Firm Heterogeneity and the Long-run Effects

Dividends are taxed at both the corporate and personal levels in the United States. This double taxation of dividends may distort investment efficiency. Partly motivated by this consideration, the US Congress enacted the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) in 2003. This act reduced the tax rates on dividends and capital gains, and eliminated the wedge between these two tax rates through 2008. Because one primary goal of JGTRRA is to promote long-run capital formation, these tax cuts could be made permanent. In this paper, we ask the following question: What is the quantitative long-run effect of the 2003 dividend tax reform on aggregate capital accumulation? This question is of significant interest to economists and policymakers. Economists disagree about the economic effects of dividend taxation on investment. Two views are prevalent. The key consideration is the marginal source of investment finance. Under the “new view,” firms use internal funds to finance investment and do not