Capital Gains Taxation and Corporate Investment

This study examines the effect of the interaction of dividend taxes and capital gains taxes on the sale of stock. Using a model of the new view of dividend taxation modified to incorporate realization-based capital gains and losses on stock, it shows that capital gains taxes increase the required rate of return on corporate investments in a way that parallels the required higher return for selling an asset due to lock-in. As a result, capital gains taxes create an incentive to accelerate dividends. Moreover, the capital gains tax rate is endogenous to dividend policy (in addition to turnover rates). Finally, modifying the model to allow sales between tax clienteles shows that the new view does not hold even when projects are financed with retained earnings if such sales occur