Dividend Taxation and Intertemporal Tax Arbitrage
We analyze the effects of changes in dividend tax policy using a life-cycle model of the firm, in which new firms first access equity markets, then grow internally, and finally pay dividends when they have reached steady state.
In accordance with the traditional view of dividend taxation, new firms raise less equity and invest less the higher the level of dividend taxes. However, as postulated by the new view of dividend taxation, the dividend tax rate is irrelevant for the investment decisions of internally growing and mature firms. Since aggregate investment is dominated by these latter two categories, the level of dividend taxation as well as unanticipated changes in tax rates have only small effects on aggregate investment.
Anticipated dividend tax changes, on the other hand, allow firms to engage in inter-temporal tax arbitrage so as to reduce investors' tax burden. This can significantly distort aggregate investment. Anticipated tax cuts (increases) delay (accelerate) firms' dividend payments, which leads them to hold higher (lower) cash balances and, for capital constrained firms, can significantly increase (decrease) aggregate investment for periods after the tax change.
The analysis of dividend taxation in a contestable democracy thus has to take into account future policy changes as well as expectations thereof. This can significantly alter the evaluation of any given dividend tax policy.
The authors would like to express their thanks for helpful comments to Raj Chetty, Allan Drazen, Jianjun Miao, Jim Mirrlees, Jim Poterba, Joel Slemrod and Michael Woodford as well as to two anonymous referees and to participants at a conference at Cambridge University in honor of Mirrlees' 70th birthday, an NBER Public Economics Program Meeting, an NBER Universities Research Conference, the 2008 AEA Meetings, and a seminar at Columbia University. Korinek acknowledges financial support from the Austrian Academy of Sciences. Stiglitz acknowledges financial support from the Ford, MacArthur, and Mott foundations. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
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. citation courtesy of