The Impact of Tax Rate Changes on Corporate Payout Policy

• In Event: Taxation 2

Abstract

This paper investigates the effects of threatened tax rate increases versus enacted tax rate decreases on firm payout policy. We utilize the initiation and proposed expiration of the 2003 tax rate reductions as the setting to test our hypotheses. Overall, we find evidence that threatened tax rate increases led to increased dividend payouts. While we do find significant increases in dividends immediately after the initiation of the 2003 tax rate cuts, they are significantly smaller than that of the fourth quarters of 2010 and 2012. This suggests that the threat of a tax rate increase causes a larger change in firm payouts than an enacted tax rate decrease. We find additional support for this hypothesis when looking exclusively at special dividends. However, we do not find evidence that firms used dividend accelerations to take advantage of lower tax rates in the fourth quarters of 2010 and 2012. Lastly, we investigate whether share repurchases changed in response to tax rate changes. While prior literature suggests that dividends and share repurchases are substitutes, advantageous tax rates for both types of distributions could lead managers to use share repurchases as an additional means to distribute cash to investors. Overall, we find mixed support for the substitution hypothesis and no support for the notion that managers adjusted share repurchases to take advantage of lower tax rates.

Authors

• Pamela Kuperstein, Temple University

• Steven Balsam, Temple University