Scandinavian Working Papers in Economics

Working Paper Series, Center for Fiscal Studies,
Uppsala University, Department of Economics

No 2009:5: Dividend taxation, share repurchases and the equity trap

Jan Södersten () and Tobias Lindhe ()
Additional contact information
Jan Södersten: Uppsala Center for Fiscal Studies, Postal: Department of Economics, Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden
Tobias Lindhe: Uppsala Center for Fiscal Studies, Postal: Department of Economics, Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden

Abstract: This paper reconsiders the effects of dividend taxation. Particular attention is paid to the form of the “equity trap”, that is, the extent to which cash paid to the shareholders must be taxed as dividends. Our analysis shows that Sinn’s (1991) criticism of the well-known King and Fullerton (1984) methodology for underestimating the cost of new share issues amounts to a misleading comparison across two different regimes for the equity trap. Contrary to Sinn,we find that when dividends are paid following a new issue, as assumed by King-Fullerton, the cost of capital is higher than is the case when no dividends are paid.

Keywords: dividend taxation; share repurchases; equity trap; cost of capital; nucleus theory; growth path

JEL-codes: H24; H25; H32

27 pages, May 15, 2009

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