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This note extends the work by Sorensen (Int Tax Public Finance 12:777-801, 2005) and others by demonstrating why the Norwegian Shareholder Income Tax may be neutral between the two sources of equity funds, i.e., new share issues and retained earnings, despite the fact that the retention of earnings to finance new investment does not add to the tax benefits. The analysis crucially relies on the assumption that the deduction for the imputed rate of return is capitalized into the market prices of corporate shares. Absent capitalization, the shareholder tax is rather likely to leave the distortions caused by the double taxation of corporate source income unaffected.

This note extends the work by Sørensen (2005) and others by demonstrating why the Norwegian Shareholder Income Tax may be neutral between the two sources of equity funds, i.e. new share issues and retained earnings, despite the fact that the retention of earnings to finance new investment does not add to the tax benefits.  The analysis crucially relies on the assumption that the deduction for the imputed rate of return is capitalized into the market prices of corporate shares. Absent capitalization, the shareholder tax is rather likely to leave the distortions caused by the double taxation of corporate source income unaffected.

It has generally been accepted in earlier research that the dividend tax reduces the rate of return to investments financed by new issues of equity, and hence raises the cost of capital. Still, and virtually without discussion, the existing literature has come to widely diverging conclusions about the size of the tax distortion. We demonstrate that the extent to which shareholders can recover their original equity injections without being subject to tax is a key factor in determining the cost of new equity. Our analysis explains for the first time why the earlier literature has come to diverging conclusions about the size of the tax distortion.

This paper examines how the effects of dividend taxation on the cost of new equity funds depend on whether or not shareholders can recover their original equity injections without being subject to the dividend tax. We point out the alternative assumptions in the literature on this, and we compare two different tax regimes, one where it is impossible for the firm to pay cash to its shareholders that is not taxed as dividends, the other where the shareholders are allowed a tax-free return of the original capital contributed through new issues. We conclude that any model, which explicitly or implicitly assumes that the shareholders cannot recover their original equity injections without being subject to the dividend tax, exaggerates the distortive effects of the tax.

This paper examines how the distortions caused by dividend taxation depend on whether or not shareholders can recover their original equity injections without being subject to the dividend tax. We point out the alternative assumptions in the literature on this, and we compare two different tax regimes, one where it is impossible for the firm to pay cash to its shareholders that is not taxed as dividends, the other where the shareholders are allowed a tax-free return of the original capital contributed through new issues. Our analysis shows that the regimes imply a substantial difference to our perceptions of the distortive effects of dividend taxation.

This paper examines how the distortions caused by dividend taxation depend on whether or not shareholders can recover their original equity injections without being subject to the dividend tax. We point out the alternative assumptions in the literature on this, and we compare two different tax regimes, one where it is impossible for the firm to pay cash to its shareholders that is not taxed as dividends, the other where the shareholders are allowed a tax-free return of the original capital contributed through new issues. Our analysis shows that the regimes imply a substantial difference to our perceptions of the distortive effects of dividend taxation.

This article reconsiders the role of dividend taxation and its effect on the cost of capital of small firms. Using a simple portfolio model for small open economies, we show that a decrease in dividend taxes on large companies unambiguously increases the required rate of return for small companies. A dividend tax cut for both, large and small companies may however lead to the counter-intuitive result of increasing cost of capital for small firms. For different small open economies, we further provide statistics on the correlation between the return of large and small firms that drives the counter-intuitive result. Our results suggest that mitigating payout taxes in small open economies can have ambiguous effects on the cost of capital of small, domestically owned firms. This is particularly relevant when tax reforms are designed to stimulate investments by small firms scarce in internal funds.

This article reconsiders the role of dividend taxation and its effect on the cost of capital of small firms. Using a simple portfolio model for small open economies, we show that a decrease in dividend taxes on large companies unambiguously increases the required rate of return for small companies. A dividend tax cut for both, large and small companies may however lead to the counter-intuitive result of increasing cost of capital for small firms. For different small open economies, we further provide statistics on the correlation between the return of large and small firms that drives the counter-intuitive result. Our results suggest that mitigating payout taxes in small open economies can have ambiguous effects on the cost of capital of small, domestically owned firms. This is particularly relevant when tax reforms are designed to stimulate investments by small firms scarce in internal funds.