Are Shareholder Dividend Taxes on Corporate Retained Earnings Impounded in Equity Prices?: Additional Evidence and Analysis

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Abstract
Recently, several studies have concluded that individual investor level dividend taxes on corporate retained earnings are impounded in common stock prices, independent of the timing of dividend payments. We show that the model underlying these studies is internally inconsistent. We also discuss why the model of dividend tax capitalization described in these recent studies is not likely to be descriptive of the taxation of corporate distributions, and we present several reasons, with corroborating data, to believe that common stock prices are not affected by dividend taxes in the manner articulated in these studies. Our empirical results can be summarized as follows. We replicate some of the basic results of prior dividend capitalization studies. We test for evidence of dividend tax capitalization around tax rate changes resulting from the ERTA81, the TRA86 and the OBRA93. Using the same methodology employed in recent research, the evidence does not support dividend tax capitalization across the three tax regimes. We also perform numerous additional data analyses that in general produce results that do not support the conclusions of recent dividend tax capitalization studies. Finally, we find that after controlling for market to book ratios, the main results in prior studies vanish. Overall, the analyses and evidence in this study indicate that shareholder dividend taxes on corporate retained earnings are not impounded in stock prices.

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