Dividend Taxation and Intertemporal Tax Arbitrage

50 Pages·2008·0.43 MB·English

Dividend Taxation and
Intertemporal Tax Arbitrage
Anton Korinek and Joseph E. Stiglitz
Oslo
August 2008
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 1/50
Contributions
1 General life cycle theory of the firm under dividend taxation
(cid:73) inastochasticworld
(cid:73) withimperfectcapitalmarkets
2 Analysis of the impact of dividend taxation:
(cid:73) effectsoftemporarydividendtaxcutoninvestmentandoutput
likelytobeadverse
3 Political economy for contestable democracies:
(cid:73) thereisnosuchthingaspermanentpolicies
(cid:73) thishasfirstorderimplicationswheneverprivateagents’actions
entailintertemporaleffects
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 2/50
Motivation
Motivation
Fierce debate over the effects of dividend taxation
(cid:73) Traditionalview: taxationdistortionary
(cid:73) Newview: marginalincentivetoinvestisunaffected
⇒ we develop a stochastic life-cycle model incorporating both
views
Role of capital market imperfections is largely ignored
(cid:73) Firm’spayoutpolicyaffectsitsabilitytoinvest
⇒ we analyze the implications of this for dividend taxation
Tax policy is analyzed as if changes were permanent
(cid:73) Incontestabledemocracynopolicyispermanent
(cid:73) Rationalagentsanticipatethis
⇒ we analyze this as an infinitely repeated dynamic game
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 3/50
Overview
Overview
1 Analysis of Firms and Effects of Dividend Taxation
(cid:73) Constructvaluefunction
(cid:73) Describebehaviorundernotaxation/constanttaxation
(cid:73) Effectsofunanticipatedchangesintaxation
(cid:73) Implicationsofanticipatedchangesintaxation
(cid:73) Aggregatebehaviorofthemacroeconomy
2 Political Economy of Dividend Taxation
(cid:73) Keydeterminantoffirmbehavior: beliefsaboutfuturetaxrates
(cid:73) Futuretaxratesinturndependonpartyrule
(cid:73) Markovmodelwithexogenouslyfixedtaxrates
(cid:73) Markovmodelwithendogenoustaxrates
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 4/50
Life-CycleModelofFirms AnalyticalSetup
Key Considerations
Holding cash is costly because of agency problems:
(cid:73) investors’discountfactorisβ < 1 ,
1+r
i.e.lessthantherisk-freediscountrate(assumedexogenous)
(cid:73) ⇒incentivetopayoutdividendsD
t
Investment opportunities arrive randomly:
(cid:73) Bernoullivariableλ˜ indicateswhetherthereisaninvestment
t
opportunityattimet
(cid:73) Probabilityforinvestmentopportunityisp
(cid:73) Ifλ˜ =1,theninvestingI yieldsG(I )=AIα−(1+r)I
t t t t t
Capital market imperfections:
(cid:73) preventfirmsfromquicklyraisingnewcash
(cid:73) investmentthusreliesoninternalcashholdingsM :
t
I ≤M −D
t t t
⇒ link between incentive to pay dividends, investment, and output
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 5/50
Life-CycleModelofFirms AnalyticalSetup
Key Results
1 Firms can be analyzed by looking at three distinct stages:
(cid:73) Newfirms: M =0,needtoraisecashinequitymarkets
t
(cid:73) Youngfirms: 0<M <M∗,retainalltheirearnings
t
(cid:73) Maturefirms: M ≥M∗,distributealltheirearnings
t
optimal cash holdings M∗ determined by the trade-off between the
cost of holding cash and expected cost of capital constraints
2 Most firms in the economy are mature: Mt ≥ M∗. For these:
(cid:73) Theleveloftaxationisirrelevant
(cid:73) Unanticipatedpermanentdividendtaxchangeshavenoeffect
(cid:73) Anticipatedincreases(decreases)intaxationallowfor
intertemporaltaxarbitrageandtemporarilylower(raise)cash
holdings,investment,andoutput
(cid:73) Probabilistictaxchangeshavesimilareffects
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 6/50
Life-CycleModelofFirms AnalyticalSetup
Key Results (2)
1 Unanticipated temporary tax changes are equivalent to:
(cid:73) unanticipatedchangeinonedirection
(cid:73) expectedreversalofthischangeinalaterperiod
2 Effects of unanticipated temporary tax cut:
(cid:73) maturefirms: noeffectoftemporarilylowerrate
atexpiration: highdividendpayout⇒loweroutputandinvestment
(cid:73) youngfirms: temporarilylowerrate:
(cid:70) iftaxcutisshort-lived: irrelevant(taxwillberaisedagainbeforefirm
makesdividendpayments)
(cid:70) iflongenough: initialperiodinwhichnewlyestablishedfirmsraise
morecapital,havehigherequitybuild-up,moreinvestmentandoutput
atexpiration: highdividendpayout⇒loweroutputandinvestment
(cid:73) aggregateeffectdominatedbymaturefirms:
⇒overallnegativeeffectonoutputandinvestment
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 7/50
Life-CycleModelofFirms AnalyticalSetup
Firms’ Maximization Problem
Optimization problem of growing or mature firms under constant
dividend tax rate τ:
(cid:40) ∞ (cid:41)
(cid:88)
V(M ) = max E βt (1−τ)D
0 t
{Dt,It,Mt+1}∞t=0 t=0
s.t. M = (1+r)[M −D ]+λ˜ G(I )
t+1 t t t t
M ≥ I +D
t t t
D ≥ 0
t
with M > 0 given.
0
or, in recursive notation:
(cid:110) (cid:111)
V(M ) = max(1−τ)D +βEV (1+r)[M −D ]+λ˜ G(I )
t t t t t t
Dt,It
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 8/50
Life-CycleModelofFirms AnalyticalSetup
Firms’ Value Function V(M )
t
5.5
V’ = 1−τ
M)t5 V’ > 1−τ
V(
e
u
al
m v4.5
fir
4
ISS = M∗ I∗
3.5
0 0.5 1 1.5 2
cash holdings M
t
Figure: ThevaluefunctionV(M )canbedeterminediterativelyfromfirms’
t
maximizationproblem. Parametervaluesused: α=1/2,β =0.93,r =0.01,
p =1/2,τ =38.6%,AcalibratedsothatISS =1.
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 9/50
Life-CycleModelofFirms Steady-StateAnalysis
Firms in Steady State
Proposition (Steady state investment)
The amount of money ISS that a firm in steady state sets aside for
investment is defined by a marginal product of
β[pF(cid:48)(ISS)+(1−p)(1+r)] = 1
Intuition:
Both sides of this equation can be multiplied by (1−τ)
Resulting equation: discounted expected benefit of holding cash =
cost of paying out dividends
Note: without capital constraints, optimum investment is
F(cid:48)(I∗) = 1+r
The two solutions coincide if β = 1 , otherwise ISS < I∗
1+r
AntonKorinekandJosephE.Stiglitz (2008) DividendTaxation Oslo 10/50