gain and that cannot borrow when they make it.