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An Agency Theory of Dividend Taxation

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  • Raj Chetty
  • Emmanuel Saez

Abstract

Recent empirical studies of dividend taxation have found that: (1) dividend tax cuts cause large, immediate increases in dividend payouts, and (2) the increases are driven by firms with high levels of shareownership among top executives or the board of directors. These findings are inconsistent with existing "old view" and "new view" theories of dividend taxation. We propose a simple alternative theory of dividend taxation in which managers and shareholders have conflicting interests, and show that it can explain the evidence. Using this agency model, we develop an empirically implementable formula for the efficiency cost of dividend taxation. The key determinant of the efficiency cost is the nature of private contracting. If the contract between shareholders and the manager is second-best efficient, deadweight burden follows the standard Harberger formula and is second-order (small) despite the pre-existing distortion of over-investment by the manager. If the contract is second-best inefficient -- as is likely when firms are owned by diffuse shareholders because of incentives to free-ride when monitoring managers -- dividend taxation generates a first-order (large) efficiency cost. An illustrative calibration of the formula using empirical estimates from the 2003 dividend tax reform in the U.S. suggests that the efficiency cost of raising the dividend tax rate could be close to the amount of revenue raised.

Suggested Citation

  • Raj Chetty & Emmanuel Saez, 2007. "An Agency Theory of Dividend Taxation," NBER Working Papers 13538, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13538 Note: CF PE
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    References listed on IDEAS

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    Cited by:

    1. Magnus Henrekson & Tino Sanandaji, 2011. "Entrepreneurship and the theory of taxation," Small Business Economics, Springer, vol. 37(2), pages 167-185, September.
    2. Marko Köthenbürger & Michael Stimmelmayr, 2009. "Corporate Taxation and Corporate Governance," CESifo Working Paper Series 2881, CESifo Group Munich.
    3. Annette Alstadsæter & Erik Fjærli, 2009. "Neutral taxation of shareholder income? Corporate responses to an announced dividend tax," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 16(4), pages 571-604, August.
    4. Jennifer Blouin & Jana Raedy & Douglas Shackelford, 2010. "Dividends, Share Repurchases, and Tax Clienteles: Evidence from the 2003 Reductions in Shareholder Taxes," NBER Working Papers 16129, National Bureau of Economic Research, Inc.
    5. Korinek, Anton & Stiglitz, Joseph E., 2009. "Dividend taxation and intertemporal tax arbitrage," Journal of Public Economics, Elsevier, vol. 93(1-2), pages 142-159, February.
    6. Tobias Lindhe & Jan Södersten, 2014. "Dividend Taxation and the Cost of New Share Issues," CESifo Working Paper Series 5001, CESifo Group Munich.
    7. Raj Chetty & Emmanuel Saez, 2010. "Dividend and Corporate Taxation in an Agency Model of the Firm," American Economic Journal: Economic Policy, American Economic Association, vol. 2(3), pages 1-31, August.
    8. Emmanuel Saez & Joel Slemrod & Seth H. Giertz, 2012. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 50(1), pages 3-50, March.
    9. Lindhe, Tobias & Södersten, Jan, 2013. "Distortive Effects of Dividend Taxation," Working Paper Series 2013:16, Uppsala University, Department of Economics.
    10. Kari, Seppo & Karikallio, Hanna & Pirttilä Jukka, 2009. "The impact of dividend taxation on dividends and investment: New evidence based on a natural experiment," Working Papers 9, VATT Institute for Economic Research.
    11. Lindhe, Tobias & Södersten, Jan, 2013. "Distortive Effects of Dividend Taxation," Working Paper Series, Center for Fiscal Studies 2013:9, Uppsala University, Department of Economics.
    12. Jesse Edgerton, 2010. "Effects of the 2003 dividend tax cut: evidence from real estate investment trusts," Finance and Economics Discussion Series 2010-34, Board of Governors of the Federal Reserve System (U.S.).
    13. Jennifer L. Blouin & Jana Smith Raedy & Douglas A. Shackelford, 2007. "Did Firms Substitute Dividends for Share Repurchases after the 2003 Reductions in Shareholder Tax Rates?," NBER Working Papers 13601, National Bureau of Economic Research, Inc.
    14. Lindhe, Tobias & Södersten, Jan, 2014. "Dividend Taxation and the Cost of New Share Issues," Working Paper Series, Center for Fiscal Studies 2014:12, Uppsala University, Department of Economics.

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    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General

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