samlet årgang - Økonomisk Institut - Københavns Universitet

TAXATION OF SHAREHOLDER INCOME AND THE COST OF CAPITAL IN AN OPEN ECONOMY 445
7. Concluding remarks
The literature on the economics of taxation has been keen on identifying »neutral«
taxes that do not distort the allocation of resources in well-functioning markets. This
paper started with the question: if private markets in a globalized economy have the
potential to ensure an efficient allocation of risk, could we design a system of shareholder
income taxation that does not distort this allocation? Our first result was that, in
an open economy with well-diversified investors, a conventional personal income tax
on the return to shares (with full loss offset) will distort the pattern of risk-taking and
investment, by favouring investment in relatively risky shares. Our main result was
that if shareholders are granted a deduction for a risk-free rate of return on their shares,
a symmetric tax on the remaining income from shares will indeed be neutral when
investors are fully diversified. Proceeding to the more realistic case with incomplete
diversification, the analysis showed that a symmetric personal tax on the equity premium
will most likely tend to reduce the cost of capital for unquoted companies. Presumably
this is socially desirable, since lack of diversification is likely to imply too
little risk-taking. In effect, a symmetric tax on the equity premium allows a pooling of
risk through the tax system as a (partial) compensation for the imperfect risk pooling
via the market. Moreover, in countries where capital income is taxed at relatively low
rates, a tax on the equity premium may counter tax avoidance by eliminating the ability
of corporate owner-managers to transform heavily-taxed labour income into lightlytaxed
capital income. Thus a shareholder income tax with a general deduction for a
risk-free rate of return may be a promising model for corporate-personal tax integration
in small open economies. As already mentioned, such a tax regime will in fact be
introduced in Norway from 2006.
Given the assumption of normally distributed returns, the results derived in this paper
are identical to those that would follow from a conventional Capital Asset Pricing Model
(CAPM) with three risky assets. Because of the limited empirical success of the
CAPM, the results and policy conclusions presented above should be interpreted with
care. For example, the CAPM cannot explain why shares in small companies tend
to yield higher risk-adjusted (beta-adjusted) rates of return than shares in large companies.
This may be because investors are less well informed about shares in small
companies and/or because the market for these shares is less liquid than assumed in
the model. Hence the CAPM probably cannot uncover all of the effects of taxation on
required returns. Moreover, the recent literature on Behavioral Finance (surveyed by
Barberis and Thaler (2003)) has cast doubts on the assumption of expected utility
maximization and has pointed to the psychological phenomenon of loss aversion which
suggests that an asymmetric tax treatment of gains and losses might be a relevant poli-