Corporate Tax Integration and the Cost of Capital
Sammanfattning: This thesis consists of an introduction and three self-contained chapters.Chapter I summarizes and relates the thesis to a larger context in the area of corporate tax integration. In particular, the main findings are related to the ongoing tax harmonization debate within the EU.Chapter II presents a comprehensive overview of existing methods of mitigating economic double taxation of corporate income within a standard cost of capital model. Two of the most well-known and most utilized methods, the imputation and the split rate systems, do not mitigate economic double taxation in corporations where the marginal investment is financed with retained earnings. However, all methods are effective when the marginal investment is financed with new share issues. The corporate tax rate, fiscal allowances, allocation to periodization funds and allocation to tax equalization reserves (or allowance for corporate equity) are effective instruments, independent of the sources of financing. The chapter also discusses why so many different methods have been employed in mitigating economic double taxation.Chapter III studies the interaction of various methods of mitigating economic and international double taxation of corporate source income. The main purpose is to determine to what extent methods effective in mitigating economic double taxation in a closed economy remain useful in an open economy, where the firm’s marginal investor is a foreigner. While a cut in the statutory corporate tax rate invariably reduces the cost of capital, the impact of the imputation and split rate systems is shown to depend on whether the credit or exemption method is used in mitigating international double taxation, and the precise design of these methods.Chapter IV addresses the ongoing debate on which view of equity, traditional or new, that best describes firm behavior. According to the traditional view, the marginal source of finance is new equity, whereas under to the new view, marginal financing comes from retained earnings. In the theoretical part, I set up a model where the firm faces a cost of adjusting the dividend level because of an aggravated free cash flow problem. The existence of such a cost - which has been used in arguing the traditional view - does not invalidate the core of the new view, namely that the marginal investment may be financed with retained earnings. The combination of costly changes in dividends and retained earnings as the marginal source of funds actually defines an extended new view of equity. In the empirical part of the chapter, I test the implication of the new view that dividends and investments are negatively is related. The overall conclusion is that the implication of the new view is supported for traded Swedish firms during 1980-98.
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