Capital tax reform and the real economy: the effects of the 2003 dividend tax cut

Policymakers frequently propose to use capital tax reform to stimulate investment and increase labor earnings. This paper tests for such real impacts of the 2003 dividend tax cut - one of the largest reforms ever to a U.S. capital tax rate - using a quasi-experimental design and a large sample of U.S. corporate tax returns from years 1996-2008. I estimate that the tax cut caused zero change in corporate investment, with an upper bound elasticity with respect to one minus the top statutory tax rate of .08 and an upper bound effect size of .03 standard deviations. This null result is robust across specifications, samples, and investment measures. I similarly find no impact on employee compensation. The lack of detectable real effects contrasts with an immediate impact on financial payouts to shareholders. Economically, the findings challenge leading estimates of the cost-of-capital elasticity of investment, or undermine models in which dividend tax reforms affect the cost of capital. Either way, it may be di¢ cult for policymakers to implement an alternative dividend tax cut that has substantially larger near-term effects.