Dividend taxes,corporate investment,and ‘Q’

Taxes on corporate distributions have traditionally been regarded as a ‘double tax’ on corporate income. This view implies that while the total effective tax rate on corporate source income affects real economic decisions, the distribution of this tax burden between the shareholders and the corporation is irrelevant. Recent research has suggested an alternative to this traditional view. One explanation of why firms in the United States pay dividends in spite of the heavy tax liabilities associated with this form of distribution is that the stock market capitalizes the tax payments associated with corporate distributions. This capitalization leaves investors indifferent at the margin between a corporation's decision to pay out dividends or to retain earnings. This alternative view holds that while changes in the dividend tax rate will affect shareholder wealth, they will have no impact on corporate investment decisions.This paper develops econometric tests which distinguish between these two views of dividend taxation. By extending Tobin's ‘q’ theory of investment to incorporate taxes at both the corporate and personal levels, the implications of each view for corporate investment decisions can be derived. The competing views may be tested by comparing the performance of investment equations estimated under each theory's predictions. British time series data are particularly appropriate for testing hypotheses about dividend taxes because of the substantial postwar variation in effective tax rates on corporate distributions. The econometric results suggest that dividend taxes have important effects on investment decisions.     

Does dividend tax impede competition for corporate charters?

We develop a model of jurisdictional competition for corporate charters among the states in which a firm’s agency cost depends on the federal dividend income tax rate and the takeover regulations of its domicile state. When firms are mobile across states, the federal dividend income tax rate affects both the intensity of competition among the states and the equilibrium level of state takeover regulations. Our model shows that increasing dividend tax rate weakens the competition for corporate charters under a condition: dividend-paying and the market for corporate control are complementary corporate governance mechanisms. This condition holds empirically, suggesting that dividend tax not only discourages firms from paying dividends but also weakens their corporate governance by disincentivizing states to improve their corporate laws.     

Information-eliciting compensation schemes

This paper examines the implications of the ‘residence’ approach to taxing foreign source income such as employed by the United States. It is argued that, because the repatriation of earnings to the home country investor and not the earnings themselves are typically the source of tax liability, the foreign source income tax should affect foreign investment differently depending on the required transfers of funds within the firm.One implication of viewing the tax in this way is that in order to maximize after-tax profits, a firm should finance its foreign investment out of foreign earnings to the greatest extent possible. That is, a firm's required foreign return jumps at the point at which desired foreign investment just exhausts foreign earnings. This allows us to draw a distinction between ‘mature’ foreign operations, which are at any point in time financed at the margin by investing earnings (and perhaps also pay dividends to their parent firm in the home country), and ‘immature’ foreign affiliates, which rely on funding from their parents (and should not be paying dividends). It is noted that survey evidence on multinational firm behavior is consistent with this distinction. Direct investment data indicate that mature foreign operations probably account for nearly 90 percent of U.S. foreign direct investment.The discussion then turns to investment incentives. It is shown that the home country's rate of tax on foreign source income and the presence or absence of a foreign tax credit should be irrelevant to a mature foreign operations's investment and dividend decisions. This conclusion, which conflicts sharply with the conventional wisdom, follows because the home country tax acts as an unavoidable cost. New firms' investment decisions are, on the other hand, influenced by home country taxes.     

Dividend Taxes and Income Shifting

In this paper, we analyze whether a dividend tax cut for owner‐managers of closely held corporations encourages income shifting, income generation, or both. We use rich Swedish administrative micro data from 2000 to 2011 comprising detailed firm‐ and individual‐level information. We find robust evidence of extensive income shifting across tax bases in response to the 2006 Swedish dividend tax cut. Owner‐managers of closely held corporations reclassify earned income as dividend income but do not increase total income. The response is more pronounced for owner‐managers with tax incentives and with easier access to income shifting through a high ownership share.     

Professor Friedman,meet Lady Rhys-Williams: NIT vs. CIT

In the conventional view, income testing is required to make a tax-transfer program ‘efficient.’ This view can be seen to hinge on the ‘target efficiency’ concept. The economic efficiency of income testing is analyzed here-including distortions of household behavior and the total administrative costs of the tax-transfer system. The income-tested program is a negative income tax system (NIT), which has divergent marginal tax rates for beneficiaries and net taxpayers; the nontested scheme is a credit income tax (CIT), which makes universal payments and imposes a uniform marginal tax rate. Theoretical analysis shows the conditions under which the CIT is more efficient than a comparable NIT. Some suggestive empirical evidence and policy considerations in the choice between NIT and CIT are presented.     

A general proposition on the design of a neutral business tax

A simple and general means of levying a business tax that is ‘neutral’ in the sense that it does not affect the firm's decisions at the margin is discussed. In particular, we analyze the effect of a business tax of our design on the investment decision of the firm. The well-known ‘imputed income’ and ‘immediate write-off’ methods of levying a neutral business tax are found to be special cases of our general tax design. The implication of our results is that a neutral ‘pure profits’ tax can be levied without the informational difficulties of the imputed income method or the cash flow disadvantages of the immediate write-off method.     

Testing and applying a theory of utility: An attempt to decompose income in compensatory and scarcity rents

Data on income after tax, schooling completed, job held, age, and ‘level of satisfaction’ of 2663 members of the Dutch Consumer Union have been used to estimate regression equations of two types. Type I may be called a specification of a utility function, Type II an ‘earnings function’ (where income after tax was used as earnings). For both types a number of alternatives were estimated both with regard to mathematical shape and with regard to variables included. Defining equitable or justified income differences as differences which do not change the level of satisfaction, a formula for equitable incomes for given combinations of job, schooling and age can be derived from Type I equations. All regression coefficients are found to be lower than the corresponding earnings function coefficients. The latter can then be decomposed into a ‘compensatory’ component and a ‘scarcity rent’ component.     

Input versus output incentive schemes

Previous analyses have modeled income tax evasion as a ‘portfolio problem’, deriving the optimal consumption of the ‘risky asset’ (unreported income) assuming a fixed probability of detection. We compare an alternative audit policy to the standard random audit policy. We focus on an ‘audit cutoff’ policy, in which an agent triggers an audit if reported income is ‘too low’, and is not audited if reported income is ‘sufficiently high’. We find that random audit rules are weakly dominated by audit cutoff rules. Given lump-sum taxes and fines, audit cutoff rules are the least-cost policies which induce truthful reporting of income.     

The repatriation incentive of the foreign dividend exemption system

Due to the high taxation of domestic corporate income, Japanese multinational enterprises have avoided to repatriate foreign profits to Japan for quite some time. As a consequence, the Japanese government introduced a new taxation system in 2009 – the so called dividend exemption system – which was aimed at reducing the effective tax burden of foreign dividends of Japanese multinational companies in order to increase tax revenue and stimulate economic growth. Applying a theoretical framework which allows comparing the repatriation incentive of the old and new Japanese tax systems, we find that in the long-run the tax regime change fails to incentivize foreign subsidiaries to repatriate foreign profits. Especially subsidiaries with high leverage located in countries with low corporate taxes and low dividend taxes might reinvest rather than distribute their earnings in the dividend exemption method.     

‘Linear’ income tax cuts: distributional effects,social preferences and revenue elasticities

The paper examines differential (yield-equivalent) distributional effects, social welfare and voting preferences as well as revenue elasticities of alternative ‘linear’ income tax cuts, each of which is progressivity-neutral with respect to a local progressivity measure. Judged by all criteria, there exists a unique preference for an income tax cut that preserves initial residual progression (or a tax increase that preserves initial liability progression).     

Global capital markets,direct taxation and the redistribution of income

Standard fiscal theory suggests that taxation should be heaviest on the least mobile factors of production – for both efficiency and revenue reasons. A shift in tax burdens from capital to labour as economies become globally integrated is thus justified. This theoretical tradition (founded by Ramsay and continued by Mirrlees and Lucas) assumes by construction that profit taxes reduce investment and growth; and while sensitive to inter-generational equity, sidesteps the issue of income distribution within generations. In contrast, starting from Keynes’ critique of these assumptions and building on modern endogenous growth models, it can be shown that profit taxation is not necessarily injurious to productive investment. In practice, moreover, the effect of globalisation has not been to reduce tax rates on capital, but rather to erode the tax base itself (i.e. ‘tax evasion’). Improved information exchange between tax authorities, which is now being driven by fiscal insolvency in developed countries, would allow tax incidence to be shifted so as to improve income distribution within OECD countries. Such cooperation could also permit the replacement of the current discretionary system of fiscal transfers from rich to poor countries (‘development aid’) by equitable sharing of global capital tax revenue.     

The German Business Tax Reform of 2000: A General Equilibrium Analysis

In the year 2000 Germany enacted a major tax reform involving significant cuts in corporate and personal tax rates and a controversial change in the system of dividend taxation. This paper discusses the effects of the business tax reform on the German economy. The analysis is based on a detailed general equilibrium model of the OECD economy which is designed to illustrate the domestic and international effects of national tax policies. The simulations indicate that the German business tax reform will raise domestic economic activity and welfare, although the welfare gain will accrue disproportionately to households with a high ratio of property income to total income.     

Ricardian Consumers With Non-Keynesian (And Possibly Ricardian) Propensities

Barsky, Mankiw and Zeldes (1986) have argued that uncertainty about future income can generate strong ‘Keynesian’ responses to tax changes by consumers who have far‐sighted ‘Ricardian’ preferences. The paper argues that this conclusion relies on an inappropriate treatment of future tax policies. Using a more appropriate framework generates behaviour which may instead be approximately Ricardian, and which, if it deviates from the Ricardian benchmark, usually does so in an anti‐Keynesian direction. If Keynesian behaviour is observed, therefore, it requires a different explanation.     

The learning path of the hidden economy: the tax burden and tax evasion in New Zealand

This paper considers the ‘learning curve’ relationship between the aggregate tax rate and the relative size of the hidden economy in New Zealand. Some simple non-linear models are estimated so that the effects of changes in the effective tax rate on the underground economy can be simulated. This study finds that about half of the hidden activity in New Zealand is a learned response to changing opportunities and constraints in fiscal policy, but this amount varies over the business cycle. Simulating a zero tax rate permits us to discover the ‘natural rate’ of underground and criminal activity. Some partial lessons are drawn for taxation policy in that country.     

Automation and inequality with taxes and transfers

Declines in low-skill labour shares are reviewed, and a stylised model is constructed to examine their determinants and future implications. A retrospective analysis of US shocks suggests that technological change has contributed more to raising income inequality and the wealth to GDP ratio than other changes. An anticipated future twist away from low-skill labour toward the capital, combined with population growth, risks high unemployment rates. Productivity growth at twice the pace since 1990 limits this, though inequality persists. Analysis shows that a generalisation of the US ‘earned income tax credit’ system with consumption tax outperforms alternatives of the ‘universal basic income’.     

Indeterminacy, underground activities and tax evasion

This paper introduces underground activities and tax evasion into a one-sector dynamic general equilibrium model with aggregate external effects. The model presents a novel mechanism driving the self-fulfilling prophecies, which is characterized by well behaved (downward sloping) labor demand schedules. This mechanism differs from the customary one, and it is complementary to it. Compared to traditional labor market income, the income derived from underground labor activity is subject to a lower expected tax rate when considering both the probability of detection and the evasion penalty. During a belief-driven expansion, the household allocates more time to both traditional and underground labor supply. In equilibrium, this action serves to lower the effective labor tax rate faced by the household, thus providing stimulus to aggregate labor supply so as to make the initial expansion self-fulfilling. The mechanism here is akin to a “regressive tax”; the household's effective tax rate depends negatively on the level of total labor income. We argue that an underground sector, and the associated tax evasion, offer a good economic rationale for a regressive tax rate.     

Agency problems and unrelated business income of non-profit organizations: an empirical analysis

Nonprofit organizations are traditionally assumed to dislike commercial activities. In the USA, they are however allowed to engage in commercial activities, but the income they derive from these activities is then subject to the so-called ‘unrelated business income tax’. If NPOs do indeed dislike commercial income, then why do they engage in these activities? Using a data set of 2103 US NPOs, this study suggests that the presence of agency problems inside the organization can at least provide an explanation for the occurrence of ‘unrelated business income’.     

A note on the neutrality of the cash flow corporation tax

The cash flow tax has been widely recommended as a form of taxing corporate income which is neutral with respect to investment decisions. This note points out that the claim is valid only under the assumption that the tax rate is constant over time. By contrast, an ‘ideal’ profits tax is neutral whatever the time shape of the tax rate.     

Income distribution and equilibrium multiplicity in a stigma-based model of tax evasion

This paper incorporates continuous income distribution into the stigma-based model of tax compliance. The paper investigates the effect of income distribution on the existence of multiple equilibria, and characterizes the conditions under which multiple equilibria emerge. Precisely, multiple equilibria exist if taxpayer incomes are sufficiently homogeneous, because the ‘social coordination effect’ dominates the ‘individual characteristics effect’. Numerical simulations show that the main proposition is robust to allowing two-step audit policies on the part of the tax agency, under the presumption that the best (or good) equilibrium is selected whenever there are multiple equilibria. As a byproduct, the effect of various forms of tax reforms on the optimal two-step audit policy, the equilibrium compliance, and fiscal revenue is analyzed.     

Employment- and growth effects of tax reforms

Since the mid-1990s almost all OECD countries have engaged in fundamental reforms of their tax systems. There is a trend towards higher social security contributions and lower tax rates on personal and corporate income. This paper explores whether these tax policy measures are effective means for reducing unemployment and accelerating economic growth. Using a Pissarides type search model with endogenous growth, we analyze how savings and the incentive to create new jobs are affected by revenue-neutral tax swaps between wage income taxes, payroll taxes, capital income taxes and taxes levied on capital costs. In our framework, cutting the capital income tax (reducing the double taxation of dividend income) financed by a higher payroll tax turns out to be superior, such a policy mix fosters both employment and growth. Most other tax reforms imply a trade-off between employment and growth.