The Norwegia Shareholder Tax Recosidered Absrac I a aricle i Ieraioal Tax ad Public Fiace, Peer Birch Sørese (5) gives a i-deph accou of he ew Norwegia Shareholder Tax, which allows he shareholders a deducio for a impued risk-free rae of reur. Sørese s posiive evaluaio appears as reasoable for a closed ecoomy where he deducio for he impued reur is capialized io he marke prices of corporae shares. We show ha i a small ope ecoomy where o capializaio occurs, he Norwegia shareholder ax is likely o leave he disorios caused by he corporae icome ax uaffeced, ad o add ew disorios o shareholders porfolio decisios. Key words: Tax euraliy, ope ecoomy, shareholder axaio, corporae-persoal ax iegraio, small firms JE code: H4, H5 Ja Söderse (correspodig auhor) Deparme of Ecoomics, Uppsala Uiversiy ja.söderse@ek.uu.se Tobias idhe Uppsala Ceer for Fiscal Sudies (UCFS) Deparme of Ecoomics, Uppsala Uiversiy obias.lidhe@bredbad.e We are graeful o Mari Jacob for useful commes.
1. Iroducio I 6 he Norwegia goverme iroduced a ew ad iovaive sysem for axig divideds ad capial gais. The ew approach is o exemp divideds ad capial gais correspodig o a ormal rae of reur from ax ad o levy a full ax equal o he persoal ax rae o icome from capial - o ay excess reurs. The ew rules replaced he earlier impuaio sysem which was iroduced i he begiig of he 199 s o elimiae ax disorios o corporae ivesme ad fiacig decisios. The Norwegia impuaio sysem effecively exemped icome from corporae shares from ax a he persoal level, ad because of his, he oal ax levied o he reur o corporae ivesme was he same irrespecive of he sources of fuds used by he firm. A he same ime, his also mea ha capial icome was axed a a lower rae ha he op margial ax raes o labor icome, creaig a srog iceive for owers of small closely held corporaios o repor highly axed eared icome as leiely axed icome from capial. Special icome-spliig rules were se up o preve such icome shifig behavior, bu over he years he Norwegia ax auhoriies foud ha hese rules failed heir purpose o a ever icreasig exe. The chose soluio o his ax policy dilemma was o abado he impuaio sysem i favor of he ew shareholder ax. A i-deph accou of he ew sysem ad is implicaios has earlier bee give i a aricle i Ieraioal Tax ad Public Fiace, wrie by he chief archiec of he reform, Peer Birch Sørese 1. Sørese cocludes ha he ew rules make he ax eural wih he respec o firms ivesme ad fiacig decisios ad o shareholders decisios o realize capial gais. As ay excess reur is double axed hrough he combiaio of he corporae icome ax ad he persoal ax o icome from capial he iceive for icome shifig is likewise cosiderably reduced. Sorese s posiive evaluaio appears as reasoable for a closed ecoomy where he deducio for he impued risk-free rae of reur is capialized io he marke prices of corporae shares. However, Norway is a small ope ecoomy wih a exesive foreig owership of corporae shares. Durig 6-9, for example, foreig ivesors o average accoued for 56 perce of he marke value of he Oslo Sock Exchage, compared o a mere 1 Sørese (5). Sørese s aricle was wrie before he implemeaio of he ew sysem o Jauary 1, 6, ad is based o a 3 repor from a goverme-appoied exper commiee.
1 perce for household ivesors (icludig idirec owership hrough muual fuds). There are reasos o believe, herefore, ha equiy prices ad he equilibrium raes of reur are deermied by foreig ivesors raher ha by he domesic households who are he beeficiaries of he ew rae of reur allowace. I his aricle, we demosrae ha, abse capializaio, he Norwegia shareholder ax is likely o leave he disorios caused by he corporae icome ax uaffeced, ad o add ew disorios o shareholders porfolio decisios. The aricle is orgaized as follows. Sarig wih a closed ecoomy seig, where ax capializaio occurs, Secio shows how differe rules for axig divideds ad capial gais affec he before ax required rae of reur o corporae shares ad he cos of capial. The holdig period euraliy claimed by Sørese for he Norwegia shareholder ax is scruiized i Secio 3. Secio 4 ex explores he case of a small ope ecoomy. O he assumpio ha o ax capializaio occurs ad ha he before-ax equilibrium rae of reur is ieraioally deermied, we compue ad compare he afer-ax reurs received by ivesors, uder differe rules for axig divideds ad capial gais. We fid ha he Norwegia shareholder ax disors he allocaio of savigs more (for a give sauory ax rae) ha does a coveioal ax regime wih a realizaio based capial gais ax. Secio 5 cosiders he possibiliy ha i small ope ecoomies he opios o fiace ivesmes o he ieraioal markes for equiy may be uevely disribued bewee firms. We exed he mea-variace porfolio model developed by Apel ad Söderse (1999) o deermie he effecs of he Norwegia shareholder ax o he cos of capial for large ad small firms. We fid ha he ieraioally deermied rae of reur requireme o large compay shares may have a very subsaial impac o he rae of reur requireme for small compay shares. Such a lik cosiderably weakes he effec of he rae of reur allowace of he shareholder ax also for small domesically owed compaies, ad may eve imply a derimeal effec o small compay ivesme iceives. Secio 6 cocludes.. Shareholder Taxaio ad Before-ax Raes of Reur To pu he Norwegia shareholder ax io perspecive, his secio of he paper briefly compares how four differe regimes for axig divideds ad capial gais deermie before- Ow calculaios, based o daa from he Norwegia Securiies Regisraio Cere (Verdipapirserale ASA, www.vps.o). The umbers exclude public secor owership. 3
ax required reurs o corporae shareholdigs ad he firm s cos of capial. The firs of hese regimes, Regime 1, assumes ha all forms of persoal icome from capial icludig accruig chages i he marke value of shares are axed a he same rae. Though rarely praciced i real world ax sysems, accruals axaio is ofe used as a referece case i ax research. Regime also assumes a uiform ax o icome from capial, bu differs from Regime 1 by assumig ha realized raher ha accruig capial gais o shares are axed. This represes a commo sysem of shareholder axaio, i couries ha do o miigae corporae double axaio a he shareholder level. Regime 3 models a iovaive echique suggesed by Auerbach ad Bradford for elimiaig he lock-i effecs ha plague realizaio-based capial gais axaio, whereas Regime 4 is he Norwegia shareholder ax. Throughou his secio, he seig is a closed ecoomy where shareholder axes are capialized io he marke values of corporae shares. We igore risk ad we assume ha he ivesor requires a reur afer all axes equal o he afer-ax marke ieres rae. Cosider a share wih a acquisiio cos of M a ime, which is expeced o have a marke value of M sa ime s. A each isa of ime a divided D(s) is paid. The marke ieres rae is i ad here is a ax o ieres icome a he rae. Regime 1 assumes, as explaied, ha he shareholder is axed a he rae also o divideds ad o he accruig chages i he marke value of he asse. A ivesor wih a required rae of reur equal o he afer- ax marke ieres rae i 1 ad a holdig period of is idiffere o acquirig he asse provided ha M s M D s e dsm e i (1 1 ) s i (1 ) s. (1) s M By compuig ad equaig he derivaive o zero, we fid ha he ivesor is idiffere also o exedig he holdig period provided ha M D i, () M ha is, he required rae of reur before persoal axaio is he marke ieres rae. 4
Regime is a coveio sysem of shareholder axaio, where realized raher ha accruig capial gais are axed, ad where he rae of ax o realized gais is se equal o he ax rae o divideds ad ieres,. This meas ha i (1 ) s i (1 ) i (1 ) 1 s M D s e ds M e M M e, (3) assumig ha he acquisiio cos M is deducible whe deermiig he axable capial gai. M Compuig we ow fid ha M D M M i 1, (4) M M which meas ha he required pre-ax rae of reur is below he marke ieres rae. The reaso for his is ha he payme of capial gais ax is deferred uil realizaio wihou ieres. The shareholder hece obais a ieres free loa from he goverme, equal o he deferred capial gais ax, ad his ax deb effecively limis he ivesor s ow ivesme o M M M 1 / per ui of marke value 3. The effec of his is also ha a ivesor who expecs he marke value M, ad hece he ax deb, o rise over ime, may accep a gradually lowered reur o his ivesme. Pu differely, here is a ax advaage o holdig o o a corporae share compared o sellig ad re-ivesig i he sock marke. This is he well-kow lock-i effec of axig capial gais upo realizaio. 4 For Regime 3, we cosider he scheme for rerospecive capial gais axaio suggesed by Auerbach (1991), ad furher developed i Auerbach ad Bradford (4). The scheme i imposes a ax upo realizaio, equal o 1 e M( ), where, as before, M() is he marke value of he share whe sold a ime, ad is he capial icome ax 5. This effecive ax rae, 1 i e, herefore depeds o he holdig period,. The scheme also subjecs 3 The effecs of acceleraed depreciaio i corporae axaio may be ierpreed i a similar way, see Söderse (198) ad Kig ad Fullero (1984). 4 Cf. Auerbach (1991), see also Secio 3 below. 5 See Auerbach (1991), p. 17, ad Auerbach ad Bradford (4), p. 961. 5
iermediae disribuios (i.e. divideds, i his case) o a correspodig ime-depede effecive rae, which is 1 i s e, a ime s. We oe ha he ime-depedecy implies ha he effecive ax rae is zero for s=, ad equals uiy whe s (=) is ifiiely large. For he shareholder o acquire he asse, i mus he hold ha M s D s 1 e D s e ds M e 1 e M( ) e is i(1 ) s i(1 ) i i(1 ) Collecig erms, (5) simplifies o. (5) is i. (5 ) s M D s e ds M e M Compuig ad equaig he derivaive o zero, we fid ha M D i, (6) M which meas ha he ivesor is idiffere o exedig he holdig period whe he pre-ax rae of reur equals he marke ieres rae. Sice he required before-ax rae of reur is idepede of he holdig period, he scheme is holdig period eural, i Auerbach s (1991) ermiology. For Regime 4, fially, cosider he effecs of he Norwegia shareholder ax, as preseed i Sørese (5). The ax is levied o he equiy premium o shares, by allowig he ivesor o deduc a impued rae of reur deoed a rae of reur allowace agais axable divideds or realized capial gais. The allowace is se equal o he afer ax ieres rae. Assume firs ha aual divideds are larger ha he allowace, Ds () i1 M meas ha M s 1 1 D s i M e dsm e M M e. This i(1 ) s i(1 ) i(1 ). (7) 6
Aleraively, he ivesor may save he allowace uil realizaio, which meas ha here is a offse of Me 1 i agais he axable realized gai. Hece M s 1 D s e dsm e M M e e i(1 ) s i(1 ) i(1 ) i(1 ) I is sraighforward o show ha he wo expressios (7) ad (8) are ideical 6.. (8) M Compuig ad equaig he derivaive o zero, we fid M D i 1 M, (9) ha is, he pre-ax equilibrium rae of reur is he afer-ax rae of ieres. The rae of reur allowace hece elimiaes he ax wedge bewee he ivesor s afer-ax reur ad he preax rae of reur o corporae shareholdigs. We ex ur o he implicaios of he differe shareholder ax regimes for he firm s cos of capial. We limi our ieres o Regimes 1, 3 ad 4 above, where he pre-ax equilibrium raes of reur are cosa over ime. To focus o he key differeces bewee he regimes, we cosider a simple case where he corporae ax rae is ad he firm ears a pre-ax rae of reur o real ivesme,, which is cosa over ime. To deermie he lowes accepable level for his pre-ax reur, ha is, he firm s cos of capial, we simply equae he expressios for he pre-ax required raes of reur o corporae shareholdigs as derived above, o he afer-corporae ax rae of reur, 1. We he obai for Regimes 1 ad 3 i, (1) 1 which meas ha he corporae icome ax is he sole deermia of he ax disorio o he cos of capial. 6 I-bewee cases where he ivesor uses par of he allowace as a offse agais axable divideds ad saves he remaider, icludig compoud ieres, as a offse agais axable capial gais yield he same resul. 7
For Regime 4 (he ew Norwegia shareholder ax, see equaio (9) above) ad oher regimes which effecively exemp equiy reurs from ax a he shareholder level, we derive i, (11) which meas ha he cos of capial is idepede of ax. The resuls derived i his secio for he before-ax required raes of reur ad he cos of capial are summarized i Table 1 below, i each of he four regimes. Table 1. The Required Rae of Reur ad he Cos of Capial for he differe regimes. Regime Required before-ax rae of reur o shareholdigs Cos of capial 1. Accruals based capial gais ax i i 1. Realizaio based capial gais ax M M i 1 M - i 3. Rerospecive capial gais ax i 1 4. Norwegia shareholder ax i 1 i As see from he firs colum of he able, he required before-ax rae of reur o corporae shareholdigs is cosa, ad is herefore idepede of he holdig period, for all regimes excep for Regime, where a realizaio based capial gais ax is applied. Hece, he Norwegia shareholder ax (Regime 4) mees Auerbach s defiiio of holdig period euraliy (cf. p.6 above for he defiiio). Holdig o o a corporae share offers o ax advaage compared o sellig ad re-ivesig i he sock marke. We oe ha holdig period euraliy would be obaied also for a ax regime which effecively exemps boh divideds ad capial gais from persoal ax, as his may be see as a special case of Regime 1 above. Such a scheme was i effec i Norway durig he period 199-5, whe he impuaio sysem for axig divideds was combied wih he so called RISK-model for axig capial gais. The RISK-model limied capial gais axaio o ha par of he gai which exceeded he shareholder s proporioae share of a corporaio s reaied earigs. 7 7 See Adersso e. al. (1998), pp. 96. 8
I Regimes 1 ad 3, he corporae ax is he sole deermia of he ax disorio o he firm s cos of capial, whereas he cos of capial is idepede of ax i Regime 4, he Norwegia shareholder ax. The explaaio o his laer resul is ha he disorio caused by he corporae icome ax is exacly offse by he reducio i shareholders pre-persoal ax required rae of reur, show i he firs colum of he able. This cofirms Sørese s (5) claim ha he Norwegia shareholder ax is eural wih respec o firms fiacig ad ivesme decisios. However, ad as emphasized i he begiig of his secio, his euraliy resul requires ha shareholders axes o divideds ad capial gais are capialized io he marke values of corporae shares. 3. Holdig Period Neuraliy a clarificaio. As show i secio above, he Norwegia shareholder ax mees Auerbach s codiio for holdig period euraliy i he sese ha he required before ax rae of reur o equiy ivesme is idepede of he ivesor s holdig period. This secio furher explais he meaig of holdig period euraliy for he Norwegia shareholder ax. Followig Sørese (5), we may assume ha a share wih marke value M is sold a ime. If B is he basis of he share for ax purposes ad is he capial gais ax, he ivesor s capial gais ax liabiliy is T M B. If he rasacio is pospoed uil +1, ad assumig ha o divided is paid, he ax liabiliy is he T 1 M 1 1 i 1 B sice he basis of he share is sepped up by he afer-ax ieres rae, i 1 ad T 1, Sørese derives. Combiig T M 1 M T 1 1i1T i1m. (1) M From (1) Sørese direcly cocludes ha he ew shareholder ax... leaves o advaage from deferrig he capial gais ax by pospoig he realizaio from oe period o he ex, sice he pospoed ax liabiliy from he previous period is carried forward wih ieres. 8 8 Ibidem 9
To peerae he meaig of equaio (1), we may assume ha he ivesor who sells he asse i period also immediaely buys i back. Suppose moreover ha he capial gais ax, T as defied above, is fiaced by a loa which is repaid i he ex period, icludig ieres. Ne of his repayme, he afer-ax wealh of he ivesor a he ed of period +1 is R W 1 M 1 M 1M 1 i(1 ) M B 1 i(1 ), (13) sice he basis of he share whe bough back i period, M, is sepped up by he afer-ax ieres rae, for capial gais axaio i period +1. Collecig erms, (13) simplifies o R W 1 M 1 M 1B 1 i(1 ). (13 ) If he ivesor isead of sellig ad buyig back a ime chooses o keep he share uil period +1, his afer-ax wealh will be H W 1 M 1 M 1 1 i(1 ) B, (14) which is exacly as i (13 ). Holdig o o he asse hece offers o advaage compared o sellig ad buyig back a ime. The Norwegia shareholder ax is holdig period eural. From (13), we also fid ha he ed-of-period value of he ivesor s oal payme of capial gais ax is M1 M1 i(1 ) M B1 i(1 ) M 1 M i (1 ) M M B 1 i (1 ), M (15) which is Sørese s expressio for he ax liabiliy i period +1, as derived above (eq. (1)). Despie he holdig period euraliy as demosraed above, he Norwegia shareholder ax may sill cause he ivesor o hold o o his ivesmes i shares, raher ha sellig ad ivesig i oher asses ouside he sock marke. This poeial lock-i effec crucially depeds o wheher or o he rae of reur allowace is capialized io he marke values of shares. 1
Assume, as before, ha a share wih a marke value of afer-ax proceeds M M B M is sold i period ad ha he are ivesed ouside he sock marke a he marke ieres rae, i. The afer-ax wealh of he ivesor i he ex period would he be 9 R* W 1 1 i(1 ) M ( M B) M 1 i(1 ) M B 1 i(1 ), (16) where he secod erm o he far righ had side is he firs period capial gais ax, augmeed wih he afer- ax ieres rae. If he ivesor isead chooses o keep he share uil period +1, his afer-ax wealh will be H W 1 M 1 M 1 1 i(1 ) B M 1 i(1 ) M B 1 i(1 ) M 1 gi 1, (17) where g M / 1 1 M is he pre-ax rae of reur o he asse. Comparig (16) ad (17), we fid ha holdig o o he ivesme i shares yields a higher ed-of -period wealh, eve whe he pre-ax reurs are equal, g=i. However, a low reur o he equiy ivesme could ouweigh he ax savigs from he rae of reur allowace. The implicaios of differe shareholder ax regimes for before-ax raes of reur have already bee examied i previous secio, o he assumpio ha he ax rules were capialized io he marke value of shares. I Regime 4 he Norwegia shareholder ax he before-ax rae of reur required o make he ivesor idiffere o exedig he holdig period was foud o be he afer-ax rae of ieres, i 1 (see equaio (9)). No surprisigly he, for g i1, expressios (16) ad (17) are equal, implyig idifferece bewee realizaio (followed by ivesme ouside he equiy marke, as i equaio (16) above) ad holdig. I summig up, we have cofirmed Sorese s claim ha he Norwegia shareholder ax implies holdig period euraliy. Uless he rae of reur allowace is fully capialized io he marke value of shares (such ha he pre-ax equilibrium reur equals he afer-ax ieres rae), here will sill be a lock-i effec favorig equiy ivesmes i he corporae secor o ivesmes i oher secors of he ecoomy. 9 The same resul is obaied if he ivesor, as i (13) above, borrows o pay he capial gais ax. 11
4. The shareholder ax i a small ope ecoomy We coclude from he previous secios ha he Norwegia shareholder ax migh well elimiae he iefficiecies caused by he combiaio of corporae ad persoal axes, provided ha shareholder axes are capialized io he marke values of compaies. However, ad as implied by earlier research by Boadway ad Bruce (199), Devereux ad Freema (1995) ad ohers, he oucome may be differe i a small ope ecoomy, where he margial ivesor o loger is a domesic perso eiled o he rae of reur allowace. Whe he rae of reur requireme o corporae equiy before persoal axes is deermied by ieraioal ivesors o world capial markes, he earlier research has show ha ay ax disorios o he cos of capial of domesic firms will remai i place, idepedely of he ax reame afforded domesic ivesors. Chages i persoal axes o equiy reurs may affec domesic savigs ad he allocaio of savigs bewee aleraive uses, bu have o effec o he level of real ivesme. I his secio, we focus o he savigs iceives i he ope ecoomy by comparig he afer-ax reurs received by he domesic shareholder i each of he four regimes examied i Secio. For his ope ecoomy case, we le he before-ax reur be equal o he marke ieres rae, i. To simplify he aalysis, we cosider a ivesme i shares wih a divided yield of u ad a rae of appreciaio of i-u. As before, we do o allow for risk. The approach is sraigh-forward. For each regime j=r1, R, R3 ad R4, we compue he afer-ax value of he ivesme, j W, if sold i period, ad he afer-ax divided, j Div. We he defie he afer-ax rae of reur received by he ivesor from margially exedig he holdig period as R j j W Div j, ad he effecive ax rae as he wedge bewee he W j pre-ax reur ad he afer-ax reur, divided by he pre-ax rae of reur, i.e. j j i R. i For Regime 1, which we iclude as a bechmark, we le boh divideds ad he accruig chages i he marke value of he asse be axed a he rae. A ivesme of ui value a ime zero, wih a rae of appreciaio of i-u he has a afer-ax value of W ime. Sice he afer-ax divided is u1 exedig he holdig period is e ( iu) 1 e R1 ( iu)(1 ), he afer-ax rae of reur from a 1
R 1 R 1 ( iu / (1 ) )(1 ) R R / 1 W u e W i(1 ), (18) wih he effecive ax rae R1 R1 i R. (19) i Regime is a coveioal sysem of shareholder axaio, where he capial gai is axed upo realizaio. The afer-ax value of he ivesme if sold a ime is he R ( iu) ( iu) W e e 1. Hece, he afer-ax reur from exedig he holdig period is R R ( / ) 1 ( iu ) R i 1 R / W u e W 1 1e ad he effecive ax rae becomes ( iu), () R e ( iu) (1 ). (1) Hece, wih a coveioal realizaio-based capial gais ax, he afer-ax reur received by he ivesor ad he implied effecive ax rae deped o he holdig period, see Figure 1. For Regime 3, ha is he Auerbach-Bradford ax scheme, we impose a ax rae of 1 upo boh divideds ad he sale of he asse. The afer-ax divided is he ( iu) i ( iu) i(1 ) u ue 1 e ue ue ad he afer-ax value of he asse R3 ( iu) i ( iu) i(1 ) u W e 1 e e e. The afer-ax rae of reur o exedig he holdig period is herefore i e R 3 3 (1 ) 3 ( R i u R / ) / R W ue W i(1 ), () wih he effecive ax rae R3. (3) Fially, Regime 4 is he Norwegia shareholder ax. We assume firs ha u i1, which meas ha divideds exceed he rae of reur allowace hroughou he holdig period. The 13
( iu) ( iu) ( iu) afer-ax divided is he ue ue i 1 1ue i 1, ad he R4 ( iu) ( iu) afer-ax value of he asse if sold a ime becomes W e e 1. The afer-ax reur from exedig he holdig period is herefore R ( W / ) 1 ue i 1 / W R4 R4 ( i u) R4 ( iu) 1 e i 1, ( iu) 1 1e (4) ad we ge he effecive ax as R4 e ( iu) (1 ). (5) As i Regime, i is clear ha he afer-ax reur received by he ivesor ad he effecive ax rae deped o he holdig period, see Figure 1. I case o cash divideds are paid durig he holdig period, ha is u=, he ivesor saves he rae of reur allowace, icludig compoud ieres, uil he asse is sold. The afer ax value of he asse a ime is he W e e e R4 i i i(1 ), cosiderig ha he cos base of he share ow is e i(1 ). The afer-ax reur from exedig he holdig period is herefore 4* ( 4 / ) / 4 1 1 i e R R R i R W W i ad we ge he effecive ax as 1 e, (4 ) R4* i e (1 ). (5 ) We oe ha for u i1, expressios (4) ad (5) ur io expressios (4 ) ad (5 ). I summig up, we have foud ha wih a exogeously deermied pre-ax rae of reur, oly Regime 1 (wih a accruals based capial gais ax) ad Regime 3 (he Auerbach- Bradford capial gais ax) yield afer-ax reurs ha are idepede of he holdig period ad effecive ax raes ha equal he sauory capial icome ax rae. These regimes hece 14
offer o ax iceives o exed he holdig period, or o reallocae savigs from ieres bearig asses io corporae equiy. I coras, for Regime (wih a realizaio based capial gais ax) ad Regime 4 (he Norwegia shareholder ax), he shareholder receives cosiderably higher afer-ax reurs, ad he implied effecive ax raes are much below he sauory ax rae. I case of Regime, his is drive by he possibiliy o defer capial gais ax uil realizaio, while for Regime 4, he leie ax reame derives from he rae of reur allowace. Moreover, ad as is clear from expressios (1) ad (5), he effecive ax rae for Regime 4 is oly imes ha of Regime. Because of his, we coclude ha he Norwegia shareholder ax disors he allocaio of savigs bewee ieres bearig asses ad corporae shares more ha does coveioal shareholder axaio wih a realizaio-based capial gais ax. To furher clarify our resuls, we have also compued afer-ax reurs ad effecive ax raes for differe holdig periods i Figures 1 ad. We have se he pre-ax rae of reur i o 5 perce ad we assume ha he capial icome ax rae is 3 perce. The compuaios have bee carried ou for wo aleraive assumpios for he divided yield. The firs assumes ha he asse does o geerae ay cash flows uil sold a ime, u, ad he oher ha he divided yield equals he afer-ax ieres rae, u i1. Disiguishig bewee asses wih differe divided yields urs ou o be of imporace oly for Regime (wih a coveioal realizaio-based capial gais ax). For Regime, he shareholder will also markedly raise his afer-ax margial reur ad reduce he effecive ax rae by exedig he holdig period. The force of his effec depeds iversely o he divided yield: The lower is he divided yield, he less of he asse s pre-ax reur is axed as i accrues, ad he more is axed upo he sale of he asse. There is hece a double lock-i effec, favorig boh a exesio of he holdig period ad ivesmes i corporae shares wih a low pay-ou rae. Regime 4, he Norwegia shareholder ax, likewise offers a ime-icreasig iceive for he shareholder o hold o o his ivesme i corporae equiy, bu his effec is much less proouced ha for Regime, ad is also isesiive o he assumed divided-yield 1. 1 This holds i he rage u i1. For u i1 as u rises, o be cosa ad equal o for u i., he curve for he effecive ax rae, R 3*, flaes ou 15
Figure 1. Afer-ax rae of reur Regime 1 ad Regime 4 Regime Regime 3 5,% 4,5% 4,% 3,5% 3,% 5 1 15 5 3 35 4 45 5 ime Figure. The effecive ax rae Regime 1 ad Regime 4 Regime Regime 3 3% 5% % 15% 1% 5% % 5 1 15 5 3 35 4 45 5 ime 16
5. Small versus large firms Though ieraioalizaio has made i possible for firms i small ope ecoomies o fiace heir ivesmes o he ieraioal markes for equiy, such opios may be uevely disribued bewee firms. I has bee argued ha small firms, i paricular, sill are cofied o raisig equiy fuds from domesic ivesors ad, because of his, would beefi from a miigaio of double axaio a he shareholder level. 11 Apel ad Söderse (1999), address his possibiliy i heir ivesigaio of he effecs of persoal axes o he cos of capial i a small ope ecoomy. Apel ad Söderse use a simple porfolio model where ivesors are assumed o hold hree asses, i.e. risk-free bods, shares i large firms ad shares i small firms wih ucerai reurs. Shares i large corporaios are raded i he ieraioal sock marke, implyig ha he (pre-persoal ax) raes of reur are exogeously give o he aioal ecoomy. Small compay shares, i coras, are raded oly domesically ad he auhors problem is o deermie he impac of axaio o he required (pre-persoal ax) rae of reur o hese shares, ha is, he (afer-corporae ax) cos of capial. The Apel-Söderse model is easily exeded o capure also he effecs of he Norwegia shareholder ax. Though he ieresed reader may cosul he Apel-Söderse paper for he derivaio of he model, he basic equaios have a sufficiely srog iuiive appeal o jusify ha we focus direcly o he resuls. The represeaive domesic ivesor acquires q S small compay shares ad q shares i large compaies, a iiial prices of P S ad P.Wih RB as he preax rae of reur o bods, ad E ad B as he persoal ax raes o he reur o equiy ad bod ieres, respecively, he auhors fid ha he expeced pre-ax required raes of reur 1 o shares i small (S) ad large () firms may be wrie as 1 B R R C 1 E S B E 1 B R R C 1 E B E q SS qs 1 P S q qss 1 P, A-S, equaio (), A-S, equaio (3) 11 For furher discussio, see Agell e. al. (1998), Chaper 4. 1 Noe he defiiio R i P P i1 i, i=s,, where i1 P i P is he expeced ed -of -period price. 17
where C (a cosa) is a measure of he ivesor s risk olerace, i (i=,s) is he variace of he ed-of-period prices ad S is he covariace bewee he ed-of period prices of shares i small ad large firms. Hece, by solvig he ivesor s porfolio problem Apel ad Söderse fid ha he expeced before-persoal-ax required reur equals he before-ax reur o risk-free bods plus a risk premium, he seize of which depeds o he ivesor s risk olerace, measured by C, muliplied by he amou of risk ha he shares add o he ivesor s porfolio. This amou depeds o boh he ow variace ad o he covariace bewee he prices of small ad large compay shares. The Norwegia shareholder ax is easily icorporaed io hese expressios. The ax due o he reur (represeed by a icrease i he marke prices) o shares of he i:h ype is E qi( Pi 1Pi) irb 1B qp i i, (6) where he secod erm wihi brackes capures he rae of reur allowace. The parameer i (which is uiy whe he allowace is i effec, ad zero oherwise) is icluded o disiguish bewee he case wih a geeral allowace ( 1), ad he case where he allowace is limied o, say, small firms (i his case 1, ). The expeced reurs, as show above, ow chages o q SS qs 1 1 B 1 B RS RB C E SERB, (7) 1 E PS 1 E q qss 1 1 B 1 B R RB C E ERB. (8) 1 E P 1 E Followig Apel ad Söderse, we rea he expeced reur o large compay shares, S S R, ad he umber of small compay shares, q S, as exogeous. As a resul of his, he adjusme o a ax chage, i he case of large firms, will ake he form of a chage i he umber of shares, q, which he ivesor chooses o hold. We derive from (8) q 1 1 P R R R C1 q C 1 q B B B E B E S S 1E 1E E S. (9) 18
The iuiively clear aswer give by he model is ha he higher is he expeced before-ax reur o large compay shares, he higher will be he umber of large compay shares i he ivesor s porfolio (he umber of risk-free bods smaller). A rae of reur allowace for large compay shares (as capured by he parameer 1) also iduces he ivesor o hold a greaer umber of large compay shares 13. Usig expressio (9) o subsiue for q i (7), we ge he expeced before-ax reur o small compay shares 1 P R R 1 1 R B S S S B S E E 1 E PS PS qs S S C 1 E 1. PS S P (3) I is immediaely clear from (3) ha, by icreasig he afer-ax rae of reur, a rae of reur allowace available o small firms ( S ) will reduce he pre-ax required rae of reur o small compay shares, R S. Coversely, a rae of reur allowace o large compay shares ( ) will icrease R S. As see from (3), he balace bewee hese opposig effecs P S depeds o he facor P S. I is sraighforward o show ha P cov( R, R ) P, (31) S S S var( R) which has a ieresig ierpreaio as he bea bewee he reurs o shares i small ad large firms. Usig his defiiio of bea ad assumig ha he rae of reur allowace is available o small ad large firms alike, S, equaio (3) simplifies o 1 B qs S S RS RB 1 E1 R C1 E 1. (3) 1E PS S 13 Sice he umber of small compay shares q is exogeously give, his meas ha he oal umber of risky S asses ( q q ) i he ivesor s porfolio will rise. S 19
Equaio (3) shows he crucial role played by bea, ha is he covariace bewee he reurs o small ad large compay shares. The higher is bea, he sroger is he impac of he ieraioally deermied rae of reur, reur allowace,, o R, ad he smaller is he effec of he rae of R S. For bea equal o uiy, he allowace is of o imporace, ad wih "bea" above uiy, he allowace will acually raise he expeced pre-ax reur o small compay shares. The impac of he rae of reur allowace o he required pre-ax rae of reur o small compay shares is hece a empirical quesio, depedig o "bea". For illusraive purposes, we have compued bea-values i accordace wih expressio (31), usig mohly daa o wo groups of compaies oed o Nordic sock exchages durig he period 4 o 1. Depedig o daa availabiliy 14, wo differe ses of calculaios have bee uderake, repored i paels a) ad b) i Table. The group of small compaies is represeed by a so-called Small Cap idex as defied by he Sock Exchage of each coury, ypically represeig he 1 perce smalles compaies oed o he marke. Table. The Bea value bewee small ad large compaies, mohly daa for differe ime periods. a) Small compaies agais he larges, mos raded compaies (abou 5-3) 199-93 1994-97 4-6 7-1 Swede, Apel ad Soderse (1999),69 1,4 Swede,79 Norway 1,4,74 Nordic couries,8 b) Small compaies agais a bechmark idex of larger compaies # large 4-6 7-1 Swede 8-1,77 Norway all 1,4,83 Filad 5-7,9 Demark 5-8,74 I pael a), he group of large compaies is represeed by a idex of he 5-3 mos raded shares o he Swedish ad Norwegia markes separaely, as well as he mos raded compaies o he whole of he Nordic marke. Alhough coverig differe ime periods, he resuls obaied i Apel ad Söderse (1999) are also repored for compariso. I pael b), we have made use of a so-called bechmark idex of large compaies as defied by he Sock Exchages. This is a broader idex, couig for 5-1 compaies, ha is available for all Nordic couries separaely (Icelad is lef ou due o oo few observaios). 14 Daa is colleced from he Nasdaq OMX Nordic s web page (coverig Swede, Demark ad Filad) ad he Oslo Sock Exchage s web page (coverig Norway), where hisorical daa is more comprehesive for Norway.
Judgig from he various esimaes of bea repored i Table wih he magiude i he rage of.7-1., idepedely of marke ad ime period we eaively coclude ha he ieraioally deermied rae of reur requireme o large compay shares may have a very subsaial impac o he rae of reur requireme for small compay shares. Such a lik cosiderably weakes ay posiive effec ha he rae of reur allowace may have for small domesically owed compaies. Moreover, he case where bea is equal o uiy or higher implyig a derime effec of he Norwegia rae of reur allowace sysem may o be jus a heoreical curiosiy. 6. Coclusios I his aricle, we cofirm Sørese s (5) resul ha he Norwegia shareholder ax will be eural owards fiacig ad ivesme decisios. However, his requires he srog assumpio ha a full capializaio of he rae of reur allowace occurs. Cosiderig ha Norway is a small ope ecoomy wih a exesive foreig owership of corporae shares, a more appropriae assumpio seems o be ha he before-ax equilibrium rae of reur is deermied by ieraioal ivesors. Ay disorios o he cos of capial creaed by he corporae icome ax will he remai i place, idepedely of he ax reame afforded domesic ivesors. The rae of reur allowace of he Norwegia shareholder ax, which oly beefis domesic shareholders, may sill affec domesic savigs ad he allocaio of savigs bewee aleraive uses. As verified i Secio 3 above, he shareholder ax is holdig period eural i he sese ha holdig o o a corporae share offers o ax advaage compared o sellig ad re-ivesig i he sock marke. Bu he shareholder ax does offer a iceive for he shareholder o hold o o his ivesme i corporae equiy compared o ivesig ouside he sock marke, whe he pre-ax rae of reur o shares is deermied o ieraioal markes. Because of his lock-i effec, he Norwegia shareholder ax disors he allocaio of savigs more (for a give sauory ax rae) ha does a coveioal ax regime wih a realizaio based capial gais ax. I has bee argued i he public debae ha a miigaio of double axaio a he shareholder level sill may affec he cos of capial i a ope ecoomy, because small compaies have limied access o ieraioal equiy markes. To cosider his possibiliy, we have briefly preseed a simple porfolio model wih small ad large firms. The effec of he rae of reur 1
allowace o he small compay cos of capial he urs ou o deped o he bea bewee he reurs o small ad large compay shares. Our eaive esimaes of bea, usig daa from Nordic sock exchages, idicae ha he ieraioally deermied rae of reur requireme o large compay shares may have a very subsaial impac o he rae of reur requireme for small compay shares. Such a lik cosiderably weakes he effec of he rae of reur allowace also for small domesically owed compaies, ad may eve imply a derimeal effec o small compay ivesme iceives. The mai reaso for he adopio of he Norwegia shareholder ax was mouig problems of ax avoidace uder he earlier impuaio sysem. Uder he ew scheme, he iceive for icome shifig is cosiderable reduced, sice ay wihdrawal of moey i excess of he rae of reur allowace is double axed hrough he combiaio of he corporae icome ax ad he persoal ax o icome from capial. Obviously, a classical corporae ax sysem wih o miigaio of double axaio a he shareholder level is equally effecive i his respec, ad would - i he small ope ecoomy - disor shareholders porfolio decisios cosiderably less, wihou worseig compaies iceives for real ivesme. However, o he exe ha he goverme was o promoe real ivesme i small compaies, here may sill be a role for a rae of reur allowace a he shareholder level. This requires, as we demosraed i secio 5, ha he allowace be argeed o his group of domesically owed compaies.
Refereces Agell, J., Eglud P. ad Söderse, J. (1998), Iceives ad Redisribuio i he Welfare Sae, he Swedish Tax Reform, MacMilla Press, 1998. Adersso, K., Kaiaie,V., Söderse,J. ad Sørese, P. B. (1998), Corporae Tax Policy i he Nordic Couries, i P.B. Sørese, ed, Tax Policy i he Nordic Couries, MacMilla Press, 1998. Apel, M. ad Söderse, J. (1999), Persoal Taxaio ad Ivesme Iceives i a Small Ope Ecoomy, Ieraioal Tax ad Public Fiace, vol. 6(1), pp. 79-88, Jauary. Auerbach, A. (1991), Rerospecive Capial Gais Taxaio, America Ecoomic Review, vol. 81, pp. 167-178. Auerbach, A. ad Bradford, D. (4), Geeralized cash-flow axaio, Joural of Public Ecoomics, vol. 88 (5), pp. 957-98, April. Boadway, R. ad Bruce, N. (199), "Problems wih iegraig corporae ad persoal icome axes i a ope ecoomy", Joural of Public Ecoomics, vol. 48(1), pp. 39-66, Jue. Devereux, M. ad Freema, H (1995), "The impac of ax o foreig direc ivesme: Empirical evidece ad he implicaios for ax iegraio schemes," Ieraioal Tax ad Public Fiace, vol. (1), pp. 85-16, February. Sørese, P. B., (5), Neural Taxaio of Shareholder Icome, Ieraioal Tax ad Public Fiace 1(6), pp. 777-81, November. 3