Payout Taxes Matter: The Financing R&D Mechanism

53 Pages Posted: 8 Oct 2014 Last revised: 19 Oct 2023

See all articles by James R. Brown

James R. Brown

Iowa State University - Department of Finance

Gustav Martinsson

Stockholm University - Stockholm Business School; Stockholm School of Economics - Stockholm School of Economics - Swedish House of Finance, Students; Royal Institute of Technology (KTH) - Department of Industrial Economics and Management (INDEK)

Date Written: October 15, 2023

Abstract

Higher taxes on corporate payouts increase the cost of financing with stock issues. As a result, corporate investments that rely on external equity financing should be particularly sensitive to payout tax rates. A large literature shows that firms rely extensively on stock issues to fund R&D, suggesting that the financing of R&D is a potentially important but unexplored micro-level mechanism through which payout taxes affect real activity. We build a broad cross-country panel of dividend taxes and firm R&D in OECD countries between 2000 and 2019. We also study a quasi-experimental dividend tax reform in Sweden, which lowered dividend taxes for a subset of firms. In each case, we document a robust negative association between dividend tax rates and corporate investment in R&D. Consistent with the theoretical (financing) mechanism, we also show that: i) the negative relation between dividend taxes and R&D is concentrated in firms that depend on external finance at the margin, ii) higher dividend taxes lead to less financing with stock issues, particularly in firms with low internal cash flow, and iii) dividend tax reforms matter more for corporate R&D in countries with stock market based financial systems. Dividend taxes are largely unrelated to investment in physical capital, highlighting the importance of focusing on equity-dependent activities to fully evaluate the real consequences of capital income taxation. Given the importance of R&D for innovation and long-run growth, our findings suggest that the economic consequences of capital income taxation are larger than generally recognized.

Keywords: R&D, Innovation, Corporate payouts, Dividend taxes, Capital income taxes

JEL Classification: G30, H25, O16, O30

Suggested Citation

Brown, James R. and Martinsson, Gustav, Payout Taxes Matter: The Financing R&D Mechanism (October 15, 2023). Swedish House of Finance Research Paper No. 15-14, Available at SSRN: https://ssrn.com/abstract=2506669 or http://dx.doi.org/10.2139/ssrn.2506669

James R. Brown (Contact Author)

Iowa State University - Department of Finance ( email )

Ivy College of Business
Ames, IA 50011
United States
5152944668 (Phone)

Gustav Martinsson

Stockholm University - Stockholm Business School

Albanovägen 18
House 2
Stockholm, 11419
Sweden

Stockholm School of Economics - Stockholm School of Economics - Swedish House of Finance, Students ( email )

111 60 Stockholm
Sweden

Royal Institute of Technology (KTH) - Department of Industrial Economics and Management (INDEK) ( email )

Stockholm, 100 44
Sweden

HOME PAGE: http://https://www.kth.se/profile/gusma

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