samlet årgang - Økonomisk Institut - Københavns Universitet

Nationaløkonomisk Tidsskrift 143 (2005): 433-447
Taxation of shareholder income and
the cost of capital in an open
economy: theory and applications
to the Nordic countries
Peter Birch Sørensen
Department of Economics, University of Copenhagen, EPRU and CESifo,
E-mail: peter.birch.sorensen@econ.ku.dk
SUMMARY: This paper discusses whether double taxation of corporate equity income
distorts corporate investment in an open economy. The integration of capital markets
has popularized the view that domestic personal taxes on dividends and capital gains
have no impact on real investment incentives in a small open economy. The present
paper argues that a personal tax on equity income in an open economy will in fact
distort the required returns on shares in small companies which are not traded in the
international stock market. However, if shareholders are granted a deduction for a riskfree
rate of return, in line with the recent Norwegian tax reform, the tax will be neutral
towards real investment when investors are well diversified. If they are not, a personal
tax on the equity premium will tend to reduce the required return on shares in small
companies, because of the income insurance effect of a tax with full loss offsets. This
tendency will be amplified if the rate-of-return allowance is granted only to holders of
shares in small companies, in line with current practice in Sweden.
1. Capital market integration and double taxation of corporate income
Equity income from the corporate sector is subject to corporation tax and to personal
taxes on dividends and capital gains. Should this double taxation be alleviated to
avoid serious distortions to corporate investment incentives? For decades academics
and policy makers have debated this perennial issue. Advocates of the »old view«
developed by Harberger (1962, 1966) and others stress the need to relieve the double
taxation of dividends. This recommendation has had a profound influence on public
policy. For example, Denmark taxes dividends at a lower rate than other capital income,
and Finland and Germany only include a fraction of dividends in taxable income.
I am grateful to Diderik Lund, Vidar Christiansen and two anonymous referees for insightful comments.
Any remaining errors or shortcomings are my own responsibility.