Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 1434: The Taxation of Closely Held Firms: The Achilles Heel of the Dual Income Tax System Reconsidered

Mikael Stenkula () and Niklas Wykman ()
Additional contact information
Mikael Stenkula: Research Institute of Industrial Economics (IFN), Postal: Research Institute of Industrial Economics, Box 55665, SE-102 15 Stockholm, Sweden
Niklas Wykman: Örebro University School of Business, Postal: and Research Institute of Industrial Economics, Box 55665, SE-102 15 Stockholm, Sweden

Abstract: This study presents an improvement of the King-Fullerton framework for calculating the marginal effective tax rate (METR) for active owners of closely held corporations in a dual income tax system with income splitting rules. The original King and Fullerton model was not modeled to incorporate this type of rule, making it difficult to fully calculate the METR in countries with a dual income tax. The model developed in this paper offers a more general method with less restrictive assumptions than earlier analyses of a dual income tax system. To illustrate the results, the model is applied to the Swedish dual income tax system and is contrasted with earlier works, revealing that the METR for new share issues may have been overestimated in earlier calculations. Our model provides a more comprehensive and flexible toolbox for calculating the METR in a dual income tax system with income splitting rules and improves the possibilities to evaluate how changes in the regulatory framework may affect the METR and the neutrality between investment opportunities. As such, the results are relevant not only for Sweden but also for other countries that have implemented a dual income tax system or are considering doing so.

Keywords: Cost of capital; Marginal effective tax rates; Dual income tax; Income splitting rules; Income shifting

JEL-codes: H24; H25; H26

Language: English

34 pages, July 7, 2022

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