A Schumpeterian Analysis of Deficit-Financed Dividend Tax Cuts

41 Pages Posted: 22 Sep 2008

See all articles by Pietro F. Peretto

Pietro F. Peretto

Duke University - Department of Economics; Duke Innovation & Entrepreneurship Initiative

Date Written: May 29, 2007

Abstract

I propose a Schumpeterian analysis of the growth and welfare effects of a deficit-financed cut of the tax rate on distributed dividends. I find that income per capita growth initially accelerates and then decelerates, eventually converging to a long-run value lower than the starting one. Interestingly, lower steady-state growth occurs despite the fact that - in line with intuition - the economy's saving ratio rises. Most importantly, I find that the policy's effect on welfare is negative. The mechanism that delivers these results is that taxes on distributed dividends affect differently the returns to investing in the growth of existing product lines and in the development of new product lines, and thus reallocate resources across activities that have different growth opportunity. The analysis is particularly relevant to the current debate about the Job Growth and Taxpayer Relief reconciliation Act of 2003 (JGTRRA), a real-world large-scale experiment in fiscal policy. A surprising implication is that the JGTRRA targeted the wrong tax rate: Holding the financing method (debt) equal, it should have cut the tax rate on corporate income, thereby reducing the distortions of the internal investment decisions of firms and improving growth and welfare.

Keywords: Endogenous Growth, Market Structure, Dividends, Corporate Taxation

JEL Classification: E10, L16, O31, O40

Suggested Citation

Peretto, Pietro F., A Schumpeterian Analysis of Deficit-Financed Dividend Tax Cuts (May 29, 2007). Economic Research Initiatives at Duke (ERID) Working Paper No. 15, Available at SSRN: https://ssrn.com/abstract=1270612 or http://dx.doi.org/10.2139/ssrn.1270612

Pietro F. Peretto (Contact Author)

Duke University - Department of Economics ( email )

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Duke Innovation & Entrepreneurship Initiative ( email )

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