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Dynamic Behaviour of the Firm Under Dual Income Taxation

Listed author(s):
  • Seppo Kari

This study examines certain incentive aspects of the dual income tax system (DIT) operated in the four major Nordic countries since the beginning of the 1990s. In this tax system capital income is taxed at a flat rate, whereas earned income is subject to a conventional progressive schedule. The analysis focuses on the splitting of dividend income received from a closely held firm into capital and earned income parts. A deterministic, dynamic investment model as developed by Sinn (1991) is applied. This basic model is extended in several directions. The study in chapters 2 and 3 reveals that Nordic DIT may have strong effects on the firm?s investment and financing behaviour. In extreme cases the firm?s cost of capital can even be negative. These effects may also have efficiency and welfare consequences. The study also shows that the distortions are very sensitive to the content of the capital base concept. For instance, when financial assets are included in the capital base the firm?s marginal return on capital is at the level of the nominal interest rate, thus eliminating the real distortions discussed above.

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Paper provided by Government Institute for Economic Research Finland (VATT) in its series Research Reports with number 51.

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Date of creation: 01 Jan 1999
Handle: RePEc:fer:resrep:51
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