Bourgeois argument against Dividend Tax elimination

[Kevin Robert Dean]

University of Arkansas, Fayetteville 
1-Mar-03 


Dividend Tax Relief Can Have Negative Consequences for
Shareholders
Library: BIZ 
Keywords: TAXES DIVIDEND TAX RELIEF SHAREHOLDERS R&D DOUBLE
TAXATION 
Description: Eliminating income taxes on shareholder
dividends, the centerpiece of tax legislation currently
being considered by congress, may have an unexpected
negative impact on research and development, according to
University of Arkansas researcher Deborah Thomas. (J. of
the Am. Taxation Association, Apr-2003) 

 

FOR RELEASE FRIDAY, FEBRUARY 28, 2003 

CONTACT: Deborah Thomas, associate professor of accounting,
Sam M. Walton College of Business; (479) 575-6132;
dthomas at walton.uark.edu 

Carolyne Garcia, science and research communication
officer, 
(479) 575-5555; cgarcia at uark.edu 

DIVIDEND TAX RELIEF CAN HAVE NEGATIVE CONSEQUENCES FOR
SHAREHOLDERS 

FAYETTEVILLE, Ark. -- Eliminating income taxes on
shareholder dividends, the centerpiece of tax legislation
currently being considered by congress, may have an
unexpected negative impact on research and development,
according to University of Arkansas researcher Deborah
Thomas. 

"We found that dividend tax relief reduces the
effectiveness of other corporate tax incentives," explained
Thomas. "As companies focus on paying higher dividends, tax
credits for beneficial corporate activities such as
research and development (R&D) stop working." 

Thomas, associate professor of accounting, investigated the
relationship between dividend taxation and research and
development expenditures along with Tracy Manly, assistant
professor of accounting and MIS at the University of Tulsa,
and Craig Schulman, associate professor of economics at
Texas A&M University. Their results will appear in the
April issue of the Journal of the American Taxation
Association. 

Currently the United States has a classical tax system,
where corporate profits are taxed twice -- first when the
corporation earns the income and again when the corporation
pays dividends to shareholders. The tax reform proposal
currently before congress will eliminate this double
taxation. A common mechanism in use in other industrialized
countries for handling this is through imputation credits. 

In this system, company shareholders receive imputation
credits, which are tax credits equal to the corporate tax
paid by the company on the dividends. Shareholders that
have received dividends and use the credits to offset
against their income tax liability, effectively eliminating
the tax on dividends for the shareholder. 

"All firms, no matter what the regime, must allocate funds
between dividends and investment," Thomas explained. "To
benefit from an R&D tax credit, a corporation must use
available funds to increase R&D spending rather than pay
dividends. But firms in countries with dividend tax relief
are encouraged to pay higher dividends to take advantage of
the lower cost of equity capital provided by the imputation
tax credit." 

The researchers used an international sample to look at
three different tax regimes. The United Kingdom and Germany
represented countries that have an imputation credit, but
no tax credit for R&D, while the United States and Japan
represented countries with a tax credit for R&D, but no
imputation credit. Canada and France have both an
imputation credit and an R&D tax credit. 

"Since we were looking at the firm response to R&D credits
when imputation credits are in place, our focus was on the
countries that had both, Canada and France," said Thomas.
"The other countries serve as control groups in the study."


The researchers have been looking at the economic effects
of dividend tax relief since 1992. Their sample of
predominantly manufacturing businesses from the years 1993
to 1997 contained 7,138 firm-year observations. They have
previously reported evidence from these data indicating
that corporations will increase dividend payments to
shareholders with the implementation of dividend tax
relief, although this increase is sensitive to changes in
capital gains taxes. 

According to Thomas, a firm's financial characteristics
determine its dividend policy. Managers typically consider
the effects on share price and the maintenance of dividend
stability when determining the amount to be paid out in
dividends. However, firms that omit dividend payments
experience unfavorable long-term share price performance. 

The researchers found that dividend pay out and R&D
expenditure were inversely related -- as one went up, the
other went down. They also found that this relationship is
significantly stronger for firms operating in a tax regime
that has both R&D and imputation tax credits. 

"Dividend tax relief reduces the effectiveness of other
corporate tax incentives," Thomas explained. "Corporations
may reduce their investment in beneficial activities, such
as research and development, in order to maintain high
dividend payments." 
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