The 2003 Tax Reform and Corporate Payout Policy in the US

This study explores the hypothesis that the 2003 tax cuts on dividends and capital gains generated an increase in aggregate dividends and aggregate share repurchases in the US after 2003. I find that the 2003 tax reform leads to a rise in both types of payouts in the General Equilibrium setting with sticky wages after incorporating two financial frictions, including the adjustment costs on dividends and endogenous constraint on repurchases. Two motives lie behind the results. First, the 2003 tax reform generates a tax motive for dividends due to higher tax cuts on dividends than tax cuts on capital gains. Second, the 2003 tax reform activates a flexibility motive for repurchases because paying dividends in the current period induces a commitment of firms to future dividend payments. Since any deviation from such a commitment might be costly for firms, those with low excess cash prefer to choose repurchases as a buffer to protect against extra penalties related to higher dividend volatility. Sticky wages in the General Equilibrium aim to provide firms with excess cash.