The Vanishing Harberger Triangle
The paper presents a trapped equity model, but instead of studying how taxes affect corporate decisions when a sufficient amount of equity is already in the trap, it asks the question how does the equity get there. To be more specific, the paper analyzes how the double taxation of dividends affects the growth of a corporation that starts with no equity capital. One conclusion is that dividend taxes are distortionary before they are paid, but not when they are paid. Once the firm is in a stage of maturity where it pays dividends and dividend taxes, tax neutrality prevails. Thus the true intersectoral distortion resulting from corporate taxation is negatively correlated with the measured tax burden, and it is lower, the higher the distortion which estimates of Harberger type would predict. Another conclusion is that the King-Fullerton cost of capital formulae are not applicable in the case of immature firms. These formulas are based on the assumption that firms distribute their profits from marginal investment projects as dividends. However, immature firms strictly prefer a reinvestment to a distribution of profits. The reinvestment changes the cost of equity capital, and typically this cost is higher than a hasty application of the King-Fullerton formulas would predict.
|Date of creation:||Jan 1990|
|Date of revision:|
|Publication status:||published as Journal of Public Economics, Vol. 45, pp. 271-300, (1991). Edited by A.B. Atkinsona and N.H. Stern, UK.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
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- Mervyn A. King, 1974. "Taxation and the Cost of Capital," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 21-35.
- James M. Poterba, 1987.
"Tax Policy and Corporate Saving,"
Brookings Papers on Economic Activity,
Economic Studies Program, The Brookings Institution, vol. 18(2), pages 455-516.
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"Wealth Maximization and the Cost of Capital,"
The Quarterly Journal of Economics,
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- J. S. S. Edwards & M. J. Keen, 1984. "Wealth Maximization and the Cost of Capital: A Comment," The Quarterly Journal of Economics, Oxford University Press, vol. 99(1), pages 211-214.
- Arnold C. Harberger, 1962. "The Incidence of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, vol. 70, pages 215.
- Mervyn A. King & Don Fullerton, 1984. "Introduction to "The Taxation of Income from Capital: A Comparative Study of the United States, the United Kingdom, Sweden, and Germany"," NBER Chapters, in: The Taxation of Income from Capital: A Comparative Study of the United States, the United Kingdom, Sweden, and Germany, pages 1-6 National Bureau of Economic Research, Inc.
- Mervyn A. King & Don Fullerton, 1984. "The Taxation of Income from Capital: A Comparative Study of the United States, the United Kingdom, Sweden, and Germany," NBER Books, National Bureau of Economic Research, Inc, number king84-1, October.
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