Dividend taxation, firms’ financial decisions and firm survival

In this project, we use Finnish corporate data that covers all Finnish companies and take advantage of tax regulations that provide variation for the tax treatment of different companies. One such tax reform was the 2005 corporate and dividend tax reform in Finland, which via an increase in the dividend tax made it more advantageous for some companies to retain funds within the company. In other words, we exploit tax-driven exogenous variation for firms’ financial position. In this study, we examine how solvency and changes in solvency due to the tax reform affected companies’ performance during the 2008–2009 economic recession, during which the GDP decreased by nearly 9 per cent in Finland. Using high-quality administrative tax data, we compare, using a difference-in-differences research strategy, firms significantly affected by the reform to otherwise similar firms which faced no major changes in their tax treatment.

One key area of interest in our research is the distinctive features of the Nordic dual income tax system and how such a tax system functions during an economic downturn. In the Nordic dual income tax system, a business owner’s dividend income is mechanically divided into earned income and capital income portions based on a formula. In the Finnish system, this division is based on the company’s net wealth—the difference between the company’s assets and liabilities. The greater the company’s net wealth, the larger the portion of the company’s income that the business owner can withdraw as dividends taxed at a lower capital income tax rate. This incentive is strongest for owners whose marginal tax rate on earned income is high, i.e., high-income owner-managers. Such a system actually encourages the accumulation of wealth within the company, and it has been argued in policy discussions that this promotes corporate solvency. In this project, we also assess how such a system functioned in practice when companies faced severe difficulties.