Measuring Tax Impact on Corporate Dividend Behavior in India

J. V. M. Sarma ()
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J. V. M. Sarma: Madras School of Economics

Chapter Chapter 11 in India’s Contemporary Macroeconomic Themes, 2023, pp 243-263 from Springer

Abstract: Abstract The non-government joint stock corporations have been dominating the Indian economic scene for quite some time now. Yet, the extent of the impact of taxation on corporate behavior remains ambiguous. Whatever be the objective, the way taxation is used for the purpose is simply to alter the relative tax burden between dividends and retained profits of companies. The differential tax burden can be injected through numerous elements in a tax system either at the company level or at the shareholders’ level. In India also the Income tax system contained several elements of tax differentiation aimed at discouraging excessive dividend payments by public limited companies. The present time-series empirical study is an objective attempt to analyze the tax differentiation underlying the Indian income tax system as well as to measure the response of public limited companies to such differentiation. Starting with a relatively simpler version of the general model, the coefficients are estimated by different methods with a view to identifying the correct version of the model. The Cobb-Douglas version of the model does not fit the data satisfactorily. Attempts to correct the lagged dependent bias, and serial correlations have not improved the situation. On the other hand, the CES version, though proved to be a better specification, yielded coefficient estimates which seem to be less stable. Specifically, the manufacturing sector proved to be very sensitive to tax changes. The quantification of the effect by means of simulating the best estimated equations for each group show that much of the effect ln India has been due to the adaptation of the ‘Classical’ system. The effect was highest in 1960–1968 during which time the Classical system was just introduced, the excess dividends taxes were levied, and the rates of personal income taxes had been higher compared to the other sub-periods. An important indication is that the effect of excess dividends taxes by itself is very low, compared to that of personal income tax, which is not fully in agreement with the prevalent view regarding these taxes.

Date: 2023
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DOI: 10.1007/978-981-99-5728-6_11

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