Do changes in dividend taxation cause reallocation of investments and dividends?

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School of Business | Master's thesis
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While the theory of the effects of dividend taxation on investments and dividends is well established, academics have failed to find a consensus on which applies universally, and empirical results are at best contradicting. Recent research has proposed heterogeneous responses between firms and this “reallocation view” has empirical support as well. I test whether similar heterogeneous investment responses to dividend taxation exist in Finland by examining the corporate income tax reforms of 2005 and 2014. By utilizing a rich panel dataset of financial statements of listed and non-listed Finnish firms and a difference-in-difference approach, I find inconsistencies in the reallocation of investments between firms with different sources of finance. New equity financed non-listed firms respond most predictably by decreasing investments when dividend taxation increases. On the contrary, the responses of non-listed firms with retained are erratic as they decrease investments despite a lower cost of capital, an observation difficult to explain with existing frameworks. The responses in listed firms seem time variant and are likely affected by non-observable external factors in addition to the examined changes in dividend taxation. Dividend responses and changes in capital structure fail to explain investment behavior and display behavior unlike in previous research. Despite statistically significant responses in investments, relative productivity seems largely unchanged following the reforms, suggesting that the productivity differences between firms are not as substantial as previously estimated. These results partially support previous research on the existence a reallocation of investments following dividend tax reforms, but on the other hand provide contradicting results. Nevertheless, the results imply that dividend taxation has real economic effects which should be considered not only by legislators trying to optimize the tax base and tradeoff from taxation, but also firms and shareholders looking to make more informed investment decisions.
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Torstila, Sami
corporate income taxation, cost of capital, dividend, dividend taxation, investment, investment allocation, tax reform
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