Capital Tax Reform and the Real Economy: the Effects of the 2003 Dividend Tax Cut

1. Contribution of the paper and research design

After the sharp dividend tax cut from 38.6% to 15% as part of the Jobs and Growth Tax Relief Reconciliation in the U.S., President Bush predicted that the tax cut would provide "short-term support to investment and “capital to build factories, to buy equipment, hire more people”. Tra-ditional economic models suggest that dividend tax cuts considerably reduce firms’ cost of capi-tal because it reduces the taxes that must be paid when profits are distributed to shareholders. This has also an effect on the level of corporate investment. The central question of the paper of Yagan is whether the 2003 dividend tax cut in the U.S.A. increased the level of corporate in-vestment and employee compensation. Against the prediction of the U.S. president, Yagan pro-vides empirical evidence that the reform did not increase these levels for his sample of private firms. Thereby, he contributes to the discussion about the effects of dividend tax reforms. Al-stadsæter et al. exploit Sweden’s dividend tax cut by using rich administrative panel data and a triple-difference approach, showing that the reform does not affect aggregate investment but that it affects the allocation of corporate investment of private firms. Becker et al. also show that apart from any level effects, dividend taxes change the allocation of capital across firms.

The main challenge of the research design is to find real effects of the 2003 dividend tax cut as level of investments are substantially influenced by business cycle effects. The different status of U.S. corporations allows to control for these business cycle effects. Yagan uses a large strati-fied random sample of US corporate income tax returns from years 1996–2008. The so-called C-corporations and S-corporations face similar tax rates except that C-corporations are subject to dividend taxation while S-corporations are not. By using a difference-in-difference approach, Yagan tests if the treatment group (C-corporations) changed levels of investments relative to the control group (S-corporations) considering the changes before and after the tax reform. He as-sesses the impact by using the following regression equation:

The dependent variable INVESTMENT equals the cost of all newly purchased tangible capital assets. The difference-in-difference estimator of interest is α2 considering the interaction be-tween an indicator variable CCORP, referring to C-corporations, and POST as indicator variable for the period after the reform. The regression equation includes firm related controls and year fixed effects. The results find an insignificantly negative effect, indicating that annual C-corporation investment trended similarly to annual S-corporation investment before 2003 and continued to do so after 2003.

After presenting visual evidence and