Tax treatment of dividends and capital gains and the dividend decision under dual income tax |
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Authors: | Seppo Kari Hanna Karikallio |
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Institution: | (1) Government Institute for Economic Research (VATT), P.O. Box 1279, 00101 Helsinki, Finland |
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Abstract: | The paper analyses efficiency aspects of a dual income tax system with a higher tax on capital gains than dividends. It argues
that apart from the distortions to investments claimed in earlier literature, the system puts even more emphasis in creating
incentives for entrepreneurs to participate in tax planning. The paper suggests that the owner of a closely held company can
avoid all personal taxes on entrepreneurial income by two tax-planning strategies. The first is the avoidance of distributions,
which would be taxed at the tax rate on labour income. These funds would instead be invested in the financial markets. The
second strategy is a distribute and call-back policy, converting retained profits into new equity capital. Interestingly,
the outcome is that investment in real capital is not distorted in the long-run equilibrium. Empirical evidence using microdata
is also provided.
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Keywords: | Dual income tax Small business taxation Income shifting |
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