Payout Taxes Matter: The Financing R&D Mechanism
53 Pages Posted: 8 Oct 2014 Last revised: 19 Oct 2023
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: Suggested Citation