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The Economic Effects of Dividend Taxation

  • James M. Poterba
  • Lawrence H. Summers

This paper tests several competing hypotheses about the economic effects of dividend taxation. It employs British data on security returns, dividend payout rates, and corporate investment, because unlike the United States, Britain has experienced several major dividend tax reforms in the last three decades. These tax changes provide an ideal natural experiment for analyzing the effects of dividend taxes. We compare three different views of how dividend taxes affect decisions by firms and their shareholders. We reject the"tax capitalization" view that dividend taxes are non-distortionary lump sum taxes on the owners of corporate capital. We also reject the hypothes is that firms pay dividends because marginal investors are effectively untaxed. We find that the traditional view that dividend taxes constitute a "double-tax" on corporate capital income is most consistent with our empirical evidence. Our results suggest that dividend taxes reduce corporate investment and exacerbate distortions in the intersectoral and intertemporal allocation of capital.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1353.

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Date of creation: May 1984
Date of revision:
Publication status: published as Poterba, James M. and Lawrence H. Summers. "The Economic Effects of Dividend Taxation." Recent Advances in Corporate Finance, edited by Edward Altman and Marti Subrahmanyam, pp. 227-284. Homewood, IL: Richard D. Irwin Publishers, 1985.
Handle: RePEc:nbr:nberwo:1353
Note: PE ME
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  1. Daniel R. Feenberg, 1980. "Does the Investment Interest Limitation Explain the Existence of Dividends?," NBER Working Papers 0530, National Bureau of Economic Research, Inc.
  2. Martin Feldstein, 1978. "The Welfare Cost of Capital Income Taxation," NBER Chapters, in: Research in Taxation, pages 29-51 National Bureau of Economic Research, Inc.
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  4. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January.
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  8. Elton, Edwin & Gruber, Martin & Rentzler, Joel, 1983. "A simple examination of the empirical relationship between dividend yields and deviations from the CAPM," Journal of Banking & Finance, Elsevier, vol. 7(1), pages 135-146, March.
  9. Joseph E. Stiglitz, 1983. "Some Aspects of the Taxation of Capital Gains," NBER Working Papers 1094, National Bureau of Economic Research, Inc.
  10. Auerbach, Alan J., 1983. "Stockholder tax rates and firm attributes," Journal of Public Economics, Elsevier, vol. 21(2), pages 107-127, July.
  11. Lewellen, Wilbur G, et al, 1978. "Some Direct Evidence on the Dividend Clientele Phenomenon," Journal of Finance, American Finance Association, vol. 33(5), pages 1385-99, December.
  12. James M. Poterba & Lawrence A. Summers, 1984. "New Evidence that Taxes Affect the Valuation of Dividends," Working papers 338, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
  14. Long, John Jr., 1978. "The market valuation of cash dividends : A case to consider," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 235-264.
  15. Auerbach, Alan J, 1983. "Taxation, Corporate Financial Policy and the Cost of Capital," Journal of Economic Literature, American Economic Association, vol. 21(3), pages 905-40, September.
  16. Fama, Eugene F, et al, 1969. "The Adjustment of Stock Prices to New Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 10(1), pages 1-21, February.
  17. Jerry R. Green, 1980. "Taxation and the Ex-Dividend Day Behavior of Common Stock Prices," NBER Working Papers 0496, National Bureau of Economic Research, Inc.
  18. Feldstein, Martin S, 1970. "Corporate Taxation and Dividend Behaviour," Review of Economic Studies, Wiley Blackwell, vol. 37(1), pages 57-72, January.
  19. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  20. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
  21. Miller, Merton H. & Scholes, Myron S., 1978. "Dividends and taxes," Journal of Financial Economics, Elsevier, vol. 6(4), pages 333-364, December.
  22. Martin Feldstein & James M. Poterba & Louis Dicks-Mireaux, 1981. "The Effective Tax Rate and the Pretax Rate of Return," NBER Working Papers 0740, National Bureau of Economic Research, Inc.
  23. Constantinides, George M, 1983. "Capital Market Equilibrium with Personal Tax," Econometrica, Econometric Society, vol. 51(3), pages 611-36, May.
  24. Fullerton, Don, et al, 1981. "Corporate Tax Integration in the United States: A General Equilibrium Approach," American Economic Review, American Economic Association, vol. 71(4), pages 677-91, September.
  25. King, M A, 1971. "Corporate Taxation and Dividend Behaviour-A Comment," Review of Economic Studies, Wiley Blackwell, vol. 38(115), pages 377-80, July.
  26. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
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