Tax Treatment of Dividends and Capital Gains and the Dividend Decision Under Dual Income Tax

Seppo Kari and Hanna Karikallio

No 416, Discussion Papers from VATT Institute for Economic Research

Abstract: The paper analyses efficiency aspects of a dual income tax system with a higher tax on capital gains than dividends. It argues that apart from the distortions to investments claimed in earlier literature, the system puts even more emphasis in creating incentives for entrepreneurs to participate in tax planning. The paper suggests that the owner of a closely held company can avoid all personal taxes on entrepreneurial income by two tax-planning strategies. The first is the avoidance of distributions, which would be taxed at the tax rate on labour income. These funds would instead be invested in the financial markets. The second strategy is a distribute-and-call-back policy, converting retained profits into new equity capital. Interestingly, the outcome is that investment in real capital is not distorted in the long-run equilibrium. Empirical evidence using micro data is also provided.

Keywords: Dual income tax, small business taxation, income shifting, Taxation, Verotus, Taxation and Social Transfers, Julkisen talouden rahoitus ja tulonsiirrot, H240 - Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes, H250 - Business Taxes and Subsidies including sales and value-added (VAT), (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-pub
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Citations: View citations in EconPapers (5)

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https://www.doria.fi/handle/10024/148402

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Journal Article: Tax treatment of dividends and capital gains and the dividend decision under dual income tax (2007)
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