The Share Price Effects of Dividend Taxes and Tax Imputation Credits

49 Pages Posted: 22 Sep 1998  

Trevor S. Harris

Columbia University - Columbia Business School

R. Glenn Hubbard

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Deen Kemsley

Tulane University - Accounting & Taxation

Multiple version iconThere are 2 versions of this paper

Date Written: September 17, 1998

Abstract

The relation between shareholder-level taxes and firm value has fundamental implications for understanding why firms pay dividends and how taxes influence capital structure choices. Despite its importance, however, several underlying problems have hampered existing research on the specific question of dividend tax capitalization. We take a new approach, directly testing the relationship between dividend taxes and the valuation of common equity and earnings. Retained earnings are subject to dividend taxes upon distribution, but paid-in equity can be returned to shareholders as a tax-free return of capital. Therefore we test the prediction that dividend taxes result in a lower value for retained earnings than for paid-in equity, after controlling for the predictable influence of dividend taxes on the valuation of earnings.

We strengthen this research design by repeating the basic test in several different tax regimes. In the United States, we perform tests for five tax regimes in the 1975-1994 period corresponding to five different levels of dividend taxation. We also conduct tests for the 1984 1994 period for Australia, France, Germany, Japan, and the United Kingdom. The non-U.S. settings allow for comparisons of empirical results across different levels of dividend tax relief provided by tax imputation credits.

Our investigation results in three principal findings. First, firm-level results for the United States indicate that accumulated retained earnings are valued less per unit than contributed capital. This finding is consistent with the capitalization of future dividend taxes in retained earnings, and it is robust to inclusion of a variety of control variables and tests for possible alternative explanations. Second, we find that differences in dividend tax rates across U.S. tax regimes are associated with predictable differences in the implied tax discount for retained earnings. Third, cross-country variation in dividend tax rates is associated with predictable variation in the implied tax discount. Furthermore, the difference in dividend tax rates across two different tax regimes in the United Kingdom is associated with predictable differences in the value discount.

JEL Classification: G12, G35, H25

Suggested Citation

Harris, Trevor S. and Hubbard, R. Glenn and Kemsley , Deen, The Share Price Effects of Dividend Taxes and Tax Imputation Credits (September 17, 1998). Available at SSRN: https://ssrn.com/abstract=123433 or http://dx.doi.org/10.2139/ssrn.123433

Trevor S. Harris (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
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212-851-1802 (Phone)
212-316-9219 (Fax)

Robert Glenn Hubbard

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

HOME PAGE: http://www.gsb.columbia.edu/faculty/ghubbard

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Deen Kemsley

Tulane University - Accounting & Taxation ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

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