Nonlinear Dividend Tax and the Dynamics of the Firm
Kari, Seppo; Laitila, Jussi (2015)
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We analyze the implications of a nonlinear tax scheme for dividends using a life-cycle model of a firm. In this model new firms first enter markets; then grow internally, financing from retained earnings; and finally distribute their profits in the steady state. We find that under a nonlinear tax the owners prefer a smooth flow of dividends, which encourages firms to begin distributions right from the start. This early-distribution incentive (EDI) slows down investments and leads to delayed growth. Our calculations indeed confirm that a revenue-neutral switch from a linear to a progressive tax exacerbates production losses. We further demonstrate that this distortion can be reduced by carrying forward unused tax allowances with interest, as proposed e.g. by Mirrlees et al. (2011).
dividend tax, early-distribution incentive, firm behavior, investment, progressive tax