Capital taxation, income shifting and retained earnings: evidence from dividend tax reforms

Abstract

Abstract In this paper, we analyse the effects of dividend tax reforms on tax revenues, income shifting and earnings retention. We examine two significant policy changes in Israel during the 2010s. Using administrative tax records, we study a permanent increase of 5 percentage points in the dividend tax rate in 2012 and a temporary tax relief enacted in 2017. The permanent tax hike triggered an immediate surge of over 100 per cent in reported dividend income and tax revenues. It did not generate a lasting shift in dividend flows. In contrast, the temporary relief of 2017 led to a sharp decline in dividend payments upon its expiration. Notably, dividend payments remained depressed after the preferential rate ended, consistent with increased earnings retention and possibly with anticipation of similar future relief. Finally, our counterfactual estimates imply that post‐2017 retention increased the downward bias in the reported top 1 per cent income share by 1–2 percentage points because income retained within firms is absent from personal tax records.