Wealth Taxes Have Unexpected Consequences

A new paper finds they encourage companies to raise dividends so executives have the funds to cover wealth taxes.

Wealth taxes may reduce social inequality, but they can have unexpected consequences, finds a new paper published by the American Accounting Association.

The study looked at wealth taxes in Europe, but the findings may also be relevant to efforts in the United States and other countries that may consider wealth taxes, the association said. Wealth taxes unexpectedly drove up dividend payments to help executives with large stock holdings pay their taxes, the study found.

“Tax-driven dividend increases may be useful for majority shareholders, but may not be in the best interest of the company — which could have used those funds to finance profitable projects,” says Gaizka Ormazabal, a co-author of the paper and a professor in the IESE Business School at the University of Navarra in Pamplona, Spain. “In other words, increasing dividends to help an executive meet tax obligations can hurt the company and, ultimately, other shareholders.”

Wealth taxes are levied as a percentage of an individual’s total net wealth, the association said in a press release. Net wealth is usually calculated by looking at the sum of an individual’s taxable assets — such as investments — minus the value of the individual’s debts.

“For many corporate executives, much of their wealth is in the form of stock in their company,” the association said. “When those stocks increase in value, so does the executive’s wealth tax.”

An executive’s wealth may consist largely of stocks, but taxes need to be paid in cash, the association noted. One way that companies use to resolve this problem is to increase dividend payouts so executives have funds for taxes.

The researchers also found that closely held companies, particularly family firms, are more likely to increase dividends when majority stockholders are facing a sharp increase in wealth taxes. The researchers also found that these higher payouts were associated with declines in subsequent investment — and brought about lower stock returns.

“Wealth taxes can also help reduce social inequality, which is valuable in itself,” Ormazabal says. “However, we think it is important to better understand the varied — and unanticipated — consequences that may be associated with implementing wealth taxes.”

The paper, “Individual Wealth Taxes and Corporate Payouts,” is published in The Accounting Review. The other co-authors of the paper are Raúl Barroso of the Université de Lille and Donald N’Gatta of the University of Navarra’s IESE Business School.

Founded in 1916, the American Accounting Association is the largest community of accountants in academia.

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