Dividend and Capital Gains Taxation Under Incomplete Markets
43 Pages Posted: 8 Sep 2014
Date Written: January 18, 2012
Abstract
Motivated by the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003, we study the effects of capital income tax cuts in an economy with heterogeneous households and a representative, mature firm. Dividend tax cuts, contrary to capital gains tax cuts, lead to a decrease in investment and capital. This is because they increase the market value of existing capital and households require a higher return to hold this additional wealth. In line with empirical evidence, the model predicts substantial increases in dividends and stock prices. Overall, the tax cuts lead to a welfare reduction equivalent to a consumption drop of 0.5%.
Keywords: Incomplete Markets, Tax Reform, Dividend Taxes, Capital Gains Taxes
JEL Classification: E23, E44, D52
Suggested Citation: Suggested Citation