Translation Results Requested Through Conyac Made Public

Even under a corporate cash-flow tax, savings at the personal level might continue to
be taxed under a capital income tax. When capital income taxes at the personal level are
considered as well, the corporation’s marginal debt-equity decision will not be distorted as
long as interest payments and the normal return on equity are taxed at the personal level
in the same way. However, the profits can be distributed as dividends or retained and
reinvested, which then yields capital gains. If capital gains are taxed upon realisation while
dividends and interest payments are taxed on accrual and/or capital gains are taxed at a
lower rate than dividends and interest payments at the personal level, the debt-equity
choice will be distorted even under a corporate cash-flow tax.
This is demonstrated in Box 6.1, which discusses the cost of capital and the marginal
increase in value of the firm’s equity in the steady state under the “new” view. The analysis
assumes that capital gains are taxed at lower rates than interest payments and dividends.
In that case, the firm will prefer to retain and reinvest its earnings instead of financing
investment with newly issued equity or debt. In order to show the impact of the taxes at
the personal level, the cost of capital under the “new new” view is derived in Box 6.1 as
well. The cost of capital under the “traditional” view is derived in Box 6.2. However, interest payments and the normal return
on equity would remain tax-exempt. If at the personal level, capital gains would be taxed on
realisation and dividends would be taxed immediately and/or capital gains are taxed at the
personal level at a lower rate than dividends, households would prefer to receive the
economic rents in the form of capital gains instead of dividends.
The debt-equity neutrality under the corporate cash-flow tax will also be maintained
if savings at the personal level are taxed under the “tax prepayment” method.
As explained
in Chapter 3 savings are not deductible from the personal tax base but the original savings
augmented by the savings’ return are not taxed at the personal level either. In this case,
only the economic rents are taxed under the corporate cash-flow tax.