Working Papers

Equity Financing, Dividend Taxes and Corporate "Non-Capital" Investment

Best Paper, Oxford Centre for Business Taxation, 2020 Doctoral Conference

I estimate that dividend taxes, by impacting the cost of equity financing, have large effects on the financing, investment, and real outcomes of many US public firms. But—in contrast with economists’ longstanding focus on capital investment responses—I find these effects occur mostly through “non-capital” investment channels: R&D and operating expenditures. Exploiting a quasi-experiment that tracks financing and expenditure responses to the 2003 dividend tax cut, I estimate a large, immediate, and sustained increase in average equity financing (+86%±11%) by small, cash-short public firms, reflecting a high elasticity (−3.9±3.1) to the cost of equity capital. Almost all of this extra cash appears to have been used for operating expenditures and R&D, rather than tangible investment. I also find higher job growth and long-run sales among the responsive firms. These results make sense, addressing conflicts in recent research: because dividend taxes affect the cost of equity financing, the firms impacted most are those that actually rely on equity financing—smaller, often unprofitable, less capital-intensive firms who invest heavily in “non-capital” pathways.