American Economic Review 2015, 105(12): 3531–3563
http://dx.doi.org/10.1257/aer.20130098

Capital Tax Reform and the Real Economy:
The Effects of the 2003 Dividend Tax Cut†
By Danny Yagan*
This paper tests whether the 2003 dividend tax cut—one of thelargest reforms ever to a US capital tax rate—stimulated corporate
investment and increased labor earnings, using a quasi-experimental
design and US corporate tax returns from years 1996–2008. I
estimate that the tax cut caused zero change in corporate investment
and employee compensation. Economically, the statistical precision
challenges leading estimates of the cost-of-capital elasticity ofinvestment, or undermines models in which dividend tax reforms
affect the cost of capital. Either way, it may be difficult to implement
an alternative dividend tax cut that has substantially larger nearterm effects. (JEL C72, C78, C91)
The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the top federal tax rate on individual dividend income in the United States from 38.6 percent to15 percent. The president projected that the tax cut would provide “near-term support to investment” and “capital to build factories, to buy equipment, hire more people.”1 The underlying rationale finds support in economics: traditional models imply
that dividend tax cuts substantially reduce firms’ cost of capital (Harberger 1962,
1966; Feldstein 1970; Poterba and Summers 1985), and investment appears highly
responsive to the cost of capital (Hall and Jorgenson 1967; Cummins, Hassett, andHubbard 1994; Caballero, Engel, and Haltiwanger 1995). Similar arguments motivate ongoing proposals to use capital tax reforms to increase near-term output (Ryan2011, 2012; Hubbard et al. 2012).2* Department of Economics, University of California, Berkeley, 530 Evans Hall #3880, Berkeley, CA 94720,
and National Bureau of Economic Research (e-mail: yagan@berkeley.edu). I thank Alan Auerbach, Effraim
Benmelech, Shai Bernstein, Raj Chetty, David Cutler, Mihir Desai, Jesse Edgerton, C. Fritz Foley, John Friedman,
Nathaniel Hilger, Patrick Kline, N. Gregory Mankiw, Joana Naritomi, James Poterba, Emmanuel Saez, Andrei
Shleifer, Joel Slemrod, Jeremy Stein, Lawrence Summers, Matthew Weinzierl, anonymous referees, and numerous
seminar participants for helpful comments. Amol Pai, Evan Rose, and Michael Stepner provided excellent research
assistance. The tax data were accessed through contract TIRNO-09-R-00007 with the Statistics of Income Divisionat the US Internal Revenue Service. This work does not necessarily reflect the IRS’s interpretation of the data. The
author declares that he has no relevant or material financial interests that relate to the research described in thispaper.
†
Go to http://dx.doi.org/10.1257/aer.20130098 to visit the article page for additional materials and author
disclosure statement.
1
The first quote is from the February 2003 Economic Report of the President (Bush 2003, p. 55); the second
quote is from President Bush’s speech on January 7, 2003, introducing the tax cut (http://cnsnews.com/news/article/
president-bushs-speech-unveiling-his-economic-stimulus-plan (accessed March 22, 2012)). Both refer specificallyto the dividend tax cut.
2
The influential “Ryan Plans” of the US House Committee on the Budget proposed to keep capital income tax
rates low or to lower them further in order to “provide an immediate boost to a lagging economy by increasing
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However, there is no direct evidence on the real effects of the 2003 dividend tax
cut, for the simple reason that real corporate outcomes are too cyclical to distinguishtax effects from business cycle effects. Aggregate investment rose 31 percent in
the five years after the tax cut, but that increase could have been driven by secularemergence from the early 2000s recession. Indeed, aggregate investment rose by
34 percent in the five years following the early 1990s recession despite no dividend
tax cut. As a result, existing work on the real effects of dividend taxes has relied
on indirect evidence such as the goodness-of-fit of alternative structural investment
equations (Poterba and Summers 1983).
This paper tests for real effects of the 2003 dividend tax cut by using a set of
unaffected corporations to control for the business cycle. Upon incorporating at thestate level, US corporations adopt either “C” or “S” status for federal tax purposes.
C-corporations and S-corporations face similar tax rates except that C-corporations
are subject to dividend taxation while S-corporations are not. S-status typically confers tax advantages, but restrictions on the number and type of shareholders prevent corporations with publicly traded stock, with any institutional equity financing,or with any divisions between ownership and control from enjoying S-status. This
paper uses S-corporations (not directly affected by the dividend tax cut) as a control
group for C-corporations (directly affected) over time.3
The identifying assumption underlying this research design is not random assignment of C- versus S-status; it is that C- and S-corporation outcomes would havetrended similarly in the absence of the tax cut. Three facts support this “common
trends” assumption. First, C- and S-corporations of the same ages operate in thesame narrow industries and at the same scale throughout the United States andare thus subject to similar cyclical shocks. Second, contemporaneous stimulative
tax provisions like accelerated depreciation applied almost identically. Third andperhaps most important, key outcomes empirically trended similarly for C- andS-corporations in the several years before 2003.
This paper uses rich data from US corporate income tax returns from years 1996
to 2008. All publicly traded corporations, and thus the absolute largest corporations,are C-corporations; I therefore focus on a stratified random sample of private C- andS-corporations with assets between one million and one billion dollars (the ninetieth and 99.9th percentiles of the US firm size distribution) and revenue between
0.5 million and 1.5 billion dollars. Based on Census Bureau data, firms in this size
range employ over half of all US private sector workers. In the tax data, C- andS-corporations in this range are densely populated within fine industry-firm-sizebins, and all results flexibly control for time-varying industry-firm-size shocks. This
paper’s main sample is an unbalanced panel comprising 333,029 annual observations from 73,188 corporations, 58 percent of which are C-corporations; I obtainwages, lowering costs, and providing greater returns on investment” (Ryan 2011) and to prevent “raising taxes oninvesting at a time when new business investment is critical for sustaining the weak economic recovery” (Ryan2012). Hubbard et al. (2012, p. 5) predicted that Governor Mitt Romney’s proposed capital and labor income tax
reforms “will increase GDP growth by between 0.5 percent and 1 percent per year over the next decade.”3
To the extent that an increase in C-corporation investment displaced S-corporation investment, this empiricaldesign overstates the magnitude of the aggregate effect. The design tests for the canonical price effect of dividend
taxation; indirect effects such as wealth effects among savers that could have increased or decreased worldwide
corporate investment are outside the scope of this paper. Switching between corporate types is rare.

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qualitatively similar results in balanced panel regressions in which the only firmlevel variable changing over time is the outcome of interest.
I find that annual C-corporation investment trended similarly to annual
S-corporation investment before 2003 and continued to do so after 2003. The difference-in-differences point estimate implies an elasticity of investment with respect toone minus the top statutory dividend tax rate of ​0.00​with a 95 percent confidence
interval of ​−0 .08​to ​0.08​ , equivalent to ​−0.03​to ​0.03​standard deviations of firmlevel investment.
The finding of no significant increase in investment is robust across alternative
specifications (with and without controls), sample frames (unbalanced and balanced panels), investment measures (gross investment and net investment), outlier top-coding (at the ninety-fifth and ninety-ninth percentiles), and subsamples(defined by size, age, growth, profitability, cash, and debt). I further find a negative
point estimate and a 95 percent confidence upper bound elasticity of ​0.04​(​0.02​
standard deviations) for the related and independently relevant outcome of total
employee compensation. Results remain unchanged when including the 76 percent
of publicly traded corporations that fall in this paper’s size range and become negative when including all publicly traded corporations.
To confirm the tax cut’s salience and relevance in spite of the lack of detectablereal effects, I test for an effect on total payouts to shareholders (dividends plus
share buybacks)—the focus of the existing academic debate over the effects of thistax reform (Chetty and Saez 2005; Brown, Liang, and Weisbenner 2007; Blouin,
Raedy, and Shackelford 2011; Edgerton 2013). I find that C-corporation payouts
spiked immediately in 2003 by 2​ 1 percent​relative to S-corporation payouts, with a​t​-statistic over 5​ ​. The payouts effect was large and persistent in percentage terms but
small in dollar terms and is consistent with a small dollar-for-dollar displacementof C-corporation investment, or alternatively with a mere reshuffling of financial
claims that had no real effects.
These core results do not necessarily apply to corporations that were smaller orlarger than the firm size range analyzed here, so I test for real effects of the tax cut
within each firm size decile and ask whether the results suggest that out-of-sample
effects were likely different. For each real outcome, I find a zero effect within every
firm size decile and no upward or downward trend across deciles. Hence, I do notfind evidence suggestive of different out-of-sample results.
Finally, a recent model notes that a dividend tax cut can increase the productivity of investment even if it does not increase its level, by causing poorly-managed
C-corporations to reduce wasteful investment and to increase payouts while causing
other C-corporations to increase productive investment via increased equity issuance(Chetty and Saez 2010). When dividing the sample by each of six firm characteristics(size, age, growth, profitability, cash, and debt), I find no relationship between thesubgroups that increased payouts the most and those that increased equity issuancethe least. Thus I do not find evidence in favor of this ­efficiency-enhancing channel.
This paper complements a large empirical literature that has found substantial
real effects of other fiscal policies. Temporary countercyclical policies such as
accelerated investment depreciation (House and Shapiro 2008; Zwick and Mahon2014), individual income tax rebates (Johnson, Parker, and Souleles 2006), and temporary durable goods subsidies (Mian and Sufi 2012) have increased at least some3534

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december 2015c­ omponent of aggregate spending. Many studies have shown that labor income taxes
reduce labor supply (see Chetty 2012 for a recent review); q​ ​-theory-based regressions suggest that corporate income taxes reduce investment (Cummins, Hassett,and Hubbard 1994); and the pooled effect on near-term output of labor income,capital income, and other tax reforms since World War II was substantial (Romerand Romer 2010). This paper contributes to this literature by documenting that incontrast to numerous other fiscal policies, the 2003 dividend tax cut—one of thelargest changes ever to a US capital income tax rate—had no detectable near-term
impact on the real outcomes it was projected to improve.
The null result relates to theory and to alternative dividend tax reforms.
Economically, the null result rejects the joint hypothesis that the tax cut substantially reduced firms’ cost of capital as in traditional models and that investment
responded to the cost of capital as much as leading estimates predict. In particular, combining the leading “traditional-view” model of dividend taxation (Poterba
and Summers 1985) with consensus estimates of the cost-of-capital elasticity ofinvestment (Hassett and Hubbard 2002) would predict a dividend tax elasticity ofinvestment range of 0​ .21​to ​0.41​—at least 2.5 times the 95 percent confidence upperbound of this paper’s empirical estimate.
The null result accords instead with the leading class of alternative models (the“new view” or “trapped equity view” of dividend taxation) in which marginal
investments are funded out of retained earnings and riskless debt rather than out of
newly issued equity or risky debt (King 1977; Auerbach 1979; Bradford 1981). The
key mechanism is that earnings from preexisting operations will inevitably be subject to dividend taxes (whether paid out immediately or paid out in the future after
being retained for investment), so a dividend tax cut increases the post-tax return on
investment by the same magnitude that it increases the opportunity cost of investment, inducing no investment change.4
Traditional models of dividend taxation can nevertheless explain the null result
as due to particular features of this dividend tax cut and other tax rates, as detailedin Section V. The bottom line from that discussion is that even in that case, it may
be difficult for policymakers to implement an alternative dividend tax cut that substantially increases near-term investment. For example, the 2003 dividend tax cut
carried a default expiration date, and it is possible that a permanent dividend tax
cut would have substantially increased investment. However, the United States has
never committed to a near-term or long-term path for tax policy so the required longevity may be infeasible to guarantee: the 2003 dividend tax cut has outlasted manytax reforms that had no expiration date, and a majority of G7 countries have revised
their dividend tax rates up or down substantially since 2003.
The corporate finance literature on the 2003 dividend tax cut has focused onwhether the post-2003 increase in dividend payouts from publicly traded corporations (Chetty and Saez 2005) represented an increase in total corporate payouts or
was offset by an equal reduction in share buybacks (Brown, Liang, and Weisbenner
2007; Blouin, Raedy, and Shackelford 2011; Edgerton 2013). This paper shows thatthe tax cut indeed increased total corporate payouts—a finding again made possible
4

In terms of Tobin’s ​q​, ​q​is less than 1 in the new view by an amount that varies proportionally with 1 minus
the dividend tax rate.

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by the S-corporation control group because, like investment, share buybacks arevery procyclical.
The remainder of this paper is organized as follows. Section I describes the 2003
dividend tax cut and the distinction between C- and S-corporations. Section II introduces the tax data. Section III estimates real effects of the 2003 dividend tax cut.
Section IV confirms salience and relevance by analyzing payouts. Section V details
economic and policy implications. Section VI concludes.
I. C- versus S-Corporations and the 2003 Tax Reform

A. C- versus S-Status
After filing incorporation documents at the state level, US corporations electeither “C” or “S” status for federal tax purposes. C-corporations pay the corporate
income tax on annual taxable income, and US shareholders pay dividend taxes on
dividends and pay capital gains taxes on qualified share buybacks. S-corporations—
named after their subchapter of the Internal Revenue Code—have the same legal
structure as C-corporations but for tax purposes are flow-through entities that do not
pay an entity-level income tax. Instead, taxable business income flows through pro
rata to individual shareholders’ tax returns and is taxed as ordinary income in theyear it is earned, regardless of whether the income is actually distributed to shareholders that year.5 When distributed, S-corporation dividends are untaxed.6
S-status typically confers tax advantages (detailed in the next subsection), but
not all corporations qualify for S-status. The most important restrictions are that thecorporation must have no more than 100 shareholders, all shareholders must be US
citizens or residents and not business entities, and the corporation must have only
one class of stock. Thus all publicly traded corporations, corporations financed withventure capital, corporations partially or wholly owned by private equity or otherfirms, corporations that widely use stock-based compensation, and corporations thatuse stock classes to divide ownership from control cannot be S-corporations. Despite
these restrictions some very large corporations are publicly-known S-corporations
such as Fidelity Investments.7 Corporations can switch status and I account for thisin the analysis below, though consecutively switching back and forth is restrictedby law and switching is rare empirically because most factors that bar S-status (e.g.,
institutional shareholders) are persistent.
Except for the very largest corporations which are all publicly traded and are thus
C-corporations, C- and S-corporations of the same ages operate in the same narrow industries and at the same scales across the United States. For example, online
Appendix Figure 1A uses data from the full population of US corporate tax returns
5
Taxable dividend income or capital gains earned by S-corporations (e.g., on passively held securities) retain
their character and are taxed as dividend income or capital gains at the shareholder level.
6
The tax treatment of C- and S-corporations differ in other, smaller ways. For example, C-corporations candeduct charitable deductions up to only 10 percent of taxable income whereas S-corporations face limits at theindividual shareholder level. S-corporations are taxed similarly to partnerships; relative to partnerships which were
not analyzed for this paper, S-corporations may be a more appropriate control group for C-corporations because,
aside from taxes, C- and S-corporations have identical legal rights and responsibilities.
7
This information was obtained from a recent press report (http://www.boston.com/business/globe/articles/
2007/11/03/fidelity_changes_its_corporate_structure/ (accessed March 22, 2012)) and not from tax data.

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to plot the distribution of C- and S-corporations by 1-digit NAICS classification
for all 397,008 corporations in 2002 that satisfy the size and industry restrictionsin this paper, detailed in Section IIB.8 The figure shows that C- and S-corporations
are relatively evenly distributed across major industries. Zeroing in on the 23,892
corporations in the most-common 3-digit NAICS classification (wholesale durable
goods trade), online Appendix Figure 1B shows the even distribution of C- andS-corporations across narrow 4-digit industries. Online Appendix Figure 1C similarly shows even distributions of firm size. Online Appendix Figure 1D uses publicdata on two large corporations (Home Depot and Menard Inc., respectively, thecountry’s largest and third-largest home improvement retailers) to illustrate a specific example of publicly known C- and S-corporations operating in the same narrow industry and in the same locale (the Chicago metropolitan area).
C- and S-corporations differ along some notable dimensions. For example,
C-corporations tend to be more asset-intensive and less-profitable than S-corporations
after controlling for revenue and industry. Nevertheless, the substantial overlap
demonstrated in online Appendix Figure 1—and below in Figure 1 and Table 1 forthe main analysis sample—by industry and size suggests that even if the corporation
types differ in the level of outcomes, they may share common trends because theyshare any time-varying industry and firm-size shocks. Common trends is the condition required for identification below. Later, I demonstrate empirically that C- andS-corporation outcomes indeed trended similarly before 2003.
B. The 2003 Tax Reform
On May 28, 2003, President George W. Bush signed into law the Jobs and Growth
Tax Relief Reconciliation Act of 2003. This tax reform reduced the marginal federal dividend income tax rate from 38.6 percent to 15 percent for the recipients ofmost taxable dividends.9 President Bush proposed the reform on January 7, 2003;
it applied retroactively to January 1, 2003; and the dividend tax proposal appears tohave been largely unanticipated (Auerbach and Hassett 2007). As the name of thelaw (“Jobs and Growth”) and the paper’s introductory quotes from President Bushindicate, the tax cut’s supporters argued that it would affect real economic outcomes
beginning in the near-term.
The tax reform changed three other relevant provisions. It reduced the top capitalgains tax rate (the rate assessed on income earned from qualified share buybacks)
from 20 percent to 15 percent. It expanded temporary accelerated depreciationfor equipment and light structures investment through 2004, which applied nearly

8

These unedited population data lack investment and other key variables and so are used only for online
Appendix Figures 1A–1C.
9
The tax reform reduced the marginal tax rate on qualified (i.e., from US or tax-treaty-qualifying f­oreign
corporation stock held for at least 60 days) and taxable (i.e., not from S-corporations or accrued to tax-preferred accounts) dividends for individual taxpayers in the top 4 ordinary income tax brackets from 27 percent, 30 percent, 35 percent, and 38.6 percent to 15 percent, and for taxpayers in the bottom 2 o­rdinary
income tax brackets from 10 percent or 15 percent to 5 percent. Most taxable dividends accrue to taxpayers in the top ordinary income tax bracket and approximately 90 percent accrue to taxpayers in the top 4.
The tax reform did not change the tax treatment of dividends received by individuals in tax-favored savings accounts
or by nonprofit, corporate, or government entities.

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Yagan: Real Effects of the 2003 Dividend Tax Cut

Panel A. Industry
NAICS 1: Agriculture & Forestry
NAICS 2: Construction & Mining
NAICS 3: Manufacturing
NAICS 4: Retail & Wholesale Trade
NAICS 5: Information & Professional services
NAICS 6: Health Care
NAICS 7: Entertainment, Food, & Hotels
NAICS 8: Other services
0%

10%

20%

30%

40%

Panel B. Size (lagged revenue)
40%

30%

20%

10%

0%

$500k−$5m$5m−$10m$10m−$50m$50m−$1.5bn

C-corporations (195k firm-years)
S-corporations (138k firm-years)

Figure 1. Industry and Size Distribution of the Main Analysis Sample
Notes: This figure plots the industry and size mix of the C-corporations (whose dividends are taxable) andS-corporations (whose dividends are not taxable) in this paper’s main analysis sample. Each graph’s bars sum
to 100 percent within corporation type. Lagged revenue denotes operating revenue averaged over the preceding
two lags. This sample is an unbalanced panel of annual corporate income tax returns, comprising all observations
from the IRS Statistics of Income stratified random sample in years 1998–2008 in which the filing corporation
had between $1 million and $1 billion in lagged assets and $500,000 and $1.5 billion in lagged revenue, was private through the previous year, and is not in the finance or utilities industries. All analyses flexibly control for any
time-varying industry or firm-size shocks by non-parametrically reweighting the S-corporation sample within every
year to match the distribution of C-corporations across 190 industry-firm-size bins as detailed in Section IIE. Cversus S-status is defined as of the second lag; corporations can switch status if they meet the legal requirements but
fewer than 4 percent ever switched in this sample. See Table 1 for summary statistics.

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Table 1—Unweighted Summary Statistics for the Main Analysis Sample
C-corporations
90th
percentile(4)

69,214,032 26,410,150
45,330,360 16,945,392
10,803,074 2,041,562

3,310,941
1,878,245
118,378

164,050,464 76,377,272 42,265,004
105,045,088 35,529,524 19,258,636
25,007,676 7,826,240 2,281,994

−0.03
0.15

0.04
0.03

−0.09
−0.21

0.17
0.45

0.08
0.10

0.06
0.03

−0.01
−0.18

0.25
0.34

0.18

0.10

0.01

0.47

0.17

0.10

0.01

0.46

0.68
26

0.66
22

0.21
6

1.00
52

0.63
27

0.66
23

0.16
7

0.97
51

2,245,204
1.608

249,801
0.153

1,185
0.001

4,599,334
0.767

1,909,465
1.112

308,066
0.166

4,502
0.005

3,803,072
0.791

440,8420.870−19,591−0.034−1,280,729−0.286

1,756,233
0.459

349,969
1.715−21,495−0.030−988,169−0.254

1,572,145
0.454

12,410,943

3,843,863

324,038

28,162,686

11,265,016

5,013,783

452,621

24,175,638

0.291

0.160

0.028

0.492

0.188

0.131

0.027

0.376

659,858
0.015

0
0.000

0
0.000

443,330
0.011

3,486,271
0.093

684,450
0.016

0
0.000

7,762,084
0.169

531,236
0.012

0
0.000

0
0.000

250,0800.006

3,410,537
0.092

658,080
0.016

0
0.000

7,599,040
0.166

2,754,047
0.239

0
0.000

0
0.000

572,898
0.013

276,790
0.023

0
0.000

0
0.000

389
0.000

Mean
(1)
Characteristics
Lagged revenue
Lagged assets
Lagged tangible
capital assets
Lagged profit margin
Lagged revenue
growthLagged cash/lagged
assets
Lagged leverage
Age
Outcomes
Investment
Investment/lagged
tangible capital  assets
Net investment
Net investment/
lagged tangible  capital assets
Employeecompensation
Employeecompensation/  lagged revenue
Payouts
Payouts/lagged
revenue
Dividends
Dividends/lagged
revenue
Equity issued
Equity issued/lagged
revenue
Number of firm-year
observations
Number of firms

S-corporations

10th
percentile(3)

Median
(2)

Mean
(5)

Median(6)

10th
percentile
(7)

90th
percentile(8)5,385,821 169,980,800
3,002,156 74,923,672
173,325
17,449,492

195,033

137,996

43,98832,113

Notes: This table lists unweighted summary statistics for C-corporations (whose dividends are taxable) andS-corporations (whose dividends are not taxable) in this paper’s main analysis sample: an unbalanced panel ofannual corporate income tax returns, comprising all observations from the IRS Statistics of Income stratified random sample in years 1998−2008 in which the filing corporation had between $1 million and $1 billion in lagged
assets and $500,000 and $1.5 billion in lagged revenue, was private through the previous year, and is not in thefinance or utilities industries. Lagged denotes averaged over the two preceding lags. Revenue equals operating revenue. Assets equals the book value of assets. Tangible capital assets, also called capital, equals the book value of tangible capital assets (e.g., excluding cash and patents). Profit margin equals one minus the ratio of operating costs torevenue. Cash equals liquid current assets. Leverage equals the book value of non-equity liabilities divided by assets(this is greater than one when accumulated losses exceed paid-in equity). Age equals the year of the return minus
the year of incorporation. Investment equals the cost of all newly purchased tangible capital assets. Net investment
equals the annual dollar change in tangible capital assets. Employee compensation equals the sum of all non-­officer
wages, salaries, benefits, and pension contributions. Dividends equals cash plus property distributions to shareholders. Payouts, also called total payouts to shareholders, equals dividends plus share buybacks (­non-negative annualchanges in treasury stock). Equity issued equals non-negative annual changes in paid-in capital. C- versus S-status
is defined as of the second lag; corporations can switch status if they meet the legal requirements but fewer than 4
percent ever switched in this sample. All monetary figures are in 2010 dollars.

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i­dentically to C- and S-corporations.10 And it accelerated the already-legislated
phase-in of reductions in individual ordinary income tax rates, such as immediately reducing the top rate from 38.6 percent to 35 percent rather than waiting for
it to fall to 37.6 percent in 2004 and 35 percent in 2006. S-corporation income(as well as dividend income until 2003) is taxed as ordinary income, but because
the small reduction in ordinary income tax rates was merely an acceleration andbased on evidence presented in Section IIIE, I make the simplification of considering S-corporation income tax rates to have been unaffected. The tax reform did notchange the corporate income tax schedule.
The 2003 dividend tax cut was originally legislated to expire in 2009 but was
extended to 2013 and has now been made “permanent” (i.e., with no default expiration date) in nearly its original form. In late 2005 Congress proposed to extend thetax cut until 2011, and President Bush signed it into law in May 2006.11 In 2010,
Congress and President Barack Obama extended it again until 2013. In the first daysof 2013, President Obama signed into law a permanent extension of the tax cut for
all individuals with taxable income below $400,000 and married couples with taxable income below $450,000, as well as a permanent marginal dividend tax rate of
20 percent for taxpayers with taxable income above these thresholds. In Section VB,
I discuss the possible implications of the original default expiration dates.
The OECD reports that when considering federal and average state tax rates,
the 2003 tax reform reduced the top statutory dividend tax rate from 44.7 percent
to 20.8 percent. In the empirical analysis below, I report elasticities with respect toone minus this top statutory rate.12 One minus the dividend tax rate is the relevant
entity for parameterizing traditional models as I illustrate in Section V. The vast
majority of taxable dividend income accrues to households in the top tax bracket.
Shares of private corporations (the focus of this paper) are unlikely to be held bydividend-tax-exempt investors like pension funds or by taxpayers in the lowest dividend tax brackets. And unlike public company share buybacks, private corporation
share buybacks are typically taxed as dividends rather than capital gains (and indeed
share buybacks are relatively uncommon in my sample).13 Readers can apply theirown assumed tax change to the raw estimates as they see fit; for example, one could
assume that private C-corporation dividends faced the average taxable dividend tax
rates for the total US economy, which Poterba (2004) reports fell from 32.1 percent
to 18.5 percent.

10

The exception is that owners of S-corporations with current losses could deduct the depreciation allowancesfrom any current wage or other ordinary income on their 1040s, while C-corporations must carry forward the tax
benefit to future years’ profit. Thus the 2003 tax reform could, in principle, have benefited low-profit S-corporations
relative to low-profit C-corporations. However, the negative point estimate in Table 3, column 1, row 4 (introducedin Section IIIC) suggests that this was not a relevant confound.
11
This law also lowered the bottom dividend tax rate from 5 percent to 0 percent beginning in 2008 and was set
to expire in 2011 but never did before being made permanent in 2013.
12
See OECD Tax Database Table II4 (http://www.oecd.org/tax/tax-policy/tax-database.htm). Elasticities withrespect to the tax rate are 19 percent smaller in absolute value; one minus the tax rate is the element relevant fortheory.
13
IRS rules require a share buyback to materially change ownership in order to qualify as a capital gain. Thismay be easier to do with dispersed shareholders who trade their stock in public markets than it is for concentrated
shareholders who do not.

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II. Data

A. SOI Sample of US Corporate Income Tax Returns
This paper uses a large stratified random sample of US corporate income tax
returns from years 1996–2008. Each year the Internal Revenue Service (IRS)
Statistics of Income (SOI) division randomly samples corporate income tax returns,
edits many variables for accuracy and consistency, and uses them to publish aggregate statistics. The sampling percentages are a function of assets and a measureof net income; corporations with at least $50 million in assets are sampled withprobability one and progressively smaller corporations are sampled at progressively
smaller rates. Corporations sampled in one year are typically though not always
sampled in subsequent years, so the SOI sample constitutes an unbalanced panel.14
The fine reweighting I detail in Section IIE accounts for any differential changes
over time in the sampling percentages.
The SOI sample has three key advantages relative to the commonly used
Compustat database on corporations: it contains data on both C-corporations andS-corporations, it contains data on many young corporations, and it has a muchlarger sample size even of relatively large corporations. As detailed below, this paper
focuses on corporations with between $1 million and $1 billion in assets. Most
Compustat corporations fall in this asset range but the SOI sample contains observations on many more such firms, including in the range $500 million to $1 billion.
B. Analysis Sample
This paper focuses on corporations in the SOI sample with between $1 million
and $1 billion in assets (the 89.7th and 99.9th percentiles of the 2002 US ­pooled Cand S-corporation size distribution) and with revenue between $0.5 million and $1.5
billion (i.e., within 50 percent of either asset threshold) in 2010 dollars, for threereasons. The $1 million lower bound restricts attention to corporations operating
at substantial scale and lies comfortably above a reporting threshold that restricts
the balance sheet information available on corporations with less than $250,000
in assets. Almost all of the very largest corporations are publicly traded and are
therefore C-corporations, so the $1 billion upper bound ensures substantial overlap
between C- and S-corporations across size bins. And corporations in this size range
are quantitatively important: firms in this size range employ over half of all US private sector workers.15
The main analysis sample is an unbalanced panel of corporations constructedfrom the SOI samples. The unbalanced panel includes a corporation’s year ​t​ tax
return if the corporation: (i) had assets in the range $1 million to $1 billion and
14
The sampling is done using a deterministic function of the last four digits of the corporation’s employer identification number, so corporations sampled in one year are usually sampled the next as well.
15
Corporate income tax returns do not include employment. In the most recent Census Bureau releasewith employment statistics by firm revenue, 45.2 percent of private sector employees were employed by firms
with between $500,000 and $100 million in revenue (http://www.census.gov/econ/susb/data/susb2007.html).
Employment at firms with revenue between $100 million and $1.5 billion is not reported separately; I estimatethat an additional 5.3 percent to 18.5 percent of private sector employees are employed at firms with between $100
million and $1.5 billion in revenue.

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r­ evenue in the range $0.5 million to $1.5 billion on average between years ​t​–​2​ and​t​–​1​ (so that lagged values can be used for scaling); (ii) was private at least until year​t​–​2​ (since all S-corporations are private); and (iii)—as restricted in earlier workon the 2003 dividend tax cut (Chetty and Saez 2005)—is not a financial company(whose main productive assets are typically not tangible capital) or a utility company (to which unique regulations apply). I further discard any tax returns that contain missing variable values or in which the filing months of consecutive tax years
indicate that the tax return did not cover a full 12 month period.
I use the unbalanced panel for all main results due to its simplicity and inclusiveness. However, it has the potential disadvantage of a changing composition overtime. I therefore repeat all analyses using a balanced panel constructed similarly
to the unbalanced panel except that it includes the same corporations in every year.
The balanced panel comprises annual observations on corporations that: (i) filed
tax returns in all years 1996–2008; (ii) had assets in the range of $1 million to $1
billion and revenue in the range of $0.5 million to $1.5 billion average over years
1996–1997; (iii) were private through 1997; and (iv) are outside the financial andutilities industries. As I describe in Section IIIB, the balanced panel allows me to
conduct the regression analysis such that the outcome of interest is the only firmlevel variable changing from year to year. However, the balanced panel carries theobvious drawbacks of omitting corporations that are young in the post-2003 era andof requiring survival through 2008.
C. Variable Definitions
The SOI data contain the variables necessary for this paper’s analysis: assets, revenue, investment, tangible capital assets, net investment, employee compensation,
dividends, total payouts to shareholders, equity issued, profit margin, cash, debt,
NAICS industry classification, and age. All variables are constructed from annual
corporate income tax returns filed by the corporation. This section defines variables
in economic terms; online Appendix A defines them in terms of line items on tax
forms.
C-corporations file the corporate income tax Form 1120 and S-corporations filethe similar Form 1120S. Year t​ ​refers to the corporation’s tax filing that covered Julyof calendar year ​t​. Each observation’s C- versus S-status is defined as of its filingin year ​t​–​2;​ this means, for example, that a spike in C-corporation payouts in 2003
refers to corporations that filed a Form 1120 in 2001. Results are insensitive to thischoice.
Investment equals the purchase price of all newly installed capital assets logged
on Form 4562, filed alongside the corporate income tax return in order to claim
depreciation deductions.16 The US tax code permits a corporation to deduct the purchase price of newly acquired capital assets (i.e., both new and used capital assets
as long as they are new to the corporation) from its taxable income. The corporation
typically cannot deduct the entire amount immediately and instead must make a
16
Throughout this paper, “capital assets” refers to property depreciable under the US tax code (equipment andstructures used in the trade or business). Thus “capital assets” is used here in its traditional economic sense rather
than in the tax accounting sense of securities that generate passive income or similar assets.

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sequence of depreciation deductions over several years, computed each year using
Form 4562. To a close approximation, investment eligible for depreciation comprises the same capital goods included in NIPA private fixed non-residential investment statistics; see House and Shapiro (2008); Kitchen and Knittel (2011); and IRS
Publication 946 for more details.17
Tangible capital assets (shortened to “capital” in table headings) equals the bookvalue of all tangible (e.g., excluding goodwill) capital assets owned by corporation
at the end of the tax year, net of accumulated book depreciation. I compute net
investment as the annual dollar change in tangible capital assets, which equals new
tangible investment less tangible capital asset retirements and accumulated bookdepreciation. Employee compensation equals the sum of wages and salaries paid to
non-officer employees, payments for employee benefit programs (e.g., health insurance), and contributions to pension or employee-profit-sharing plan contributions.
Dividends equals the sum of cash and property distributions to shareholders.
Total payouts to shareholders (sometimes shortened to “payouts”) equals dividends
plus share buybacks—where share buybacks are defined as non-negative annual
dollar changes in treasury stock, the primary method used in Blouin, Raedy, andShackelford (2011); Skinner (2008); and Edgerton (2013). Equity issued equals
non-negative annual changes in total paid-in capital.
Assets equals total book assets. Revenue equals operating revenue. I use tax fields
to define operating profit margin (sometimes shortened to “profit margin”) homogeneously for C-corporations and S-corporations. Operating profit margin equals operating revenue less cost of goods sold and all components of total deductions except
interest, depreciation, domestic production activities, and officer ­compensation
deductions.18 Cash equals the sum of all liquid current assets. Debt equals the sumof all non-equity liabilities. For each corporation, 2-digit NAICS classification
equals the first two digits of the 6-digit NAICS classification code reported on thecorporate income tax return observed for each corporation that was filed nearest to
2003. There are 19 valid 2-digit NAICS classifications. Age is defined similarly,
using the date incorporation field reported on the return filed nearest to 2003.
D. Summary Statistics
Table 1 displays unweighted summary statistics for the main analysis sample (theunbalanced panel) by C- and S-status. All values are annual and all monetary amounts
are in 2010 dollars. The sample comprises 195,033 annual observations on 43,988
C-corporations and 137,996 annual observations on 32,113 S-corporations. The
average C-corporation observation has lagged revenue of $69 million, ­investmentof $2.2 million, and employee compensation of $12 million; S-corporation averages
17
Kitchen and Knittel (2011) demonstrate that SOI Form 4562 aggregates approximate NIPA investment statistics. Software, equipment, and structures are included; land and depletable assets (e.g., oil deposits) are not. New
purchases of patents and certain other intangible assets can be logged as new investment. If the investment purchaseis only partially used by the firm, only a portion is logged as new investment. US-based corporations with foreign
operations typically establish wholly-owned foreign entities that are regarded as separate entities; property placed
into service in separate entities do not appear on Form 4562.
18
I exclude interest, depreciation, and domestic production activities deductions because they are not operating
costs. I exclude officer compensation because private corporations may have leeway in the timing and form ofcompensating owner-managers.

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are similar. When weighted by lagged revenue as is done for all subsequent analyses(see next subsection), the average lagged revenue in the sample is $281 million,so the average firm in this paper’s analysis operates at considerable scale. Figure 1
shows that there is substantial overlap across C- and S-corporations by industry
and size; in the next subsection, I explain how I flexibly account for any differences along these dimensions. The size distribution of corporations is right-skewed,
reflecting the right-skewness of the population firm size distribution. Fewer than 4
percent of firms ever switched between C and S status.19
E. Weighting and Winsorizing
I specify the final weight used for each observation in online Appendix B; the formula can be understood as the result of two steps. I initially weight each observationaccording to its revenue, averaged over the previous two lags. Thus each observation
contributes to all graphs and regression estimates according to its economic scale,making the parameter estimates “dollar-weighted” in this sense. I then reweight
the S-corporation sample to match the C-corporation sample along 190 size-industry bins in order to flexibly control for time-varying size- or industry-based shocks
using the reweighting method of DiNardo, Fortin, and Lemieux (1996) that iscommonly used in labor economics when datasets are large enough to support it.
Specifically, after initially weighting observations by their lagged revenue, I bineach corporation into one of 190 (​= 19​two-digit industries ​×​ ​10​ ­within-industry
size deciles) bins according to the within-industry size-decile distribution of
C-corporations in 2002. Then within each corporation type and year, I inflate or
deflate each bin’s weight so that each bin carries the same relative weight as the2002 distribution of C-corporations. This ensures, for example, that ­time-varying
shocks to large construction firms will not influence the results because large construction firms will contribute to the results equally for each corporation type andin every year. Empirically, this reweighting turns out to be a careful precaution thatmakes almost no quantitative difference (compare estimates reported in Table 2­column 2 and online Appendix Table 4 ­column 10, introduced below) because Cand S-corporation industry distributions are very similar (Figure 1, panel A) andeffect sizes are constant across firm sizes (Figure 3, introduced below).
Finally and unless otherwise specified, I winsorize (top-code) scaled outcomes(e.g., investment divided by lagged tangible capital assets) at the ninety-fifth percentile.20 I intentionally winsorize observations differently for the time series panels of Figure 2 than I do for the regressions. The figures are intended to illustrate
how investment and other outcomes change year-by-year and especially around the­passage of the 2003 dividend tax cut. Thus for the figures, I hold the winsorization
19
The total number of corporations reported in the introduction is slightly smaller than the sum of the total
number of C-corporations and the total number of S-corporations reported in Table 1 because of this small numberof switching corporations.
20
By “winsorize,” I mean that any observations with values above the ninety-fifth percentile are assigned theninety-fifth percentile value. Winsorizing removes the influence of data coding errors, which are occasionally present even in the edited SOI samples. Even without data errors, winsorizing can be optimal when estimating means infinite samples from skewed distributions as one trades off bias with minimizing mean squared error (Rivest 1994).
I winsorize controls at the ninety-ninth percentile since they’re used as quartics; winsorizing at the ninety-fifth
percentile yields nearly identical results.

3544

Panel A. Investment

Panel B. Net investment$0.100∆ Capital per dollarof lagged capital

Investment per dollarof lagged capital

$0.32

$0.28

$0.24

$0.20

$0.075$0.050$0.025$0.00098 99 00 01 02 03 04 05 06 07 08

98 99 00 01 02 03 04 05 06 07 08

Year

Year

C-corporations
S-corporations

C-corporations
S-corporations

Panel C. Employee compensation

Panel D. Total payouts to shareholders

$0.18
$0.17

Payouts per dollarof lagged revenue

Compensation per dollarof revenue

december 2015

THE AMERICAN ECONOMIC REVIEW

$0.16
$0.15
$0.14
98 99 00 01 02 03 04 05 06 07 08

200%[$0.0063]

200%[$0.075]150%[$0.0047]150%[$0.056]100%[$0.0031]

100%[$0.037]
98 99 00 01 02 03 04 05 06 07 08

Year

Year

C-corporations
S-corporations

C-corporations (left scale)

S-corporations (right scale)Figure 2. Effects of the 2003 Dividend Tax Cut
Notes: These figures plot the time series of annual mean outcomes for C-corporations and S-corporations in themain analysis sample net of a rich set of controls. Investment equals the cost of all newly purchased tangible capital assets. Net investment equals the annual dollar change in tangible capital assets. Employee compensation equals
the sum of all non-officer wages, salaries, benefits, and pension contributions. Total payouts to shareholders equals
dividends plus share buybacks (non-negative annual changes in treasury stock). Each panel is constructed by scaling each observation by either the firm’s tangible capital assets or revenue averaged over the two preceding lags;
winsorizing (top-coding) observations at the ninety-fifth percentile; regressing this scaled outcome variable withinevery year on a C-corporation indicator, two-digit NAICS industry fixed effects, and quartics in age, lagged revenue, lagged profit margin, and revenue growth; and requiring that the vertical distance between the two lines equals
the regression coefficient on the C-corporation indicator and that the weighted average of the lines equals the sample average in that year. The regressions are dollar-weighted (each observation is weighted by its lagged revenue) and flexibly control for any time-varying industry or firm-size shocks by non-parametrically reweighting the
S-corporation sample within every year to match the distribution of C-corporations across 190 industry-firm-sizebins as detailed in Section IIE. Panel D is included as a test for an immediate behavioral response in financial outcomes and differs from the other graphs in two ways that account for income-tax-induced differences in baseline
payout levels and for slightly differential pre-trends as detailed in Section IVA.

percentiles fixed across years and, in particular, use the pre-2003 distribution of theoutcome to compute winsorization levels in all years. However, as will be relevant
for the payouts outcome only, the tax cut can shift the outcome distribution (e.g.,increasing the ninety-fifth percentile), and estimates of the impact of tax cut would
ideally censor an equal share of observations over time. Thus for the regressions, I
winsorize pre-2003 observations using the pre-2003 distribution of the outcome andVOL. 105 NO. 12

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3545

Investment per $ of lagged capital

Panel A. Investment
0.5 SD[$0.125]0−0.5 SD[−$0.125]

1

2

3

4

2

3

4

5

6

7

8

9

10

5

6

7

8

9

10

5

6

7

8

9

10

Size decile

4 capital per $ of lagged capital

Panel B. Net investment
0.5 SD[$0.127]

0−0.5 SD[−$0.127]1

Size decile

Compensation per $ of lagged revenue

Panel C. Employee compensation
0.5 SD[$0.07]

0−0.5 SD[−$0.07]

1

2

3

4

Size decile

Figure 3. Effects by Size Decile
Notes: This figure plots estimated within-size-decile effects of the 2003 dividend tax cut in the main analysis sample. Variables are defined, scaled, and winsorized as detailed in Figure 2. Each y-axis height equals one standard
deviation of the outcome. Each panel is computed by binning corporations into deciles according to the unweighted
deciles of the pooled C-corporation lagged revenue distribution, and then within each decile estimating a regressionof the outcome on a C-corporation indicator, the interaction of a C-corporation indicator and post-2003 indicator,
year fixed effects, two-digit NAICS industry fixed effects, and quartics in age, lagged revenue, lagged profit margin,
and revenue growth. Each panel plots the coefficients on the interaction term with Bonferroni-corrected 95 percent
confidence intervals to adjust for multiple (ten) hypothesis testing; uncorrected confidence intervals are one-thirdtighter. Standard errors are clustered by firm. The solid line is the best unweighted linear fit through the coefficients.
Observations are weighted analogously to Figure 2.

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I winsorize 2003-and-beyond observations using the 2003-and-beyond distributionof the outcome.21
III. Effect on Investment and Employee Compensation

I first test whether the 2003 dividend tax cut caused C-corporations to increase
investment: a key real behavioral response suggested by policymakers and by economic theory. I begin by presenting visual evidence and regression estimates of theeffect of the tax cut on investment. I then present extensive robustness checks, tests
for effects on employee compensation, heterogeneity analyses, tests for internal andexternal validity, and a test for an efficiency-enhancing reallocation of investment.
A. Investment
Figure 2, panel A plots the time series of mean investment for C-corporations
and S-corporations in the unbalanced panel, net of a rich set of controls as done in
Chetty et al. (2011). As is standard in corporate finance, I first scale each corporation’s annual investment by its lagged tangible capital assets and top-code observations at the ninety-fifth percentile as described in Section IIE. Then within each year,
I regress scaled investment on a C-corporation indicator and this paper’s standard
set of controls: indicators for two-digit NAICS industry classification and quartics
in age, lagged revenue, lagged profit margin, and revenue growth from the second
to the first lag.22 I then construct the two series shown in the figure by setting eachyear’s difference between the two lines equal to that year’s regression coefficienton the C-corporation indicator and setting the weighted average of that year’s data
points equal to the year’s sample average. To be concrete, the 2002 C-corporation
data point indicates that the average C-corporation in 2002 invested $​ 0.21​per dollar
of its lagged capital assets, net of controls.
The figure shows that the time series of C-corporation investment tracked thetime series of S-corporation investment closely in the several years before 2003,
suggesting that the two time series would have continued to track each other in theabsence of the 2003 dividend tax cut. The two series in fact continued to track eachother after 2003, suggesting that the tax cut had little or no effect on C-corporation
investment.
Table 2 formalizes this visual evidence by reporting estimates of the following
difference-in-differences (DD) regression that uses the same definitions, scaling,
and controls underlying the figure:(1)	​​INVESTMENT​ it​​​  = ​​α​1​​​​​CCORP​ i,t−2​​​  + ​​α​2​​​​​CCORP​ i,t−2​​​  × ​​POST​ t​​​ + ​​X​i,t−2​​​β + ​​YEAR​t​​γ​ ,21In each case, I compute percentiles separately for C-corporations and S-corporations to account for level
differences in the outcome. When I use only the pre-2003 distribution to winsorize, main regression results
remain nearly unchanged but the payouts effect size is approximately two-thirds as large and still very statisticallysignificant.
22“Lagged” denotes “averaged over the previous two lags.”

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Yagan: Real Effects of the 2003 Dividend Tax Cut

Table 2—Effect of the 2003 Dividend Tax Cut on Investment, Net Investment,
and Employee Compensation
Dependent variable:
Dep. var. winsorized at:Panel:

Panel A. Investment
C-Corp × Post-2003
Lagged controls
Firm FE’s

Observations (firm-years)
Clusters (firms)
R2
Pre-2003 C-corp mean
Pre-2003 C-corp SD

Implied ε wrt (1 − ​​τ​div​​​)

Dependent variable:
Dep. var. winsorized at:Panel:

Investment
95th percentile
Unbalanced
Balanced($ per lagged capital)(1)(2)
0.0008(0.0044)−0.0002(0.0042)X

333,029
73,1880.01
0.24280.2514333,029
73,1880.07
0.24280.25140.01
0.00[−0.08, 0.09][−0.08, 0.08]
Net investment
Unbalanced($ per lagged capital)(7)(8)

B. Net investment and employee compensation
0.00480.0042
C-Corp × Post-2003(0.0041)(0.0039)
Lagged controls
X
Firm FE’s
333,029333,029
Observations (firm-years)
73,18873,188Clusters (firms)
0.01
0.04
R2
Pre-2003 C-corp mean
0.0421
0.0421Pre-2003 C-corp SD
0.25410.2541
0.26
0.23
Implied ε wrt (1 − ​​τ​div​​​)[−0.18, 0.71][−0.19, 0.66]

99th percentile
Unbalanced
Balanced($ per
96–97 cap.)(3)($ per lagged capital)(4)(5)($ per
96–97 cap.)(6)−0.0063(0.0226)−0.0104(0.0068)−0.0118(0.0066)X−0.1884(0.1483)

X
85,6247,784
0.53
0.29390.3070333,029
73,1880.01
0.28280.4181333,029
73,1880.05
0.28280.4181−0.05[−0.4, 0.3]

−0.09
−0.10
[−0.19, 0.02] [−0.2, 0.01]

X
85,6247,784
0.55
0.36820.6478−1.18[−3.01, 0.64]

Employee compensation
95th percentile
Balanced
Unbalanced
Balanced($ per
96–97 cap.)(9)($ per lagged revenue)
(10)
(11)

($ per
96–97 rev.)(12)−0.0110(0.0116)−0.0013(0.0025)

0.0083(0.0062)X
85,6247,784
0.20
0.08850.2732−0.29[−0.88, 0.3]

−0.0013(0.0020)X

X
85,6247,784
0.87
0.17270.1450
0.11
−0.02
−0.02
[−0.09, 0.05][−0.07, 0.04] [−0.05, 0.27]
333,029
73,1880.00
0.16470.1415333,029
73,1880.37
0.16470.1415

Notes: This table reports difference-in-differences estimates of the effect of the 2003 dividend tax cut on real outcomes. All columns display the coefficient on the interaction between a C-corporation indicator and an indicator
for the year being 2003 or later, from a regression of the outcome on this interaction, a C-corporation indicator,
year fixed effects and possibly additional controls. Lagged controls indicates that the regression includes two-digit
NAICS industry fixed effects and quartics in age, lagged revenue, lagged profit margin, and revenue growth. Firm
FE’s indicates that the regression includes firm fixed effects. The unbalanced panel is this paper’s main sample; see
Table 1 for details. The balanced panel is constructed similarly, except the sample restrictions apply only to years
1996–1997 and observations are required in all years 1998–2008. Before the regression, each observation’s outcome value is scaled by either the firm’s tangible capital assets or its revenue (see online Appendix Table 2 for alternative scalings) averaged over the two preceding lags in the unbalanced panel and over 1996–1997 in the balanced
panel, and then winsorized (top-coded) at the level indicated. The regressions are dollar-weighted (each observation
is weighted by its lagged or 1996–1997 revenue) and they flexibly control for any time-varying industry or firmsize shocks by non-parametrically reweighting the S-corporation sample within every year to match the distribution of C-corporations across 190 industry-firm-size bins as detailed in Section IIE. Elasticity equals the reported
coefficient divided by the pre-2003 C-corporation outcome mean, divided by the percent change in one-minus-thetop-statutory-dividend-tax-rate (the top rate fell from 44.7 percent to 20.8 percent). Standard errors are clustered byfirm. See online Appendix Tables 1–7 for robustness checks.

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where I​ NVESTMEN​Tit​  ​​​denotes scaled investment for firm i​ ​in a year t​ ​between 1998
and 2008 and C​ COR​Pi​  , t−2​​​denotes an indicator for whether firm i​ ​was a C-corporation​ i,​ t−2​​​denotes ain ​t​–​2​  , ​POS​Tt​  ​​​denotes an indicator for year t​​being 2003 or later, ​X
possibly empty vector of lagged firm controls, and ​YEA​R​t​​​denotes a vector of year
fixed effects.23 The coefficient ​​α​2​​​represents the mean effect of the tax cut on annual
C-corporation investment and is my statistic of interest. Standard errors clustered byfirm are reported below each estimate.
Column 2 of Table 2 reports that when controlling for the full set of controls usedin the graph, the 2003 dividend tax cut is estimated to have had an insignificantly
negative effect on C-corporation investment: a change of −​ $0.0002​per dollar oflagged tangible capital assets with a standard error of $​ 0.0042​ , relative to a pre2003 mean of ​$0.2428​and standard deviation of ​$0.2514​. The 2003 dividend tax
cut reduced the top statutory dividend tax rate from 44.7 percent to 20.8 percent(see Section IB), so these estimates imply an elasticity of investment with respect toone minus the top statutory dividend tax rate of ​0.00​with a 95 percent confidence
interval of ​− 0.08​ to ​0.08​.24 The confidence interval in terms of standard deviationsof firm-level investment is ​−0.03​to ​0.03​. Column 1 reports similar estimates whenomitting the firm-level controls.
B. Robustness
I conduct several robustness checks. First, columns 4–5 of Table 2 replicate­columns 1–2 when top-coding at the ninety-ninth percentile. Second, online Appendix
Table 1 replicates Table 2 while allowing for differential pre-2003 trends.25 Third,
online Appendix Table 2 replicates Table 2 when scaling investment by lagged revenue. Online Appendix Table 3 replicates Table 2, restricted to years 1998–2004 inorder to omit years in which the controls, scaling variable, and C-corporation indicator use potentially endogenous post-2003 values. All report more negative point
estimates than Table 2 with similar or smaller 95 percent confidence upper bounds.
Online Appendix Tables 4 and 5 report results under 14 additional variations to thesample frame, variable definition, or reweighting with continued null or marginallysignificantly negative results; see online Appendix C for details.
Additionally, I replicate the analysis in the balanced panel of corporations; thissample comes at the obvious cost of omitting corporations that are young in the
post-2003 era and requiring survival through 2008, but it permits regressions inwhich the only firm-level characteristic changing from year to year is investment.
Column 3 of Table 2 reports results from estimating equation (1) in the balanced
panel, with three changes relative to column 2: each corporation’s C- versus S-status
23

See online Appendix CII and online Appendix Table 5 for similar results when scaling investment by(time-invariant) pre-2003 tangible capital rather than (time-varying) lagged tangible capital.
24
The elasticity is computed as the percent change in C-corporation investment divided by the percent change in
one-minus-the-tax-rate: ​( ​​α̂ ​​2​​  /​  ‾investment ​)/(0.239/0.553)​  , where ​​  ‾investment ​​equals mean pre-2003 C-corporation
investment and is reported in Table 2. The elasticity bounds are computed similarly, replacing ​​​α̂ ​​2​​​in the above formula with ​​α​ ̂ ​​2​​​plus or minus ​1.96​times the standard error.
25
For
this
table,
I
estimate:
I​
NVESTMEN​Tit​  ​​  = ​α​1​​CCOR​Pi,​  t−2​​  + ​α​2​​CCOR​Pi,​  t−2​​  × POS ​Tt​  ​​+ ​α​3​​  CCOR​Pi,​  t−2​​  × t + ​α​4​​CCOR​Pi,​  t​​  × POS ​Tt​  ​​  × t + ​X​i, t−2​​  β + YEA​R​t​​γ​. I report the effect of the tax cut on
investment averaged across the post-period, equal in this regression to ​​α2​ ​​  + 2005.5​α​4​​​since 2005.5 is the midpointof the post-period.

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is defined as of 1996, each corporation’s annual investment value is scaled by its
mean tangible capital assets over years 1996–1997, and I replace the lagged firmlevel controls with firm fixed effects. The resulting estimate has a wider confidence
interval but is also essentially zero.
Finally, Figure 2, panel B replicates Figure 2, panel A for the related outcome ofnet investment, equal to the real annual dollar change in the corporation’s stock oftangible capital assets as reported on the balance sheet. Arithmetically, net investment equals investment less tangible capital asset retirements and book depreciation. The figure shows no relative change in C-corporation net investment after the
2003 tax cut. Columns 7–9 of Table 2 repeat the specifications underlying columns
1–3 for the net investment outcome. The unbalanced panel point estimates are positive while the balanced panel point estimate is negative, and none is statisticallysignificantly different from zero.26 Online Appendix Tables 1–3 repeat these analyses using the same alternative specifications described above for investment, withsimilar results.
C. Employee Compensation
Figure 2, panel C replicates Figure 2, panel A for the outcome of employee compensation. Each firm’s level of employee compensation is scaled by lagged revenue.
The figure shows no relative change in C-corporation employee compensation after
2003.27 Columns 10–12 of Table 2 repeat the specifications underlying columns 1–3
for the employee compensation outcome. Column 11 lists the results from equation(1) using the set of lagged controls. The point estimate is a change of −​ $0.0014​ per
dollar of lagged revenue with a standard error of $​ 0.0020​ , relative to a pre-2003
mean of $​ 0.1647​and standard deviation of $​ 0.1415​. This corresponds to an elasticity of ​−0.02​with 95 percent confidence interval of ​− 0.07​ to ​0.04​. The confidence
interval in terms of firm-level standard deviations is ​− 0.04​ to ​0.02​. The balanced
panel point estimate is positive but is similarly not statistically significantly different
from zero. Online Appendix Tables 1–3 repeat these analyses using the same alternative specifications described above for investment and with similar results.
D. Heterogeneity Analysis
Although the above results indicate no statistically significant impact of thedivided tax cut on C-corporation investment, it is possible that this overall result
obscures a particular spike in investment at, for example, large C-corporations relative to small C-corporations. To investigate this in a compact way, I estimate six
triple-difference regressions, one for each of six prominent firm-level traits: firm
size (lagged revenue), age, lagged revenue growth, lagged profitability, lagged cash
(liquid assets as a fraction of total assets), and lagged leverage (debt as a fraction of
total assets).
26
Elasticity confidence intervals for net investment are larger than those for investment because the base levelof net investment is close to zero, but standard-deviation confidence intervals are similar.
27
Note that the downward trend in scaled employee compensation after 2005 is due in part to rising lagged revenue (the scaling variable). Trends are less stable when scaling by tangible capital assets; online Appendix Table 2
shows that the results are robust to the choice of scaling variable.

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In order to avoid strong parametric assumptions such as whether these traits
should enter the regressions linearly or in logs, I divide corporations along these
traits by their ranks. To explain the general procedure, consider the example of firmsize. I compute the twentieth and eightieth percentiles of firm size in the pooled
C-corporation distribution, drop all corporations in the middle quintiles (between
the twentieth and eightieth percentiles), and define an indicator for each observation
equal to one if and only if the corporation’s size lies in the top quintile (above theeightieth percentile). I then estimate the triple-difference analogue of equation (1):(2) ​​INVESTMENT​ it​​​  = ​​α​1​​​​​CCORP​i,t−2​​​  + ​​α2​​​​​​CCORP​ i,t−2​​  × ​​​POST​ t​​​  + ​​α​3​​​​​TRAIT​ i,t−2​​​ + ​​α​4​​​​​CCORP​ i,t−2​​​ × ​​TRAIT​ i,t−2​​​ + ​​α​5​​​​​TRAIT​ i,t−2​​​ ​​× POST​ t​​​+ ​​α6​ ​​​​​CCORP​ i,t−2​​​  × ​​TRAIT​ i,t−2​​​  × ​​POST​ t​​​ + ​​X​i,t−2​​​β + ​​YEAR​t​​γ​ ,where ​TRAI​Ti,​  t−2​​​is the top-quintile indicator defined above, ​X​ i​, t−2​​​denotes the vectorof lagged firm characteristics used in column 2 of Table 2, and all other variables
retain the definitions used above. The triple-difference coefficient ​α​ 6​ ​​​represents thequantity of interest: the effect of the 2003 dividend tax cut on large C-corporations
relative to small C-corporations and relative to S-corporations.
Columns 1–3 of Table 3 report the results for investment, net investment, andemployee compensation. Each cell reports the point estimate of the ­triple-difference
coefficient and its standard error from a separate regression in which the trait indicator is defined using the trait listed in the row heading. For example, the upper
left cell indicates that large C-corporations increased investment by a statisticallyinsignificant ​$0.0105​per dollar of lagged tangible capital assets more than small
C-corporations. All coefficients are small relative to the standard deviation of theoutcome (displayed in Table 2 columns 2, 8, and 11, respectively) and are statistically insignificant even when not accounting for the large number of hypotheses
being tested simultaneously, though with wider standard errors than in the main
analysis.
E. Internal Validity
As mentioned in Section IB, a threat to the internal validity of the empirical designis that temporary or small contemporaneous changes to other tax policies could in
principle have increased S-corporation investment relative to C-corporation investment after 2003, masking positive effects of the dividend tax cut on C-corporation
investment. Specifically, the 2003 tax reform accelerated the already-legislated
reduction in the individual ordinary income tax rates from 38.6 percent to 35 percent (which benefited S-corporations relative to C-corporations) and it expanded
temporary accelerated depreciation of investment expenditures (which would haveVOL. 105 NO. 12

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Table 3—Effect Heterogeneity

C-Corp × Post-2003
× High lagged revenue
× High age
× High lagged rev. growth
× High profit margin
× High cash/assets
× High leverage

Investment($ per lagged
capital)(1)

Net investment($ per lagged
capital)(2)

Employeecomp.
($ per lagged
revenue)(3)(Percent)(4)

Equityissued($ per lagged
revenue)(5)0.0103(0.0127)0.0104(0.0168)−0.0069(0.0160)−0.0265(0.0167)−0.0212(0.0155)−0.0030(0.0199)−0.0017(0.0102)0.0003(0.0144)−0.0164(0.0165)0.0103(0.0140)−0.0217(0.0148)0.0144(0.0190)−0.0042(0.0054)−0.0055(0.0060)−0.0006(0.0082)−0.0106(0.0109)−0.0120(0.0115)−0.0120(0.0101)

−3.6
(8.9)
40.0
(10.4)−8.5(11.0)
97.9(16.0)
34.7(12.2)−59.6(17.8)−0.0009(0.0004)
0.0003(0.0006)−0.0005(0.0008)
0.0020(0.0012)−0.0006(0.0011)−0.0002(0.0012)

Payouts

Notes: This table reports triple-difference estimates of the effect of the 2003 dividend tax cut. Each cell represents a
separate regression and reports the coefficient on the triple interaction of a C-corporation indicator, an indicator forthe year being 2003 or later, and an indicator for the firm being in the top quintile rather than the bottom quintile (themiddle three quintiles are omitted) of the trait specified in the row heading (see Table 1 for definitions). The specifications underlying each cell of columns 1–3 are identical to the difference-in-differences specifications underlying Table 2 columns 2, 8, and 11, respectively, except that each regression fully interacts the top-quintile indicatorwith the C-corporation and post-2003 indicators. Similar to Table 2, regressions are dollar-weighted (each observation is weighted by its lagged revenue) and flexibly control for any time-varying industry and firm-size shocks by
non-parametrically reweighting the S-corporation sample within every year and quintile to match the distributionof C-corporations across 190 industry-firm-size bins; the exception is regressions by the lagged-revenue trait which
can be reweighted only across 19 industry bins since the top and bottom quintiles do not overlap in size. Column 4
makes the same modifications to the difference-in-difference regression underlying Table 4 column 2. Column 5
replicates this table’s column 3 for the outcome of equity issued. Standard errors are clustered by firm.

benefited S-corporations relative to C-corporations if S-corporations used capitalwith moderately longer asset lives).28
I conduct three tests for quantitatively important bias; see online Appendix D
for full detail. First and most simply, I conduct placebo tests for an increase in
S-corporation investment in 2001 and 2002, taking advantage of the fact that the
reduction in individual ordinary income tax rates began in 2001 and accelerated
depreciation began in 2002.29 Online Appendix Table 6 columns 2–3 in fact show
statistically insignificant reductions in S-corporation investment in those years, providing the simplest evidence suggesting little or no bias.30 Second, column 4 showsthat controlling flexibly for asset life differences across firms has almost no effect on
the estimated effect of the dividend tax cut on C-corporation investment, explainedby C- and S-corporations having nearly identical asset life mixes in this sample. Thirdand most completely, I follow Auerbach and Hassett (1992) and Cohen, Hansen,
and Hassett (2002) in computing a structural firm-year-specific measure of the costof capital that encompasses the effects of these contemporaneous ­non-dividend-tax
28
It also reduced the top capital gains tax rate from 20 percent to 15 percent. The Auerbach-Hassett parameterization below addresses this minor potential confound.
29
In standard models, both the 2001 reduction in individual income tax rates and the 2001-legislated future
reductions lowered S-corporations’ cost of capital immediately in 2001 (Auerbach 1989).
30
This null result can also be seen visually in Figure 2, panel A.

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december 2015changes. Columns 5–10 show that controlling for this all-in cost-of-capital measureagain has almost no effect on the results, explained by S-corporations’ cost of capital falling by similarly modest amounts both before and after 2003. Thus none ofthese varied tests suggests a violation of internal validity.
F. External Validity
The above results are local to the sample and do not necessarily apply to publicly
traded corporations and to corporations that were smaller or larger than the size
range analyzed here. I therefore conduct two additional analyses to test for suggestive evidence of different out-of-sample results. First, recall that publicly traded
corporations were excluded from the main sample because all publicly traded corporations are C-corporations and thus may have no reasonable S-corporation counterparts. I nevertheless repeat the regressions of Table 2 on a broadened sample
that includes the 76 percent of publicly traded corporation observations matched to
tax data that also satisfy this paper’s firm size restrictions. Publicly traded corporations are large, so these additional observations loom large in these size-weighted
regressions. Online Appendix Table 7 shows that this inclusion leaves the results ofTable 2 nearly unchanged.31
In a second test, Figure 3, panels A–C display heterogeneity in the main overall difference-in-differences effects on investment, net investment, and employeecompensation, respectively, by firm size decile. The graph is constructed by computing the deciles of the pooled C-corporation distribution of lagged revenue, using
them to divide all corporations into size deciles, estimating equation (1) withineach decile using the full set of lagged controls, and plotting the resulting regression ­coefficients, 95 percent confidence intervals, and the best unweighted linear fit
through the coefficients.32 The figures reveal three facts: no within-decile estimate
is statistically significantly different from zero, each graph’s cross-decile variancein point estimates is small relative to the standard deviation, and there is no upward
or downward trend in any graph’s point estimates. Hence if one were to extrapolate from these results, one would predict that the 2003 dividend tax cut had noreal effects on C-corporations outside of this paper’s size range. However, further
research is necessary to support out-of-sample conclusions.
G. Potential Reallocation of Investment
The central question of this paper is whether the 2003 dividend tax cut increased
the level of corporate investment and employee compensation. This section has foundno detectable increase in these levels. I now briefly investigate the separate question of whether there is evidence to suggest that the dividend tax cut improved theallocative efficiency of investment, even if it did not increase its overall level. This
31

Online Appendix Table 4, column 5 shows a more negative result when including all public corporations
regardless of size.
32
Each graph’s y-axis is centered at zero and has total height equal to one standard deviation of the outcome
used in the regression (reported in columns 2, 8, and 11 of Table 2). Each confidence interval is Bonferroni-adjusted
for the fact that each graph tests multiple (ten) hypotheses; each interval would be 30 percent tighter if unadjusted(i.e., the t​​-statistic threshold for statistical significance at the 5 percent level is 2.81 rather than 1.96).

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possibility is motivated by a recent theoretical contribution (Chetty and Saez 2010,
building on Shleifer and Vishny 1986) that argues that a dividend tax cut can reduce
wasteful investment at some C-corporations (as shareholders improve monitoring
and force managers to reduce wasteful investment spending) while increasing productive investment at other C-corporations (via the traditional cost-of-capital channel described below in Section VA), consistent with Swedish evidence (Alstadsæter,Jacob, and Michaely 2014). Among other predictions, this agency theory predicts
that the subgroups of C-corporations that increased total payouts to shareholders
the least are also the ones that most increased equity issuance.33 Columns 4–5 ofTable 3 repeat the heterogeneity analysis of Section IIID for the outcomes of payouts and equity issuance. The results are noisy but no negative relationship is apparent between equity issuance and payouts when comparing coefficients across thecolumns. Hence, I do not find evidence in support of investment rebalancing acrossC-corporation subgroups.34
IV. Confirmation of Salience and RelevanceThe previous section documented robust zero effects of the 2003 dividend tax cut
on C-corporation investment and employee compensation. Whenever an intervention is found to have had no significant impact, an important concern for interpretation is that perhaps the intervention was simply not salient or relevant. A lack ofsalience is perhaps unlikely given the prominence and size of the 2003 dividend tax
cut; more plausible is that unknown tax provisions neutralized the actual applicability of the tax cut. The dividend tax is assessed on dividend income, so I now test
for an immediate impact of the dividend tax cut on dividends and on total payouts toshareholders (dividends plus share buybacks).
I focus on total payouts in the text and report the very similar dividend results inthe online Appendix in order to allow the main results to speak to the unresolved
academic debate on the effects of the 2003 dividend tax cut on total payouts. Chetty
and Saez (2005) showed that the tax cut increased the dividends of publicly traded
corporations. However, subsequent papers have questioned the relevance of thisbehavior by arguing that planned buybacks may have simply been relabeled as dividends, leaving total payouts unchanged (Blouin, Raedy, and Shackelford 2011;
Brown, Liang, and Weisbenner 2007; Edgerton 2013).
A. Effect on Payouts
Figure 2, panel D plots the time series of mean payouts to shareholders from
C-corporations and S-corporations in the unbalanced panel. Each corporation’s payouts value is scaled by its lagged revenue in the spirit of Lintner (1956), though
results are robust to this choice. The figure is then constructed exactly as in Figure 3,
panels A–C except for two differences. Because C-corporations pay taxes on annual
33
Reduced wasteful investment results in increased payouts; increased productive investment is funded byincreased equity issuance.
34
Public corporations have much more dispersed ownership and thus may be more prone to agency problems
than this paper’s private corporations.

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december 2015c­ orporate income at the entity level while S-corporation shareholders are liable forthem at the shareholder level, S-corporations often pay higher levels of dividends(approximately ten times larger on average than C-corporations) to help shareholders cover these tax liabilities. Thus I account for level differences in pre-2003 scaled
payouts by dividing firm i​​’s scaled payouts in year t​​by the mean level of payoutsfor ​i’​s corporate type (C or S) in the pre-2003 period, essentially transforming thecomparison into percentage terms.35 Second, I account for slightly differential pretrends by de-trending each series; I show below that the main qualitative result does
not depend on de-trending.36 To be concrete, the 2002 C-corporation data pointmeans that the average C-corporation in 2002 paid out 0​ .34​cents per dollar of its
lagged revenue, net of controls.
The figure shows that C-corporation and S-corporation payouts tracked eachother in the five years before 2003, suggesting that in the absence of a tax change thetwo series would have continued to track each other after 2003. Then ­immediately
after the dividend tax cut, C-corporation payouts spiked by ​20 percent​relative to
S-corporation payouts and relative to the 2002 difference, and remained elevatedabove S-corporation payouts through the end of the sample.
The first row of Table 4 columns 1–3 formalizes this visual evidence by replicating columns 1–3 of Table 2 for the scaled payouts outcome; Table 4 columns 4–6
report estimates for analogous regressions that allow for differential pre-2003 trends(see footnote 25). To test for a statistically significant increase immediately in 2003,
each column also reports coefficients from a separate regression that is analogous
to the main specification (1) except that it replaces the post-period indicators withindicators for each post-period year. That is, I estimate(3)	​PAYOUT​Si​  t​​  = ​α​1​​CCOR​Pi​  , t−2​​  + ​X​i, t−2​​β + ​YEAR​t​​γ+ CCOR​Pi​ , t−2​​ × YEA​Ri​ , t​​δ​  ,where ​CCOR​Pi,​ t−2​​  × YEA​Ri​ t​​​is a vector of six indicators for each year T​ ∈ { 2003​  ,​2004​  , ​2005​  , ​2006​  , ​2007​  , ​2008}​ , each equal to one if and only if ​t = T​and corporation i​​was a C-corporation in year t​​–​2​.37 The coefficient vector δ​ ​contains thecoefficients of interest: the effect of the tax cut on C-corporation payouts from thepre-period to each post-period year, net of the change in S-corporation payouts.
For brevity, Table 4 reports only the estimates I refer to in the main text; see online
Appendix Tables 8 and 9 for full results for the payouts outcome and the dividends-only outcome, respectively.

35
C and S-corporation payouts may be expected a priori to track each other in percentage terms because
S-corporation income tax liabilities are approximately a flat percentage of income, and a corporate finance tradition
conceives of firms paying out a set fraction of after-tax earnings (Lintner).
36
The C-corporation series has a slightly steeper downward trend, consistent with the well-documented twenty-year decline in dividend payments (Chetty and Saez 2005), combined with the fact that S-corporation dividends
include payouts intended to cover tax payments that need not have been in secular decline.
37
Columns 4–6 of Table 4 report estimates when an additional term—​CCOR​Pi,​  t−2​​  × t​—is included in the
regression in order to allow for differential pre-trends.

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Table 4—Effect of the 2003 Dividend Tax Cut on Total Payouts to Shareholders (Percent)Panel:

Unbalanced

Balanced

Unbalanced

Balanced

C-Corp × Post-2003

(1)

(2)

(3)

(4)

(5)

(6)

23.4
(3.6)

27.6
(3.3)

78.1
(8.0)

39.4
(7.3)

45.5
(6.5)

53.6
(15.1)

C-Corp × Year-2003

18.1
(4.3)
32.1
(5.2)
26.8
(5.8)

21.4
(4.1)
35.6
(5.0)
29.8
(5.5)
X

58.5
(8.8)
66.6
(11.4)
81.4(12.4)

26.2
(4.8)
43.3
(6.5)
41.2
(8.2)

30.5
(4.6)
48.3
(6.2)
46.0
(7.5)
X

45.1
(11.3)
48.8(10.4)
59.1(16.6)

X

X

X
X

333,029
73,1880.0031333,029
73,1880.0031

85,624
7,784
0.0061

C-Corp × Year-2004
C-Corp × Year-2005
Lagged controls
Firm FE’s
Pre-trend controls

X

Observations (firm-years)
Clusters (firms)
Pre-2003 C-corp mean($ per lagged revenue)

333,029
73,1880.0031333,029
73,1880.0031

85,624
7,784
0.0061

Notes: This table reports difference-in-differences estimates of the effect of the 2003 dividend tax cut on total payouts to shareholders (dividends plus buybacks). The first row of columns 1–3 use the same specifications, controls,
scaling, weights underlying Table 2 columns 10–12 except that before the winsorizing and in order to account forlarge level differences in pre-2003 payouts (see Table 1 and the y-axis of Figure 2, panel D), each firm i’s payouts in year t​​is divided by the mean level of payouts for ​i​’s corporate type (C or S) in the pre-2003 period, essentially transforming the comparison into percentage terms. The second through fourth rows of each column reportresults from a separate regression in which the C-corp × post-2003 interaction term is replaced with a vector ofinteractions between the C-corporation indicator and post-2003 year indicators; see online Appendix Table 8 foradditional reported coefficients. Columns 4–6 modify the specifications of columns 1–3 in order to allow for differential pre-2003 trends; see Section IVA for the specification and online Appendix Table 1 for analogous specifications for real outcomes. Standard errors are clustered by firm. See online Appendix 9 for results on the outcomeof dividends only.

Across all specifications and samples, I find a large and statistically significant
effect on C-corporation payouts. Column 2 reports that in the unbalanced panel withthe full set of controls, I estimate that the dividend tax cut caused an immediate ​21.5
percent​increase in C-corporation payouts in 2003, with a ​t​-statistic over ​5​  , ­implying
an elasticity of payouts with respect to one minus the top statutory dividend tax
rate of ​0.50​ (reported in online Appendix Table 8). The remaining columns reportsimilar or larger estimates when considering all years, when de-trending, and in thebalanced panel. Online Appendix Table 9 reports similar estimates for the outcomeof dividends only. I conclude that the 2003 dividend tax cut was immediately salient
and relevant to C-corporations.
B. Compatibility of the Payouts and Investment Results
Standard models of dividend taxation abstract from cash and debt and assume
that every dollar of increased payouts substitutes for a dollar of investment; thesignificant payouts effect may therefore appear at first glance incompatible with thenull investment result. However, the payouts effect was large in percentage terms
but small in dollar terms relative to all other balance sheet flows and the investment
effect’s standard error, so the results are consistent with a small dollar-for-dollar
reduction in investment, or with a mere reshuffling of corporate financial claims

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(e.g., a little less cash or a little more debt) and no reduction in investment.38 The
main relevance of the payouts result for this paper is that it validates the empiricaldesign and salience.
V. Economic Interpretation and Policy Implications

The previous sections documented that the 2003 dividend tax cut was immediately salient and relevant but had no detectable impact on investment or employeecompensation. This section considers reasons for the null investment result and asks
under what circumstances would future dividend tax cuts be expected to have large
and positive real effects. I begin by noting that a near-zero dividend tax elasticity
of investment implies either a small dividend tax elasticity of firms’ cost of capital,
or a small cost-of-capital elasticity of investment, or both. I then detail whether andwhy either elasticity would likely have been small and the implications for the realeffects of future alternative dividend tax reforms. The section ends with a discussionof the payouts response.
A. Economic Interpretation
The prediction that a dividend tax cut can substantially increase investment derives
from models that are referred to as representing the “traditional view” (Harberger
1962, 1966; Feldstein 1970; Poterba and Summers 1985). Traditional-view models
feature permanent dividend tax cuts and firms that finance marginal investmentswith newly issued equity.39 A dividend tax cut reduces firms’ cost of capital—thepretax rate of return required on marginal investments—because it reduces the taxes
that must be paid when profits are distributed to shareholders; this induces firms toraise new investment funds and increase investment.40
I now derive a quantitative traditional-view prediction for the elasticity of investment with respect to one minus the dividend tax rate (“the dividend tax elasticity
of investment”). I do so by multiplying a traditional-view parameterization of theelasticity of the cost of capital with respect to one minus the dividend tax rate (“thedividend tax elasticity of the cost of capital”) by empirical estimates of the elasticity
of investment with respect to the cost of capital (“the cost-of-capital elasticity ofinvestment”).
Desai and Goolsbee (2004) parameterize the workhorse traditional model(Poterba and Summers 1985) as follows. A C-corporation faces a cost of capitalequal tor___________________________     ​​  ,
	​​   (1 − ​τ​inc​​)​[(1 − ​τ​div​​)p + (1 − ​τa​ cg​​)(1 − p)]​
38
The standard error on the investment effect (Table 2, column 2) implies a 95 percent upper bound reduction
in investment of $​ 87,557​per C-corporation, while the payouts response (Table 4, column 2) implies a payouts
increase of $​ 59,922​per C-corporation.
39
Similar qualitative predictions obtain when firms finance investment with risky debt, since debt holders often
become equity holders after bankruptcy reorganization. Dai et al. (2013) formulate a related argument based on
financing constraints with similar predictions.
40
In terms of Tobin’s ​q​, ​q​always equals ​1​under the traditional view: the marginal dollar invested within thefirm generates the same after-tax return as outside options, and investment must rise after a dividend tax cut in orderto maintain q​ = 1​.

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where ​r​is the economy’s rate of time preference, ​​τinc​ ​​​is the corporate income tax
rate, ​τ​ ​div​​​is the tax rate applied to dividends and other payouts,41 ​p​is the share of
earnings paid out rather than retained, and ​​τa​ cg​​​is the effective tax rate on accrued
capital gains.42 The effective tax rate on accrued capital gains represents a combination of future payouts (taxed at ​​τ​div​​​), future realized capital gains (taxed at the statutory capital gains tax rate), and bequests (taxed at the estate tax rate). Based on theirreading of the literature, Desai and Goolsbee assume a payouts share of earnings
equal to 0​ .5​and an effective tax rate on accrued capital gains equal to one-quarterof the top statutory rate.43 Combining these parameters with the decrease in the top
statutory dividend tax rate from 44.7 percent to 20.8 percent yields an elasticity of
the cost of capital with respect to one minus the payout tax rate of −​ 0.411​. Hassettand Hubbard (2002) summarize the recent empirical literature as reaching a consensus range for the cost-of-capital elasticity of investment of ​−0.5​to ​−1.0​.44
Multiplying these elasticities together, one obtains a predicted range of the dividend tax elasticity of investment of 0​ .21​to ​0.41​. These predicted elasticities are 2.5 to
5 times as large as this paper’s estimated 95 percent confidence upper bound (​0.08​).
Hence, either the consensus range for the cost-of-capital elasticity of ­investment or
the parameterized tax elasticity of the cost of capital, or both, failed to materialize.
There is no obvious reason to believe that corporations would have been unusually unresponsive to cost-of-capital changes in the 2003–2008 time period. Fixedcosts to capital stock adjustment can temporarily mute investment responses to­cost-of-capital changes (Caballero, Engel, and Haltiwanger 1995), but the 2003
dividend tax cut was passed at the end of a cyclical downturn in investment, so
corporations are unlikely to have been particularly far from any positive investment
thresholds. The short-run supply of capital assets may be inelastic (Goolsbee 1998),
but this cannot explain the lack of a relative change (between C- and S-corporations)in investment expenditures (price times quantity, not just quantity).
There are at least three reasons that the true cost-of-capital elasticity of investment may be smaller than the Hassett-Hubbard consensus range. First, a large timeseries literature dating back to Eisner’s (1969, 1970) responses to Hall and Jorgenson(1967) finds small cost-of-capital elasticities of investment, and the newer estimatesthat underlie the modern consensus range employ reasonable but difficult-to-verify structural assumptions (e.g., Caballero, Engel, and Haltiwanger 1995). Second,
these newer estimates may reflect intertemporal substitution over short horizons(c.f. Caballero 1994 and Cummins, Hassett, and Hubbard 1994) or relaxation offinancing constraints (e.g., Zwick and Mahon 2014) that would apply, for example,

41

Most private C-corporation payouts are taxed at the dividend tax rate; see footnote 13.
Poterba and Summers allow r​ ​to depend negatively on p​ ​so that the required rate of return is lower for corporations that pay dividends, e.g., because regular dividends may have signaling value. Dividend-paying private
corporations tend to pay dividends frequently but in irregular amounts so I ignore this dependency here.
43
The top statutory capital gains rate equals approximately the top dividend tax rate of 20.8 percent; it is quantitatively irrelevant whether one uses this value or a five-percentage-points-higher pre-2003 rate.
44
The investment time horizon that these estimates are based on varies but a two-year-or-shorter horizon iscommon (e.g., Cummins, Hassett, and Hubbard 1994 and Caballero, Engel, and Haltiwanger 1995). Note that in
the very long run after adjustment to a new steady-state capital stock, measured elasticities of investment scaled bylagged tangible capital will be zero, but recall that this paper’s results hold even when scaling investment by pre2003 tangible capital (see online Appendix CII and online Appendix Table 5).
42

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to temporary accelerated depreciation but likely not to a dividend tax cut.45 Third,
there may be publication bias toward statistically significant empirical results (Cardand Krueger 1995) and such bias could have led to the publication of erroneously
large estimates.
Because this paper is fundamentally concerned with the effects of the dividend
tax cut, I proceed by taking as given the Hassett-Hubbard consensus range for the
cost-of-capital elasticity of investment and turning to why the dividend tax elasticityof the cost of capital could have been small and the implications for the real effects
of future alternative dividend tax cuts.
B. Policy Implications of a Small Cost-of-Capital Change
Explanations for why the large 2003 dividend tax cut could have caused asmall reduction in the cost of capital fall into either of two lines of reasoning:
traditional-view models are the wrong models, or traditional-view models are correct but the above parameterization is wrong. Each line of reasoning clarifies thecircumstances under which future dividend tax cuts would be expected to substantially increase investment
Wrong Model.—The leading alternative to the traditional view—called the “newview” (also called the “trapped equity view”; King 1977; Auerbach 1979; Bradford
1981)—can explain the null result on investment. New-view models feature firms
with profits from preexisting operations that are abundant enough to fund all profitable investment.46 Because those preexisting profits will ­inevitably be ­subject todividend taxes (whether paid out immediately, or retained for investment and paidout in the future), a permanent dividend tax cut increases the post-tax return on
investment by the same factor that it increases the opportunity cost of investment.47
Thus the new view predicts that a permanent dividend tax cut affects firm value but
does not affect the cost of capital and does not affect corporate investment.48
The policy implication of the new view is that dividend tax cuts typically do not
reduce firms’ cost of capital and thus are typically not useful tools for increasing
investment. The exception would be if a dividend tax cut today signaled that dividend tax rates would fall even further in the future. This is possible, though the45
In other words, cost-of-capital formulas could be misspecified in the sense that a unit reduction in the costof capital due to temporary accelerated depreciation affects investment more than a unit reduction due to other tax
changes.
46
Access to riskless debt generates similar results because interest payments are not subject to dividend taxes.
47
To see this in a simple riskless two-period setup in which all profits in the second period are paid out as dividends,
consider a new-view firm in a small-open economy that begins the first period with abundant past profits. It chooses
how much to retain for investment (equal to past profits minus dividend payouts) by equating the return on marginal
investment to the opportunity cost of that investment: ​(​1 − ​τ​DIV)​​ ​ ​(1 − ​τ​INC)​​ ​  f ′​(PASTPROFITS − PAYOUTS)​  = ​​ ​​​is the dividend tax rate, ​​τ​INC​​​is the business income tax rate, ​f ′( · )​is a concave gross profit(1 − ​τ​DIV)​​ ​  r​ , where ​​τDIV
function, and r​ ​is the fixed return available on outside investments. A reduction in the dividend tax rate increases
both sides of the equation by the same factor, inducing no change in optimal investment. In terms of Tobin’s ​q​, ​q​ isless than 1 in the new view by an amount that varies proportionally with one minus the dividend tax rate.
48
An anticipated dividend tax cut would induce an increase in investment before the tax cut, which Figure
2, panel A suggests did not happen. See Poterba and Summers (1985); Ayers, Cloyd, and Robinson (2002); andAuerbach and Hassett (2007) for evidence of effects on firm value.

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policy debate since 2003 has centered on keeping top dividend tax rates constant orincreasing them.49
Of course, even if the new view characterizes most firms, the traditional view
may characterize other firms (Auerbach and Hassett 2003; Dhaliwal et al. 2005),
especially start-ups that may be particularly reliant on external equity financing.
This paper’s main analysis sample contains many start-ups, but most firms are notyoung: the median firm age studied here is 22 years, and only 1 of the 100 mostvaluable publicly traded companies in the United States was founded since 2003.50
The implication would be that the effect of dividend tax cuts on the US capital stock
may grow large as start-ups (traditional-view firms) gradually replace mature (newview) firms over the very long run, but the near-term effect may be small because
mature firms dominate US production.
Wrong Parameterization.—An alternative explanation of the null investment
result is that the traditional view correctly models firms’ investment decisions andthat alternative dividend tax cuts can substantially reduce firms’ cost of capital andthereby increase investment, even if the 2003 dividend tax cut in this sample did not.
There are at least three distinct versions of this explanation. Considered together, theimplication is that it may be difficult for policymakers to implement an alternative
dividend tax cut that has substantially larger near-term effects.
First, the returns to new investment can take years to accrue in the form of higher
profits that can be paid out to shareholders, and a dividend tax cut reduces the costof capital for new investment only insofar as those payouts will be taxed at the new
low rate. The 2003 dividend tax cut originally carried an expiration date of 2009
before being extended to 2013 and then being made permanent at nearly the full rate
reduction (see Section IB). It is therefore possible that a dividend tax cut with no
initial default expiration date would have substantially reduced the cost of capital,
even if the 2003 dividend tax cut did not.51 In this case, modern democracies may
be unable to guarantee the permanence necessary for a dividend tax cut to substantially reduce firms’ cost of capital and thus increase investment. For example, theTax Reform Act of 1986 reduced the top personal income tax rate to 28 percent in1988 with no default expiration date, but the rate was subsequently raised to 39.6
percent in 1993. Looking globally, a majority of the G7 economies (Japan, Italy, theUnited States, and the United Kingdom) have substantially raised or lowered their
top dividend tax rates since 2003.52
Second and despite stock price evidence that the tax cut was unanticipated(Auerbach and Hassett 2007), perhaps C-corporations had been expecting to enjoy
low dividend taxes at some point in the future and thus had been investing at a49
In fact, the new view implies that reducing the dividend tax rate to a minimum conceivable rate could actually
reduce investment because dividend tax rates could then only rise (Korinek and Stiglitz 2009).
50
Inference on start-ups is also challenging because the counterfactual (e.g., perhaps not founding the company
in the first place) may be difficult to discern.
51
That is, with respect to the traditional-view parameterization, perhaps the assumed change in the dividend
tax rate was too large.
52
Japan lowered its top rate from 43.6 percent to 10 percent; Italy raised its top rate from 12.5 percent to 20
percent; and the UK raised its top rate from 25 percent to 36 percent (OECD 2012). These figures include average
subnational top rates.

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THE AMERICAN ECONOMIC REVIEW

december 2015p­ ermanently higher rate even before the tax cut.53 Under this candidate explanation,a future dividend tax cut would increase investment only if its magnitude exceeded
expectations or if it increased expectations of future cuts.
Third and although substantial corporate profits are subject to dividend taxation—
about $300 billion in 2008 and similar in magnitude to total taxable capital gains—it
is possible that most profits from private C-corporations escape dividend taxation
and are instead taxed as capital gains in corporate acquisitions, as bequests subject tothe estate tax, or not at all through various capital income exclusions.54 This would
imply that a future dividend tax cut could substantially increase near-term investment if the dividend tax base were substantially broadened, such as by lowering thedividend tax rate relative to the capital gains tax rate. However, there may be political impediments to doing so: US policymakers have historically kept tax rates ontaxable dividend income weakly greater than those on taxable capital gains, perhaps
because most Americans hold small portions of their assets in stocks relative to housing (Campbell 2006) and may be more receptive to low tax rates on capital gains.55
C. The Payouts Response
This paper shows that the 2003 dividend tax cut increased total corporate payouts. This increase was small in dollar terms and may have been irrelevant for real­outcomes (see Section IVB), but the effect is relevant for the study of corporate
finance and I now discuss its potential drivers and outline directions for future
research.
Traditional-view models do not explain the payouts response.56 A new-view
explanation of the payouts response is that firms viewed the tax cut as temporary
and thus engaged in intertemporal tax arbitrage by distributing payouts before tax
rates rise (Korinek and Stiglitz 2009). The time series of payouts provide one reason to doubt this mechanism: Figure 2, panel D and Table 4 suggest that payouts
did not decline substantially after 2004 when President Bush won reelection andhis party won control of both houses of Congress, which likely reduced expectations of a near-term rise in dividend taxes and hence incentives for immediate tax
arbitrage (Korinek and Stiglitz 2009).57 However, this is not conclusive because
expectations are not observable, because various concerns may govern the timingof ­tax-arbitraging payouts, and because of sampling and specification uncertainty.
53

That is, with respect to the parameterization, perhaps the assumed tax change was again too large.
That is, with respect to the parameterization, perhaps the assumed value of p​ ​was too large. Payouts canescape taxes if they are distributed in the form of bequested corporate equity below the estate tax threshold, if thecorporate stock is held in tax-favored investment accounts or by untaxed entities like pension funds (though this isunlikely for most private corporations), or if private C-corporations preparing to distribute earnings manage to meet
S-status requirements and switch tax status (though switching is relatively rare).
55
All forms of capital income accrue very disproportionately to high-income Americans, but Republican
lawmakers in 2003 explained that in contrast to cutting dividend taxes, “millions of Americans understand thepower of cutting the tax on capital gains” making low capital gains tax rates “easier to sell” (David Firestone, “AsBush Tax Plan Falters, Conservatives Find a Silver Lining,” New York Times, May 8, 2003, http://www.nytimes.
com/2003/05/08/us/as-bush-tax-plan-falters-conservatives-find-a-silver-lining.html).
56
The exception is the traditional-view model of Poterba and Summers (1985) which allows for a dividend tax
cut to immediately increase payouts (and investment) when payouts such as regular dividends carry signaling value.
This is unlikely to be relevant for the private corporations studied here.
57
The 2004 Democratic presidential challenger, John Kerry, pledged to repeal the tax cut for high-income
Americans and at one point was the front runner according to betting markets (Auerbach and Hassett 2007).
54

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Chetty and Saez (2010) show that the new view can explain the payouts increase asa permanent dividend tax cut causing dispersed shareholders to incur the monitoring
costs necessary to prevent wasteful investment by managers. This too is possible,
though such agency problems would be expected to be least severe among private
corporations, whose shareholders are typically concentrated.
Three under-emphasized mechanisms may instead explain the payouts response.
First, the dividend tax cut raised the value of C-corporation equity (Auerbach andHassett 2007), so owners of illiquid private C-corporation stock may have increased
payouts in order to rebalance their portfolios or to reoptimize consumption among
themselves and their heirs. Second, the dividend tax cut could have induced controlling owners to use payouts for their own liquidity, against the interests of minority
shareholders and similar to tunneling (Johnson et al. 2000). Third, high dividend
tax rates incent owner-managers to avoid or evade taxes by paying out earnings
as officer compensation or purchasing consumption goods through the corporation(Gordon and Slemrod 2000); the tax cut reduced the benefits of such behavior andmay have caused C-corporations to increase formally-labeled payouts. These effects
are observationally equivalent in the data available to me, but testing among thesevarious mechanisms is an interesting area for future research.
VI. Conclusion

The 2003 dividend tax cut was one of the largest changes ever to a US capitalincome tax rate and was intended to increase corporate investment and labor utilization, beginning in the near term. This paper used a large sample of tax returns fromlarge private corporations—some subject to dividend taxation (C-corporations) andothers not (S-corporations)—to test whether these real goals were achieved in a firm
size range that employs most US private sector workers. I estimate that the tax cut
caused no change in C-corporation investment or employee compensation relative
to S-corporations. Evidence of an immediate increase in payouts confirms salienceand relevance. External validity remains an open question, but neither broadening
the sample to include publicly traded corporations nor heterogeneity by firm size
suggests different out-of-sample results.
The findings contrast with evidence of large real effects of numerous other fiscal
policies. Economically, the null result implies either that the dividend tax cut had
little effect on firms’ cost of capital, or that investment responded to cost-of-capitalchanges substantially less than recent evidence would have predicted, or both. The
tax cut could have failed to reduce the cost of capital either because marginal investments are funded out of retained earnings and riskless debt as in “new-view” models
of dividend taxation (King 1977; Auerbach 1979; Bradford 1981) or because ofparticular features of the tax regime. Each potential mechanism suggests that it may
be difficult for policymakers to implement an alternative dividend tax cut that has
substantially larger near-term effects.
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CAPITAL TAX REFORM AND THE REAL ECONOMY:
THE EFFECTS OF THE 2003 DIVIDEND TAX CUTDanny Yagan
ONLINE APPENDIX

Online Appendix A: Variable De…nitions in Terms of Tax Return Line
Items
Section II.C listed economic de…nitions of all variables used in this paper. This appendix
de…nes variables in terms of line items on tax forms.
Investment equals the sum of Form 4562 lines 8, 14, 19a-19i column (c), 20a-20c column(c), and 21. Form 4562 is …led alongside either Form 1120 or Form 1120S in order to claim
investment depreciation deductions.
Tangible capital assets is reported on Form 1120 or Form 1120S Schedule L (balance sheet)column (d) line 10b.58
For C-corporations, employee compensation equals the sum of Form 1120 lines 13, 23, 24,
and Schedule A line 3. For S-corporations, employee compensation equals Form 1120S lines 8,17, 18, and Schedule A line 3.
For C-corporations, dividends equals the sum of Form 1120 Schedule M-2 lines 5a and 5c.
For S-corporations, dividends equals Form 1120S Schedule K line 17c. These …elds are sourcesof NIPA dividend aggregates.
Treasury stock is reported on Form 1120 Schedule L column (d) line 27 for C-corporations
or on Form 1120S Schedule L column (d) line 26 for S-corporations.
Total paid in capital equals the sum of the equity capital stock and additional paid-in capital.
Equity capital stock is reported on Form 1120 Schedule L column (d) line 22b for C-corporations
and Form 1120S Schedule L column (d) line 22 for S-corporations. Additional paid-in capital isreported on Form 1120 and Form 1120S Schedule L line 23. Note that these equity valuations
are book concepts.
Assets is reported on Form 1120 and Form 1120S Schedule L column (d) line 15 and includes …nancial assets (e.g. cash), inventories, tangible assets (e.g. investment purchases), andintangible assets (e.g. goodwill).
Revenue equals operating revenue and is reported on Form 1120 and Form 1120S line 1c;this excludes non-operating income such as gains from selling used capital goods.
Pro…t margin is the ratio of operating pro…t to revenue. For C-corporations, operating pro…tequals the sum of Form 1120 lines 1c, 12, 18, 19, 20, and 25, minus the sum of lines 2 and 27.
For S-corporations, operating pro…t equals the sum of Form 1120S lines 1c, 7, 13, and 14, minus
the sum of lines 2 and 20.
58
This excludes passive securities, inventories, depletable assets (e.g. oil deposits), land, and non-depreciableintangible assets (e.g. goodwill). Tangible capital assets is computed according to standard book accounting
practices and equals the purchase price of all investment goods currently in use by the corporation, less accumulated book depreciation (as opposed to accumulated tax depreciation, which is a¤ected by temporary accelerated
depreciation).

Cash equals the sum of column (d) lines 1, 4, 5, and 6 on Schedule L of Form 1120 or Form
1120S.
Debt equals the sum of column (d) lines 16-21 on Schedule L of Form 1120 or Form 1120S.
NAICS is reported on Form 1120 Schedule K line 2a and Form 1120S Schedule B line 2a.59
For C-corporations, incorporation date is reported on Form 1120 Box C. For S-corporations,
incorporation date is reported on Form 1120S Box E.
59

Corporations whose closest return to 2003 was …led before 1999 have 4-digit SIC classi…cations rather than
6-digit NAICS; I impute a 6-digit NAICS to each 4-digit SIC using the universe of corporations that …led tax
returns in both 1998 and 1999 and use the …rst two digits of this imputed 6-digit NAICS for 2-digit NAICS.

Online Appendix B: Reweighting
Section II.E verbally described the application of the reweighting method of DiNardo, Fortin,and Lemieux (DFL 1996) to ‡exibly control for any time-varying industry-…rm-size shocks.
DFL-reweighting is similar to matching but is less parametric. As mentioned in that section,
this reweighting does not drive the paper’s main results. This appendix speci…es the formulafor the …nal weight on every observation used in every table and graph.
DFL reweighting is useful when comparing outcomes across groups g (e.g. corporation types
and years) that di¤er along observable traits (e.g. the S-corporation sample has a larger shareof big construction …rms than the C-corporation sample). One wants to reweight the sample tohold “…xed” the distribution of observable traits across groups. To do so, one …rst divides allobservations into bins b according to the traits (e.g. small construction …rms, big construction…rms, etc.). Then one in‡ates or de‡ates weights in every group-bin so that the within-group
distribution of weights across bins equals the original cross-bin distribution of weights in somebase group g (e.g. C-corporations in 2002). For example, if the 1998 S-corporation grouphas relatively more big construction …rms than the 2002 C-corporation group, then the DFL
procedure will down-weight big construction …rms and up-weight small construction …rms in the1998 S-corporation group. In this way, DFL holds …xed the distribution of observable traits
across groups.
This paper’s main analyses (Figure 2, Table 2, and all appendix tables) compare outcomes
across corporation types and time, so I DFL-reweight across 22 (= 2 corporation types
11
years 1998-2008) groups g. I de…ne the base group g to be the 2002 C-corporation group. I
implement DFL-reweighting to control for any industry and …rm-size di¤erences; I therefore use
each observation’s two-digit industry and …rm size (revenue averaged over the preceding twolags) to bin it into one of 190 (= 19 two-digit industries 10 within-industry size deciles) bins b,
where the bins are de…ned using the within-industry size deciles of 2002 C-corporations. Recall
that in order to make the results dollar-weighted, each observation is initially weighted by its…rm size (revenue averaged over the preceding two lags); let sizej denote note this initial weight
on …rm-year observation j. Let b denote the bin and let g denote the group that observation jfalls in. The …nal weight w on observation j equals:P! P!
j 0 2b \ j 0 2g sizej 0
j 0 2g sizej 0
P(4)
wjbg = sizej P
j 0 2b \ j 0 2g sizej 0
j 0 2g sizej 0
where j 0 denotes …rm-year observations generally.
To explain the formula, note that the two parenthetical factors each equal 1 for every observation j that is in the base group g, so every observation in the base group has …nal weightequal to its size sizej . Every observation not in the base group has …nal weight that is smalleror greater than its size, depending on whether its bin is overrepresented or underrepresented inits group relative to the base group. The …rst parenthetical factor is the key factor: it ensuresthat within every group g, the ratio of the sum of …nal weights in an industry-size bin b (e.g.
top-decile construction …rms) to the sum of …nal weights in any other industry size bin b0 (e.g.
bottom-decile construction …rms) is identical to the corresponding ratio in the base group g.
The second factor ensures that
P the sum of
Peach group’s …nal weight equals the sum of that0group’s original weight (i.e.
w=
0
j 2g j bg
j 0 2g sizej 0 , 8g); without this factor, the procedure
would impose that the sum of each group’s …nal weight equals the sum of the base group’s

PP
original weight (i.e. j 0 2g wj 0 bg = j 0 2g sizej 0 , 8g) regardless of the relative size of that group’s
observations in the raw data.
This paper’s main heterogeneity analysis (Table 3) reports coe¢ cients from triple-di¤erence
regressions between corporation types (C vs. S), time period (pre-2003 vs. post-2003), and…rm trait rank (top quintile vs. bottom quintile). Hence for the regressions underlying thistable, I construct weights using equation (4) in which groups g denote one of 44 type-year-traitgroups (one for each corporation type, year 1998-2008, and top or bottom quintile), base groupg denotes 2002 top-quintile C-corporations, and industry-size bins b are de…ned according to
the within-industry size-decile distribution of top-trait-quintile C-corporations in 2002.60
Finally, this paper’s detailed …rm size heterogeneity analysis (Figure 3) reports coe¢ cientsfrom di¤erence-in-di¤erences regressions within each …rm size decile. Thus for the regressions
underlying these graphs, I construct weights using equation (4) in which groups g denote one of
220 type-year-decile groups (= 2 corporation types 11 years 1998-2008 10 …rm size deciles
where the deciles are de…ned over the pooled C-corporation sample), base group g denotes 2002
…fth-decile C-corporations, and bins b denote one of 19 two-digit industries. Corporations are
unweighted in Table 1, Figure 1, and Appendix Figure 1.
60

The exceptions are the triple-di¤erence regressions by …rm size, which can be reweighted only across 19
industry bins since the top and bottom …rm size quintiles of course do not overlap.

Online Appendix C: Additional Robustness Checks (results reported
in Online Appendix Tables 4-5)
Online Appendix Tables 1-3 and 7 replicate the paper’s primary results (reported in Table2) across four alternative sample frames, variable de…nitions, and speci…cations: allowing fordi¤erential pre-2003 trends, scaling by lagged revenue instead of lagged tangible capital or viceversa, restricting the analysis to years 1998-2004 only, and including all public corporations
that satisfy the paper’s sample restrictions other than being privately held, respectively. Thoserobustness checks are detailed in the text in Section III.B and III.F and in the notes to thosetables.
Online Appendix Tables 4-5 report results for additional robustness checks for the paper’s
main speci…cation. This appendix supplements the details listed in those tables’notes.
(C.i) Online Appendix Table 4
The paper’s main speci…cation is equation (1) estimated in the main analysis sample withthe paper’s standard set of controls: year …xed e¤ects, indicators for two-digit NAICS industry
classi…cation, and quartics in age, lagged revenue, lagged pro…t margin, and revenue growthfrom the second to the …rst lag. The estimated e¤ect of the 2003 dividend tax cut on corporate
investment in this main speci…cation is reported in Table 2 column 2. For easy reference, Online
Appendix Table 4 column 1 reprints Table 2 column 2.
Some corporations have foreign operations that yield special tax treatment. Online Appendix Table 4 column 2 repeats the main speci…cation on the main analysis sample excluding
corporations with an indication of foreign operations, de…ned as listing a positive foreign tax
credit on its t 2 tax return (Form 1120 Schedule J line 5a or Form 1120S Schedule K line 14l).
Some corporations, especially those managed directly by a small number of owners, may
relabel corporate income as o¢ cer bonuses, changing the tax treatment of that income. Column
3 repeats the main speci…cation on the main analysis sample excluding corporations with higho¢ cer compensation, de…ned as having a top-quintile value of o¢ cer compensation to revenue
in year t 2 following quintile de…nitions used in Section III.D.
The Tax Reform Act of 1986 altered incentives to operate as an S-corporation relative to a
C-corporation. Column 4 repeats the main speci…cation on the main analysis sample excluding
corporations with an incorporation date lying before 1986.
Because there are few extremely large S-corporations and all S-corporations are privately
held, the main analysis sample excludes corporations with lagged assets greater than $1 billion(or lagged revenue greater than $1.5 billion) and corporations that were ever publicly held
through the previous year. Column 5 repeats the main speci…cation on an analysis sample thatapplies no lagged asset or lagged revenue upper bound and applies no privately-held restriction
and thus includes all public corporations that could be matched to the SOI data and survive
the remaining sample restrictions.
Dividend-paying C-corporations may be expected to respond di¤erently from non-dividendpaying C-corporations. Column 6 repeats the main speci…cation on the main analysis sample
restricted to dividend-paying corporations, de…ned as those with a positive dividend in yeart 2.
Young corporations may be expected to respond di¤erently from older corporations, forexample if they are less able than older corporations to fund pro…table investments using retained
earnings (see Section V for theoretical motivation). Column 7 repeats the main speci…cation on
the main analysis sample restricted to young corporations, de…ned as those with bottom-quintile

age following quintile de…nitions used in Section III.D.
Salinger and Summers (1983) argued that …rm capital stocks estimated using recursions
on investment ‡ows are superior to annually reported capital stocks, and some in‡uential subsequent papers (e.g. Cummins, Hassett, and Hubbard 1994; Desai and Goolsbee 2004) scale
investment by such estimated capital stocks in their empirical analyses. Column 8 repeats
the main speci…cation on the main analysis sample except that the dependent variable (investment) is scaled by lagged Salinger-Summers-estimated capital stocks rather than lagged tangible
capital. To compute Salinger-Summers-estimated capital stocks, I follow Cummins, Hassett,and Hubbard (documented in their Appendix B) and Desai and Goolsbee (documented in their
Appendix A) by estimating the declining balance depreciation rate that is consistent with each…rm’s initial and terminal reported tangible capital assets under perpetual inventory accounting.
Speci…cally for each …rm i, I solve for i in the non-linear equation:
KiT = Ki0 (1Ti ) + Ii1 (1T 1+ ::: + Ii;T 1 (1i)

i ) + IiT

where Kit denotes tangible capital assets for …rm i in year t and where year 0 corresponds to the…rst year and year T corresponds to the last year observed in the SOI data for …rm i in years 19962008.61 Then for each …rm, I use the estimated ^i , actual annual values of investment Iit , andactual initial and terminal values of tangible capital assets Ki0 and KiT to estimate intermediate^ i1 ; :::; K^ i;T 1 . I then compute lagged tangible capital assets for eachtangible capital assets K…rm-year observation as in the main sample, using this estimated path of tangible capital assets^ i1 ; :::; K^ i;T 1 ; KiT rather than the actual reported path Ki0 ; Ki1 ; :::; Ki;T 1 ; KiT from theKi0 ; K
…rm’s annual balance sheet.
The DFL-reweighting used in the main speci…cation controls non-parametrically for di¤erences across C- and S-corporations along two dimensions known to predict investment behavior: …rm size and industry. Propensity-score matching is a more-parametric and less-datademanding weighting technique that permits ‡exible reweighting along many dimensions known
to predict investment behavior. Column 9 repeats the main speci…cation on the main analysis
sample with propensity-score matching following Dehejia and Wahba (2002) instead of DFL
reweighting.
Speci…cally, I implement a version of the caliper matching utilized in Dehejia and Wahba(2002) that permits easy comparison to this paper’s DFL weights and maintains the dollarweighting described in Online Appendix A. Speci…cally within each year, I estimate a probit
regression of the C-corporation indicator on quartics in the six traits used in Table 3— lagged
revenue, age, lagged revenue growth, lagged pro…tability, lagged cash as a fraction of lagged
total assets, and lagged leverage— along with two-digit industry and year …xed e¤ects and use
the resulting coe¢ cients to construct a propensity score for each …rm equal to the estimatedprobability that the …rm is in the treatment group (i.e. is a C-corporation) based on thosecontrols. Let bin bt denote the decile of the …rm-year’s propensity score, where each bin
bt 2 f1; 2; :::; 10g comprises …rm-year observations with a propensity score in the range [b=10:1; b=10]. I then up-weight or down-weight S-corporations within each bin bt so that the sumof …nal S-corporation weights in any bin bt equals the sum of …nal C-corporation weights inthat bin. For comparability to the …nal weights detailed in Online Appendix A, let group61
A solution to the non-linear equation was found for 99.9% of …rms; the remaining 0.1% are excluded from theregression underlying column 8. For the few instances in which a single …rm appears in multiple non-contiguous
sets of years 1996-2008, I estimate a separate depreciation rate for each set.

marker g equal the C-corporation indicator, and let g denote C-corporations. Then the …nal
propensity-score weight w on …rm-year observation j equals:
P
!
! P
0
size
0
j 0 2bt \ j 0 2g sizej 0j
Pj 2g
wjbt g = sizej P0sizejj 0 2bt \ j 0 2g
j 0 2g sizej 0Comparison of this equation to the equation (4) shows that these propensity-score weights di¤er
from the DFL weights in that more traits than just size and industry are used to construct thebins b. To ensure overlap within each propensity-score bin, I set to missing any observations jbt gwith no corresponding observations j 0 bt g 0 for j 6= j 0 and g 6= g 0 ; this sets only nine observations
to missing.
Finally and in a related vein, column 10 repeats the main speci…cation on the main analysis
sample with no reweighting (i.e. with weight wj = sizej , 8j). All speci…cations continue to yieldstatistically insigni…cant estimates of the e¤ect of the 2003 dividend tax cut on C-corporation
investment, except for one that yields a marginally signi…cant negative estimate.

(C.ii) Online Appendix Table 5
The paper’s main speci…cation (equation 1) follows the investment literature by scalingannual investment by lagged (averaged over the previous two years) tangible capital assets.
If C-corporations immediately adjusted to a higher steady state capital stock by making verylarge investments in 2003, investment divided by lagged tangible capital would not be elevatedafter 2004 when lagged capital would equal the new steady state— driving estimated e¤ects ofthe dividend tax cut on investment toward zero by construction.62 In practice, C-corporation
investment was unusually low immediately after the tax cut (see Online Appendix Table 3) andadjustment to new steady state capital stocks appears to take years due to adjustment costs(e.g. Auerbach and Hassett 1992). I nevertheless address such concerns in Online Appendix
Table 5 by repeating the paper’s main speci…cation when scaling investment by time-invariant
pre-2003 measures of …rm capital stocks.
Columns 2-6 repeat the paper’s main speci…cation on the main analysis sample, restricted to“…rm-era”observations (i.e. either the pre-2003 era or the post-2003 era) on …rms that are in mysample for a speci…c number of years around 2003 and computing investment as average annual
investment divided by pre-2003 lagged tangible capital. Speci…cally, each column corresponds
to a year radius S 2 f1; 2; 3; 4; 5g. For a given radius S, I restrict the pre-2003 subset of themain analysis sample to …rms with observations in all years [2003 S; 2002] and restrict the
2003-and-beyond subset to …rms with observations in all years [2003; 2002 + S]. I then estimate
equation (1) at the …rm-era level in which the scaled investment dependent variable for …rm iin era E 2 f0; 1g (referring to the pre-2003 era or the 2003-and-beyond era, respectively) equals
the …rm’s average annual investment in the era divided by the earliest lagged capital value in
62

In steady state with no technology growth, investment divided by lagged capital equals the depreciation
rate; taxes and other prices a¤ect only the scale of the steady state.

the era in this subset:
1S

IN V EST M EN Ti0 =IN V EST M EN Ti1 =SP

Ii;2003 s

s=1

1(Ki;2001 S + Ki;2002 S )2SP
1
Ii;2003+sS
s=1
1(Ki;2001 + Ki;2002 )2

where Iit and Kit denote the …rm’s investment and tangible capital assets in year t, respectively.63
For example, consider column 4, which uses radius S = 3. I restrict the pre-2003 subset of themain analysis sample to …rms with observations in all years 2000-2002, and I restrict the 2003and-beyond subset to …rms with observations in all years 2003-2005. I then condense pre-2003
observations to one observation per …rm with IN V EST M EN Ti0 = [(Ii2000 + Ii2001 + Ii2002 ) =3]=[(Ki1998 + Ki1999 ) =2] and condense post-2003 observations to one observation per …rm withIN V EST M EN Ti1 = [(Ii2003 + Ii2004 + Ii2005 ) =3]=[(Ki2001 + Ki2002 ) =2]. Because these speci…cations scale annual investment by pre-2003 measures of the …rm’s capital, any post-2003
increases in investment are not re‡ected in larger denominators. Relative to the paper’s main
result (reprinted in column 1), columns 2-6 report typically more negative and insigni…cante¤ects of the 2003 dividend tax cut on C-corporation investment.
63This di¤ers from the …rm-year observations in the main analysis sample in which IN V EST M EN Tit =Iit =[(Ki;t 1 + Ki;t 2 ) =2]. I do not require …rms to be present in both eras. The regression controls for the
standard set of lagged controls, de…ned over the same years as the earliest lagged capital.

Online Appendix D: Controlling for Contemporaneous Tax Changes(results reported in Online Appendix Table 6)
The paper’s identifying assumption is that C- and S-corporation outcomes would havetrended similarly in the absence of the 2003 dividend tax cut. As mentioned in Section I.B, accelerated depreciation allowances and small changes to other tax rates were enacted 2001-2003,
and these contemporaneous tax reforms could in principle have a¤ected C- and S-corporations
di¤erently enough to confound the paper’s quasi-experiment. Speci…cally, the Economic Growthand Tax Relief Reconciliation Act of 2001 (“EGTRRA”) instituted a gradual reduction in the
top federal individual ordinary income tax rate from 39.6% to 39.1% in 2001, 38.6% in 20022003, 37.6% in 2004-2005, and 35% in 2006. The Job Creation and Worker Assistance Act of2002 (“JCWAA”) instituted accelerated depreciation for equipment and light structures investment, allowing …rms to immediately deduct from their taxable income 30% of the purchase priceof eligible investment placed into service between September 11, 2001 and September 11, 2004.
The 2003 tax reform increased the accelerated depreciation allowance from 30% to 50% throughDecember 31, 2004, accelerated from 2006 to 2003 the reduction in the top individual ordinary
income tax rate to 35%, and reduced the top individual capital gains tax rate from 20% to 15%.
The Economic Stimulus Act of 2008 reinstated for 2008 the temporary accelerated depreciation
provisions of the 2003 tax reform.64
As detailed in Section III.E, the pre-2003 enactments of EGTRRA and JCWAA provide
reduced-form “placebo” tests for quantitatively important e¤ects of both accelerated depreciation and the change in the top ordinary income tax rate. The results of these tests suggest
no important violations of the identifying assumption. This online appendix details additional
tests that control for the e¤ects of these contemporaneous tax changes on investment incentives,
the results of which are reported in Online Appendix Table 6 columns 4-10. The controls barelychange the results. Econometrically, the reason is that the contemporaneous tax changes either (in the cases of accelerated depreciation and the capital gains tax rate) had similar e¤ects
on investment incentives for C-corporations and S-corporations or (in the case of the ordinary
income tax rate) a¤ected S-corporation incentives relative C-corporation incentives similarly
before and after 2003.
(D.i) Reduced-Form Controls for the E¤ects of Accelerated Depreciation
The temporary accelerated depreciation provisions of JCWAA and the 2003 tax reform havebeen found to have had quantitatively large e¤ects on investment (House and Shapiro 2008;
Zwick and Mahon 2014)— likely due to some combination of inducing substantial intertemporal
substitution (House and Shapiro) or substantially relaxing …nancing constraints (Zwick and
Mahon) in ways that the relatively small changes in the ordinary income tax rate and thecapital gains tax rate likely did not.65 Hence, temporary accelerated depreciation could be aparticularly quantitatively important confound. Below, I include structural controls for the64

EGTRRA was introduced into Congress in May 2001 and signed into law on June 7, 2001. JCWAA wasintroduced into Congress in October 2001 and signed into law on March 9, 2002. The Economic Stimulus Act
of 2008 was introduced into Congress in January 2008 and signed into law on February 7, 2008.
65
House and Shapiro argue that temporary accelerated depreciation induces especially large increases in investment because the intertemporal elasticity of investment approaches in…nity for in…nitely-lived capital goods.
Zwick and Mahon argue that the observed e¤ects of accelerated depreciation are inconsistent with intertemporal substitution alone but can be explained by a relaxation in …nancing constraints induced by accelerated
depreciation.

e¤ects of accelerated depreciation on investment incentives, but I …rst include reduced-form
controls for these e¤ects, with results reported in Online Appendix Table 6 column 4.
Corporations deduct the nominal cost of each investment purchase from their annual taxable
income in a series of annual deductions over an “asset life”(also known as a recovery period) that
depends on the durability of the investment property. For example, cars are assigned an asset
life of …ve years while warehouses are assigned an asset life of thirty-nine years. New purchasesof investment property with asset lives of twenty years or less were eligible for accelerated
depreciation, and within that eligible category, property with longer asset lives received greater
subsidies because of discounting (see e.g. House and Shapiro 2008). Thus to control ‡exibly forthe e¤ects of temporary accelerated depreciation across …rms with di¤erent asset life mixes, I
control for a very ‡exible function of each …rm’s asset life mix interacted with year …xed e¤ects.
Speci…cally, I use the itemized investment …elds of Form 4562 to construct two variables foreach …rm-year observation: ELIGIBLESHAREit equal to the share of …rm i’s investment overyears t 2 and t 1 with an asset life of twenty years or less, and M EAN ELIGIBLELIF Eit
equal to the mean asset life of …rm i’s investment over years t 2 and t 1 with asset life oftwenty years or less.66 I then construct a quartic in ELIGIBLESHAREit and a quartic in
M EAN ELIGIBLELIF Eit and fully interact those quartics together and also with year …xede¤ects, yielding a new 208-variable (= 4 4 13) vector of controls to include in the maininvestment speci…cation. These interactions ‡exibly absorb time-varying nonlinear e¤ects ofthese two variables on investment.
Column 4 displays the estimated e¤ect of the 2003 dividend tax on C-corporation investment
after controlling for this ‡exible vector of asset life controls. The addition of this vector ofcontrols barely changes the point estimate and con…dence interval. The econometric reasonsare straightforward. First, the main speci…cation is reweighted on two-digit NAICS industry
codes within each year, so cross-industry di¤erences were already ‡exibly controlled for. Secondand su¢ cient on its own, the distribution of asset lives of C-corporations and S-corporations
in my sample are nearly identical: the C-corporation means of ELIGIBLESHAREit andM EAN ELIGIBLELIF Eit are 85% and 6.05 years, while the S-corporation means are 84% and6.04 years, respectively, implying that accelerated depreciation subsidized investment similarly
for the two types of corporations.
(D.ii) Structural Controls for the Combined E¤ect of Contemporaneous Tax Changes(a) Primary speci…cation and inputs. Whereas column 4 ‡exibly controls for the e¤ect ofaccelerated depreciation only, columns 5-10 use the investment model of Auerbach and Hassett(1992, hereafter “AH”) to control for the combined e¤ect of contemporaneous changes in the
top individual ordinary income tax rate, the capital gains tax rate, and accelerated depreciation
on …rms’(user) cost of capital: the required pre-tax rate of return on marginal investments.
An extensive literature in the 1980s (e.g. Summers 1981; Abel 1982; Feldstein 1982; Auerbach and Hines 1987; Auerbach 1989) extended the canonical model of investment, taxes, andthe cost of capital (Hall and Jorgenson 1967) to encompass microfounded adjustment costs and66
More precisely, eligible property comprises property depreciable under the General Depreciation System(GDS) of the Modi…ed Accelerated Cost Recovery System with an asset life of 20 years or less. Property
required to be depreciated under the Alternative Depreciation System (ADS, typically property installed outside
the United States) was not eligible regardless of asset life, so the small fraction of investment depreciated under
ADS is not included in ELIGIBLESHAREit or M EAN ELIGIBLELIF Eit . I assume that the small fractionof investment expensed under Section 179 was eligible.

more features of the tax code. Linearizing from a …rm’s steady state and still ignoring certain
features of the tax code such as dividend taxation and tax loss asymmetries, AH solved for arepresentative …rm’s optimal investment path as a direct function of tax rates (rather than an
indirect function of the shadow price of capital “q”) in discrete time, applied it to aggregate
U.S. time series data, and reported estimates of adjustment costs and of cost-of-capital e¤ects on
investment that are useful in the present exercise. I now reprint AH’s key investment equationfor easy reference here, specify this paper’s empirical implementation which closely follows AH
and Cohen, Hansen, and Hassett (2002), and report the regression results.
AH consider a representative forward-looking value-maximizing U.S. …rm that smooths its
investment over time because of quadratic adjustment costs. AH derive the …rm’s optimal
investment rule in which investment is high relative to lagged capital assets when the present
year’s or immediately upcoming years’costs of capital are low relative to its steady-state value
and when the …rm’s capital stock is low relative to its steady-state value. Speci…cally, optimal
investment approximately equals:
(4)

It
=
Kt 1

1

1

+n+ t

1

1

cK

Et

1
P

ws t cs (Kt 1 )s=twhere It denotes investment in year t, Kt 1 denotes the lagged tangible capital stock,isa measure of the curvature of the production function, n is the trend growth-rate of totalfactor productivity, the terms ws t are geometrically declining weights that sum to one andare a function of adjustment cost parameters, 1 is a function of adjustment cost parameters,t denotes the stochastic year-t depreciation rate with E ( t ) = , cK denotes the steady-statevalue of the summation, and cs denotes a measure of the cost of capital for investment purchases
made in year s:sg(1+ + s+1
s)
1 s
cs =
biz )
(1
s
s
where bizs denotes the business income tax rate in year s, g denotes the relative price of capital
goods, s denotes stochastic productivity in year s, is the discount rate applied to the …rm’s
risky cash ‡ows, and s denotes the present-value of tax savings from depreciation deductions
Dz s per dollar of investment:
(5)

s =

1
P

z=s

(1 + r) (z s)bizz Dz swhere r equals the economy’s risk-free rate of return.67 AH focus on C-corporations, so biz
s in
AH’s empirical implementation refers to the corporate income tax rate. As in AH, let “costof capital” COCt refer to the summation term, which isPa weighted average of current and future capital costs for a given steady state: COCt = Et 1
s=t ws t cs (Kt 1 ) . AH parameterize
the future stream of costs of capital for each year t in 1953-1988, estimate the best-…t rate ofgeometric decline in weights ws t for aggregate equipment investment and separately for aggregate structures investment, and estimate equation (4) for equipment investment and separately
for structures investment by regressing aggregate investment as a share of lagged capital on aconstant and on the cost of capital.
67

I omit the investment tax credit from equation (5) since that has long since been repealed.

In Online Appendix Table 6, I repeat the paper’s main speci…cation on the main analysis
sample while controlling additionally for the two potential …rm-year-level omitted variables
illuminated by equation (4): the cost of capital encompassing all taxes except for dividend
taxes (COCit , which varies by …rm-year according to the corporation type, tax regime, and…rm’s asset mix) and the depreciation rate ( it , which varies by …rm-year according to the …rm’s
asset mix). I compute each …rm-year’s cost of capital COCit equal to the AH cost of capital
COCt , averaged over the …rm’s asset mix and under the …rm type’s business income tax rate:(6)

COCit = Et

1 PP

s=t a2Aa aait ws t cccorp(i);s (Ki;t 1 )where ccorp(i) denotes whether …rm i is a C-corporation and where a denotes an asset life
category within the full set of asset life categories A.68 I follow Cohen, Hansen, and Hassett(2002, hereafter “CHH”) in computing asset-life-speci…c costs of capital, which I then weight byeach …rm’s asset life mix. Speci…cally, the cost of purchasing a dollar of asset type a in year s
equals:aa
ccorp(i);saa+ ccorp(i);s+1
1g
ccorp(i);t +ccorp(i);s1 accorp(i);sacccorp(i);s =biz
1isccorp(i);swhere biz
ccorp(i);s equals the expected (at time t) corporate income tax rate in year s if i is a
C-corporation and equals the expected top individual ordinary income tax rate in year s if i isan S-corporation, accorp(i);s equals as (equation 5) under the corresponding set of biz
ccorp(i);z valuesaand under the depreciation schedule for property of asset type a,equals the …xed economic
depreciation rate of property in asset type a, and ccorp(i);t (following CHH’s extension of AH)
is a weighted average of required rates of return on debt and equity:
32
biz(r + ) 1
ccorp(i);tre + acg
t
5
4
+ 1 b
acg
ccorp(i);t = b
ord
1
1
t
t

where b is the average debt share of enterprise value, denotes the in‡ation rate, ord
denotest
ethe top individual ordinary income tax rate, r equals the rate of return on equity, and acg
tequals the tax rate on accrued capital gains. The weight wsa t refers to either an equipment
weight or a structures weight, depending on asset type a. Asset life share ait equals the shareof …rm i’s total investment across years t 2 and t 1 that was in asset category a.69
I follow CHH as closely as possible in parameterizing equation (6).70 Speci…cally, I follow
CHH in assuming b = :4, r = :025, = :03, and re = :1 and computing biz
ccorp(i);s as equal to 1.3
times the statutory top business income tax rate (either corporate income tax rate or ordinary
68

See Online Appendix D.i for a description of asset lives.
In years with accelerated depreciation, I impute accelerated depreciation allowances pro-rata to eligible
investment categories. Investment in these and other GDS investment categories constitute the vast majority
of investment in my sample. Because …ve years is the modal GDS asset life, I assume that the small share ofinvestment expensed under Section 179 or as listed property has an asset life of …ve years. Because ADS asset
lives are typically a few years longer than the properties’corresponding GDS asset lives, I assume that the small
share of investment in the ADS class life category has an asset life of nine years.
70
I thank Kevin Hassett for kindly providing template code from CHH.
69

income tax rate) in order to account for inventory tax penalties.71 I further follow CHH byusing depreciation schedules for each asset type a assuming the half-year convention as reported
in IRS Publication 946 and in assuming that the level-shifter g (Ki;t 1 ) = is equals unity.72 I
depart from CHH in areas necessary to conform to conventions used in the main text: I use
state-plus-federal tax rates rather than just federal tax rates and (as in Desai and Goolsbee
2004) I assume that the tax rate on accrued capital gains equals one-quarter the statutory rate
rather than the full statutory rate.
Finally and in addition to the …rm-year-level asset life weights ait de…ned above, I extend
CHH by constructing asset-life-speci…c depreciation rates, de…ning equipment investment andstructures investment in terms of asset lives, and specifying a reasonable and minimally complicated path of tax rate expectations for this analysis. For each asset type a, I assign an economic
depreciation rate a equal to 47.3% of the best-…t non-accelerated-depreciation tax depreciation
rate for that asset type.73 I compute the …rm-year-level economic depreciation rates it equal
to the average across economic depreciation rates a , weighted by the …rm’s asset-life weights:
P a a
it =
it
a2A

I use AH’s main equipment weight estimates (declining at rate :583) for asset lives of less thanten years and AH’s main structures weight (declining at rate :95, indicating higher adjustment
costs) for asset lives of ten years or more.74 I follow AH in assuming that terminal tax rates(year-2008 in this sample) are expected to last forever whereas temporary accelerated depreciation is not. Except for terminal tax rates, I assume that tax reforms come as a surprise when
legislated and are expected to be enacted as legislated.75
This paper’s cost-of-capital measure is similar in both levels and in estimated investmente¤ects to earlier work. This paper’s overall mean level of the cost of capital is 0:24, compared
71

Reducing in‡ation and other rates to re‡ect the lower interest rate environment of the 2000s changes little,
as does ignoring the inventory adjustment.
72
This latter simpli…cation is without loss of generality in the empirical analysis to the extent that productivity
shocks are at the industry-year level and is shown below to have an evidently minor e¤ect on both the levels
and the observed investment e¤ects of the cost of capital. This has the advantage of avoiding strong production
function assumptions such as those adopted and rejected empirically by AH (p.154).
73
House and Shapiro (2008, Appendix Table 2) assign economic geometric depreciation rates from Fraumeni(1997) to many types of investment. These economic depreciation rates are on average 47.3% of the corresponding
best-…t geometric depreciation rate— re‡ecting the fact that economic depreciation is slower than tax depreciationin the United States even without accelerated depreciation (Auerbach 1989; House and Shapiro). In regressionsof investment divided by lagged capital on the estimated economic depreciation rate of the …rm’s asset life mix
it , I obtain a very signi…cant coe¢ cient with magnitude close to one as would be expected near steady state,providing validation for these economic depreciation rates.
(s t+1)
74
That is, wsa t = (1=:583 1) (1=:583)(see AH Table 2 column 1) for asset types with lives less than(s t+1)ten years and wsa t = (1=:95 1) (1=:95)
for other asset types (see AH Table 3 column 1). In the property
classi…cations of Publication 946, light structures predominate beginning with asset lives of approximately 10
years (House and Shapiro).
75
For example, the analysis makes the following assumptions. Firms before year 2001 expected pre-2001 tax
rates to last forever. Firms in 2001 and 2002 expected the individual ordinary income tax rate to decline gradually
through 2006 as legislated in 2001, were surprised when the 2003 tax reform accelerated that decline, and expected
these declines to last forever. Firms were surprised when JCWAA introduced accelerated depreciation, whenthe 2003 tax reform expanded it, and when the Economic Stimulus Act of 2008 reinstated it. Firms in years
2002-2004 expected accelerated depreciation to be repealed beyond 2004 as legislated, and …rms in year 2008
expected it to be repealed beyond 2008 as legislated.

to AH’s mean of 0:21 (reported on AH p.153). At the asset-type-year level, this paper’s cost ofcapital measures are similar to CHH’s (reported in CHH Table 2). Finally, the estimated e¤ectof the cost of capital on investment as a share of lagged capital in this paper (i.e. the coe¢ cienton the cost of capital in the regression underlying Online Appendix Table 6 column 7, detailed
below) equals 0:457, which is larger in magnitude and not signi…cantly di¤erent from theaverage of AH’s estimates of 0:253 for equipment investment and 0:045 for (quantitatively
much less important) structures investment.
(b) Primary results. Online Appendix Table 6 column 7 repeats this paper’s main investment
speci…cation on the main analysis sample with controls for the e¤ects of contemporaneous nondividend-tax changes speci…ed above: the cost of capital COCit and the depreciation rate it .
Relative to the paper’s main results (reprinted in column 1), these controls have almost noe¤ect on the point estimate and standard error. Column 8 controls for a quartic in the cost ofcapital rather than just linearly, with very similar results. Columns 5-6 show the same whencontrolling only for the depreciation rate or only for the cost of capital.76
Econometrically, the coe¢ cient on the cost of capital in the regression underlying column 7 issubstantial and negative (mentioned above), but the cost of capital is largely uncorrelated withthe key interaction term (between the C-corporation indicator and the post-2003 indicator).
Thus the omission of the cost of capital from the main speci…cation induces little omitted
variables bias. Economically, the cost of capital variable is conditionally uncorrelated with theinteraction term because accelerated depreciation and the capital gains tax rate reduction had
similar e¤ects on the cost of capital for C- and S-corporations and because the reduction in
the top individual ordinary income tax rate reduced S-corporations’cost of capital by similar
magnitudes both before and after 2003. I explained in Online Appendix D.i why accelerated
depreciation had similar e¤ects across C- and S-corporations. The capital gains rate a¤ects
C- and S-corporations similarly via the discount rate ccorp(i);t . The legislated path of top
ordinary income tax rate reductions immediately lowered S-corporations’cost of capital because
economic depreciation is slower than tax depreciation, shown analytically in the very similar
setup of Auerbach (1989 Section 3B).
(c) Extended cost-of-capital speci…cation and results. This appendix’s primary results implement a close analogue of AH’s original empirical analysis in ignoring e¤ects of contemporaneous
tax changes on steady-state values of the cost of capital and the …rm’s capital stock when computing the cost of capital control COCit . This omission need not be innocuous a priori: forexample, temporarily low costs of capital under accelerated depreciation could in principle haveinduced …rms to overshoot their target steady-state capital stocks by the end of 2004, implying
unusually low investment in 2005 in spite of a lower value of COCit for S-corporations relative
to the pre-2003 period. Thus as an extra precaution though under strong assumptions, I extend AH’s production function assumptions in order to account empirically for the expected
path of capital stocks for C-corporations and S-corporations in an “extended” measure of thecost of capital EXT EN DEDCOCit and control for this extended measure in the paper’s main
speci…cation.
76

When failing to control for the omitted variable it , the coe¢ cient on COCit is mechanically biased toward
one, since …rms specializing in long-lived capital obviously have lower investment rates (see equation 4). Controlling for it yields a negative coe¢ cient on COCit as expected. AH control for economic depreciation rates
by running separate regressions for each asset type (equipment and structures).

AH’s investment rule (equation 4) characterizes the law of motion of a representative …rm’s
capital stock given adjustment costs, technology, and a path of tax rates: the …rm increases its
capital stock Kt 1 on net if and only if the current capital
P1 stock and the current and near-term
capital costs are su¢ ciently low (i.e. if and only if Et s=t ws t cs (Kt 1 ) < ct (Kt ) ) and to adegree that depends on the adjustment costs ( 1 ) and the curvature of the production function( ). I therefore consider a representative C-corporation and a representative S-corporation (eachwith a corporation-type-speci…c asset life mix, averaged over the corporation type’s observations
1998-2008) that was at its steady state in years 1998-2000, before the tax reforms consideredhere. Assuming = :5 (the midpoint of the feasible range) and solving for the 1 consistent with
= :5 and AH’s cost of capital coe¢ cients, I compute the estimated path of each representative77^ ccorp(i);t and steady state capital stock K^
corporation-type’s capital stock K
I thenccorp(i);t .
compute EXT EN DEDCOCit as the main cost of capital COCit ; multiplied by a steady statefactor indicating how much the current cost of capital and capital stock deviate from theirsteady-state values:
10^ ccorp(i);t 1
KA
EXT EN DEDCOCit = COCit @^COCit Kccorp(i);tThis equals one in steady state and is less than one when the …rm’s cost of capital is su¢ ciently
low relative to its steady value or when the …rm’s capital stock is su¢ ciently low relative to its
steady state value.
Online Appendix Table 6 columns 9-10 report results for the estimated e¤ect of the dividend
tax cut on investment when controlling for EXT EN DEDCOCit , instead of controlling for
COCit as in columns 7-8. The results change very little. Econometrically, the reason is that
EXT EN DEDCOCit does not di¤er tremendously from COCit . Economically, the reason isthat AH’s estimates (and a large but contentious literature) imply that adjustment costs aresubstantial, inducing substantial investment smoothing and thus no capital stock overshootingthat could make EXT EN DEDCOCit substantially di¤erent from COCit over time.
As a …nal discussion, note that the placebo test results from Section III.E (indicating that
S-corporation investment did not rise signi…cantly relative to C-corporation investment in years
2001-2002) may appear to con‡ict with the result from this cost-of-capital exercise that thecost of capital has a negative e¤ect on investment and in which S-corporations’cost of capitalfell relative to C-corporations’ 2001-2002. In fact, the 95% con…dence interval lower bounds
on the placebo tests are consistent with sizeable cost-of-capital e¤ects on investment given therelatively small change in the cost of capital for S-corporations relative to C-corporations 20012002. Alternatively and due to frictions not present in standard models like AH, it is possiblethat investment responds more to accelerated depreciation (e.g. due to …nancial frictions as
in Zwick and Mahon 2014) than to small changes in business income tax rates (e.g. due to
optimization frictions as in Chetty 2012). By this alternative account, the zero result in the77

AH report that the value of implied by their empirical results exceeds the feasible range [0; 1] and statistically rejects the value (zero) implied by constant returns to scale. For AH’s production function F (K) = AK 1biz
and steady-state Euler equation F 0 (Kt ) =+ (1where ( )t denotes an exepctedt ) g= 1t
steady state value as of year t, the …rm’s steady state targeted capital stock grows between year t 1 and t
1=
1=
biz
biz
by factor 1= 1
1. This year-on-year growth factor is all that istt)
t 1
t 1 = (1needed to compute the time path of each corporation type’s capital stock in this exercise.

placebo test is unsurprising given that the 2001-2002 cost-of-capital reduction for S-corporations
was driven by the relatively small change in S-corporations’ business income tax rate rather
than by accelerated depreciation. Distinguishing between these explanations is left to future
work. Regardless, none of the tests reported in Online Appendix 6 suggests that the paper’s
main estimate of the e¤ect of the dividend tax cut on investment is confounded by e¤ects ofcontemporaneous tax changes.

References Used Only in the Online Appendix
Abel, Andrew B. 1982. “Dynamic E¤ects of Permanent and Temporary Tax Policies in a q
Model of Investment.”Journal of Monetary Economics, 9: 353-373.
Auerbach, Alan J. 1989. “Tax Reform and Adjustment Costs: The Impact of Investment on
Market Value.”International Economic Review, 30(4): 939-962.
Auerbach, Alan J., and James R. Hines. 1987. “Anticipated Tax Changes and the Timingof Investment.” In The E¤ects of Taxation on Capital Accumulation, ed. Martin Feldstein,163-200. Chicago: University of Chicago Press.
Feldstein, Martin. 1982. “In‡ation, Tax Rules, and Investment: Some Econometric Evidence.”In In‡ation, Tax Rules, and Capital Formation, ed. Martin Feldstein, 243-286. Chicago:
University of Chicago Press.
Salinger, Michael and Lawrence H. Summers. 1983. “Tax Reform and Corporate Investment: A Microeconometric Simulation Study.”In Behavioral Simulation Methods in Tax Policy
Analysis, ed. Martin Feldstein, 247-288. Chicago: University of Chicago Press.
Summers, Alan J. 1989. “Taxation and Corporate Investment: A q-Theory Approach.”
Brookings Papers on Economic Activity, 1981(1): 67-140.

ONLINE APPENDIX TABLE 1
Effect of the 2003 Dividend Tax Cut on Investment, Net Investment, and Employee Compensation
Allowing for Differential Pre-2003 Trends
A. Investment
Investment

Dependent variable:
Dep. var. winsorized at:Panel:

C-Corp × Post-2003th

95 percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(1)
(2)
(3)
-0.0123(0.0124)-0.0157(0.0119)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)-0.0600(0.0278)

99th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(4)
(5)
(6)
-0.0213(0.0196)-0.0255(0.0191)X-0.2278(0.0810)

X
X

X

R2

333,029
73,1880.01

333,029
73,1880.07

85,6247,784
0.53

333,029
73,1880.01

333,029
73,1880.05

85,624
7,784
0.55

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.24280.25140.24280.25140.29390.30700.28280.41810.28280.41810.36820.6478-0.12[-0.35, 0.11]-0.15[-0.37, 0.07]-0.47[-0.9, -0.04]-0.17[-0.49, 0.14]-0.21[-0.52, 0.1]

-1.43[-2.43, -0.43]

Implied ε wrt (1-τdiv)

B. Net Investment and Employee Compensation
Net Investment

Dependent variable:
Dep. var. winsorized at:Panel:

C-Corp × Post-2003

0.0246(0.0124)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)

Employee compensation

95th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(7)
(8)
(9)
0.0217(0.0119)-0.0463(0.0348)

95th percentile
Unbalanced
Balanced($ per lagged revenue)($ per 96-97 rev.)
(10)
(11)
(12)
0.0054(0.0057)

X

0.0044(0.0047)

0.0034(0.0061)

X
X

X

R2

333,029
73,1880.01

333,029
73,1880.04

85,6247,784
0.20

333,029
73,1880.00

333,029
73,1880.37

85,624
7,784
0.88

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.04210.2541

0.04210.25410.08850.27320.16470.14150.16470.14150.17270.14501.35[0.01, 2.69]

1.20[-0.09, 2.48]-1.21[-2.99, 0.58]

0.08[-0.08, 0.23]

0.06[-0.07, 0.19]

0.05[-0.12, 0.21]

Implied ε wrt (1-τdiv)

Notes: This table replicates Table 2 except that it allows for differential pre-2003 trends by including an interaction between the
post-2003 indicator and a year variable, as well as interacting the C-corporation indicator and the C-Corp × Post-2003
interaction with the year variable. The reported coefficient equals the estimated effect of the tax cut averaged over the post2003 period, equal to the coefficient on the C-Corp × Post-2003 interaction plus 2005.5 times the coefficient on the C-Corp ×
Post-2003 × year interaction, since 2005.5 is the mid-point of the post-2003 period. See the notes to Table 2 for additional
details.

ONLINE APPENDIX TABLE 2
Effect of the 2003 Dividend Tax Cut on Investment, Net Investment, and Employee Compensation
Alternative Scalings
A. Investment
Investment

Dependent variable:thDep. var. winsorized at:Panel:

95 percentile
Unbalanced
Balanced($ per lagged revenue)($ per 96-97 rev.)
(1)
(2)
(3)

99th percentile
Unbalanced
Balanced($ per lagged revenue)($ per 96-97 rev.)
(4)
(5)
(6)

C-Corp × Post-2003-0.0022(0.0005)-0.0036(0.0007)-0.0021(0.0004)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)-0.0002(0.0012)-0.0033(0.0007)X-0.0005(0.0017)

X
X

X

R2

333,029
73,1880.01

333,029
73,1880.16

85,6247,784
0.64

333,029
73,1880.01

333,029
73,1880.13

85,624
7,784
0.63

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.02430.03220.02430.03220.03190.04090.02920.05240.02920.05240.03680.0602-0.21[-0.3, -0.12]-0.20[-0.28, -0.12]-0.01[-0.19, 0.16]-0.29[-0.4, -0.17]-0.26[-0.37, -0.16]-0.03[-0.24, 0.18]

Implied ε wrt (1-τdiv)

B. Net Investment and Employee Compensation
Net Investment

Dependent variable:

Employee compensation

Dep. var. winsorized at:Panel:

95th percentile
Unbalanced
Balanced($ per lagged revenue)($ per 96-97 rev.)
(7)
(8)
(9)

C-Corp × Post-2003-0.0001(0.0003)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)-0.0001(0.0003)-0.0007(0.0012)95th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(10)
(11)
(12)
-0.0103(0.1076)X-0.0538(0.0949)

0.1570(0.1564)

X
X

X

R2

333,029
73,1880.01

333,029
73,1880.05

85,6247,784
0.23

333,029
73,1880.02

333,029
73,1880.18

85,624
7,784
0.90

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.00250.02620.00250.02620.00740.02803.1821
3.9833

3.1821
3.98332.87413.6007-0.13[-0.75, 0.49]-0.11[-0.7, 0.48]-0.23[-0.94, 0.49]-0.01[-0.16, 0.15]-0.04[-0.17, 0.1]

0.13[-0.12, 0.37]

Implied ε wrt (1-τdiv)

Notes: This table replicates Table 2 except that outcomes that were scaled by lagged tangible capital are now scaled by lagged
revenue, and vice versa. See the notes to that table for details.

ONLINE APPENDIX TABLE 3
Effect of the 2003 Dividend Tax Cut on Investment, Net Investment, and Employee Compensation
Years 1998-2004 Only
A. Investment
Investment

Dependent variable:
Dep. var. winsorized at:Panel:

C-Corp × Post-2003th

95 percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(1)
(2)
(3)
-0.0145(0.0053)-0.0136(0.0051)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)-0.0256(0.0235)

99th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(4)
(5)
(6)
-0.0312(0.0085)-0.0299(0.0083)

X-0.1467(0.1204)

X
X

X

R2

232,787
63,0480.01

232,787
63,0480.07

54,488
7,784
0.52

232,787
63,0480.01

232,787
63,0480.05

54,4887,784
0.50

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.24280.25140.24280.25140.29390.30700.28280.41810.28280.41810.36820.6478-0.14[-0.24, -0.04]-0.13[-0.22, -0.03]-0.20[-0.56, 0.16]-0.26[-0.39, -0.12]-0.24[-0.38, -0.11]-0.92[-2.4, 0.56]

Implied ε wrt (1-τdiv)

B. Net Investment and Employee Compensation
Net Investment

Dependent variable:
Dep. var. winsorized at:Panel:

C-Corp × Post-2003-0.0050(0.0052)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)

Employee compensation

95th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(7)
(8)
(9)
-0.0040(0.0050)-0.0312(0.0146)

95th percentile
Unbalanced
Balanced($ per lagged revenue)($ per 96-97 rev.)
(10)
(11)
(12)
-0.0040(0.0024)X-0.0035(0.0020)0.0041(0.0052)

X
X

X

R2

232,787
63,0480.02

232,787
63,0480.05

54,4887,784
0.23

232,787
63,0480.00

232,787
63,0480.37

54,488
7,784
0.91

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.04210.2541

0.04210.25410.08850.27320.16470.14150.16470.14150.17270.1450-0.27[-0.83, 0.28]-0.22[-0.76, 0.32]-0.82[-1.56, -0.07]-0.06[-0.12, 0.01]-0.05[-0.1, 0.01]

0.05[-0.08, 0.19]

Implied ε wrt (1-τdiv)

Notes: This table replicates Table 2 except that it restricts the sample to years 1998-2004 only. See the notes to that table fordetails.

ONLINE APPENDIX TABLE 4
Effect of the 2003 Dividend Tax Cut on Investment
Alternative Sample Frames, Variable Definitions, and Reweighting

Excludingcorporations
Excludingwith highcorporations No firm-size orofficerfounded before publicly traded
compensation
1986
restriction
(3)
(4)
(5)

No variation(reprinted from
Table 2 column
2)(1)

Excludingcorporations
with foreign
operations(2)

C-Corp × Post-2003-0.0002(0.0042)-0.0005(0.0043)0.0015(0.0044)-0.0010(0.0110)N (firm-years)
Clusters (firms)

R2

333,029
73,1880.07

318,899
72,2530.07

275,72964,081
0.06

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.24280.25140.24410.25620.00[-0.08, 0.08]

0.00[-0.08, 0.08]

Variation:

Implied ε wrt (1-τdiv)

Scaling
investment by
SalingerPropensitySummers
score matching(1983) capital instead of DFLstocks
reweighting No reweighting
(8)
(9)
(10)

Restricting todividendpaying
corporations(6)

Restricting toyoung
corporations(7)-0.0247(0.0125)-0.0095(0.0059)-0.0251(0.0169)0.0010(0.0044)0.0032(0.0055)

0.0019(0.0040)

117,72132,3590.08

368,383
78,4800.10

131,31334,8320.07

61,782
23,008
0.09

332,756
73,0980.06

333,020
73,1870.06

333,029
73,1880.06

0.23850.24550.26550.30970.21580.19540.22770.21330.28050.33340.25520.26550.23950.2476

0.23790.24300.01[-0.07, 0.1]

-0.01[-0.2, 0.18]-0.27[-0.53, 0]-0.10[-0.21, 0.02]-0.21[-0.48, 0.07]

0.01[-0.07, 0.09]

0.03[-0.07, 0.13]

0.02[-0.06, 0.09]

Notes: This table reports results from repeating the paper's main investment regression specification (underlying Table 2 column 2) under alternative sample frames, variable definitions, andreweighting not already considered in Online Appendix Tables 1-3. For easy reference, column 1 reprints Table 2 column 2; see the notes to that table for specification details. The remainingcolumns replicate this main specification except for the variation specified in the column heading. Column 2 excludes corporations with an indication of foreign operations (defined asreceiving a positive foreign tax credit in year t-2 ). Column 3 excludes corporations with high officer compensation (defined as having a top-quintile value of officer compensation divided byrevenue in year t-2 ). Column 4 excludes corporations founded before the Tax Reform Act of 1986. Column 5 removes the paper's firm size upper bounds and privately held requirement andthus includes all publicly traded corporations that could be matched to the SOI data and survive the remaining sample restrictions. Column 6 restricts the sample to dividend-paying
corporations (defined as those with a positive dividend in year t-2 ). Column 7 restricts the sample to young corporations (defined as those with bottom-quintile age). Column 8 scales
investment by estimated capital stocks, computed using recursions on investment flows as in Salinger and Summers (1983); 0.1% of firms are excluded because estimated capital stocks
could not be computed. Column 9 flexibly controls for differences between C- and S-corporations using propensity-score matching as in Dehejia and Wahba (2002) based on the full set ofcontrols used in the main specification and the traits used in Table 3, rather than DFL-reweighting; nine observations are excluded from the regression because of insufficient overlap acrosstreatment (C-corporations) and control (S-corporations) along within-year propensity score deciles. Column 10 implements no reweighting. See Online Appendix C.i for full detail.

ONLINE APPENDIX TABLE 5
Effect of the 2003 Dividend Tax Cut on Investment
Scaling Investment by Pre-2003 Measures of Tangible Capital Assets

No variation(reprinted
from Table 2
column 2)(1)

2002
versus2003(2)

2001-2002
versus2003-2004(3)

2000-2002
versus2003-2005(4)

1999-2002
versus2003-2006(5)

1998-2002
versus2003-2007(6)

C-Corp × Post-2003-0.0002(0.0042)-0.0223(0.0061)-0.0193(0.0070)0.0050(0.0082)-0.0068(0.0098)-0.0167(0.0112)N (firm-years)
Clusters (firms)

R2

333,029
73,1880.07

77,994
44,6830.08

67,16341,4950.07

49,79834,5930.08

31,06621,991
0.09

27,355
19,9740.09

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.24280.25140.20220.21140.21760.20500.24570.22040.26700.23670.29010.25050.00[-0.08, 0.08]-0.26[-0.39, -0.12]-0.21[-0.35, -0.06]

0.05[-0.1, 0.2]

-0.06[-0.23, 0.11]-0.13[-0.31, 0.04]

Sample variation:

Implied ε wrt (1-τdiv)

Notes: This table reports results from repeating the paper's main investment regression specification (underlying
Table 2 column 2) when scaling investment by time-invariant pre-2003 measures of firm capital stocks. For easy
reference, column 1 reprints Table 2 column 2; see the notes to that table for specification details. The remainingcolumns replicate this main specification except that they restrict to "firm-era" observations (i.e. either the pre-2003
era or the post-2003 era) on firms that are in my sample for a given number of years around 2003 (specified in thecolumn heading) and compute investment as average annual investment divided by the earliest lagged tangible
capital value available for that firm-era in the truncated time series. See Online Appendix C.ii for full detail. To
convey the algorithm by example, consider the specification underlying column 4. I first restrict the pre-2003 subsetof the main analysis sample to firms with observations in all years 2000-2002, and I restrict the post-2003 subset tofirms with observations in all years 2003-2005. I then condense pre-2003 observations to one observation per firmwith the dependent variable equal to [(I i2000 +I i2001 +I i2002 )/3]/[(K i1998 +K i1999 )/2] where I it and K it denote firm i 's investment
and tangible capital in year t , respetively, and condense post-2003 observations to one observation per firm with thedependent variable equal to [(I 2003 +I 2004 +I 2005 )/3]/[(K 2001 +K 2002 )/2] . Because these specifications scale annual
investment by pre-2003 measures of the firm's capital, any post-2003 increases in investment are not reflected inlarger denominators in the scaled investment dependent variable.

ONLINE APPENDIX TABLE 6
Effect of the 2003 Dividend Tax Cut on Investment
Placebo Tests and Controls for Contemporaneous Tax Changes

Type of test:
Sample years:
C-Corp × Post-2003

None(Table 2column 2)All(1)

Pre-period placebos
1998-2000
1998-2001
and 2002(2)(3)-0.0002(0.0042)

C-Corp × Post-2001

0.0095(0.0067)

Structural cost-of-capital controls

All
(4)

All
(5)

All
(6)

All
(7)

All
(8)

All
(9)

All
(10)

-0.0021(0.0043)-0.0013(0.0043)-0.0018(0.0043)-0.0011(0.0043)-0.0012(0.0043)-0.0013(0.0043)-0.0019(0.0044)

X
X

X

X

X

X

0.0130(0.0071)

Additional covariates:
Asset life mix (quartics) × Year FE's
Depreciation rate
AH cost of capital (linear)
AH cost of capital (quartic)
Extended AH cost of capital (linear)
Extended AH cost of capital (quartic)
N (firm-years)
Clusters (firms)

Reducedform cost-ofcapital
controls

X
X

X
X
X

R2

333,029
73,1880.07

115,679
48,1100.06

117,484
52,8070.07

333,029
73,1880.09

333,029
73,1880.08

333,029
73,1880.08

333,029
73,1880.08

333,029
73,1880.08

333,029
73,1880.08

333,029
73,1880.08

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.24280.2514

0.26680.2627

0.26680.26270.24280.25140.24280.25140.24280.25140.24280.25140.24280.25140.24280.25140.24280.2514

Implied ε wrt (1-τdiv)

0.00[-0.08, 0.08]

0.08
0.11
[-0.03, 0.2] [-0.01, 0.23]-0.02[-0.1, 0.06]

-0.01
-0.02
-0.01
-0.01
-0.01
-0.02
[-0.09, 0.07] [-0.1, 0.06] [-0.09, 0.07] [-0.09, 0.07] [-0.09, 0.07] [-0.1, 0.06]

Notes: This table reports results from varying the paper's main investment regression specification (underlying Table 2 column 2) in order to conduct placebo tests or to control for effectsof contemporaneous tax changes on firms' user cost of capital. For easy reference, column 1 reprints Table 2 column 2; see the notes to that table for specification details. The
remaining columns replicate this main specification except for the variation specified in the column heading and control rows. Columns 2-3 restrict the sample to the years specified in thecolumn heading and replace the post-2003 indicator with a post-2001 indicator equal to 1 if the observation is from year 2001 or beyond. Column 4 includes controls for full interactions
between a quartic in the share of the firm's lagged investment (summed over the previous two lags) made in accelerated-depreciation-eligible property (i.e. property with asset lives thatwere eligible for accelerated depreciation 2001-2004 and in 2008), a quartic in the mean asset life of the firm's lagged bonus-eligible investment, and year fixed effects. Column 5
includes controls for the mean depreciation rate of the firm's lagged investment, computed based on the firm's lagged investment asset life mix and the economic depreciation rates byasset life reported in House and Shapiro (2008). Columns 6-8 include controls for the firm-year's user cost of capital as a function of accelerated depreciation, the top corporate income
tax rate, the top individual ordinary income tax rate, and the top individual capital gains tax rate as derived in Auerbach and Hassett (1992) and following closely the empirical
implementations of Auerbach and Hassett and of Cohen, Hansen, and Hassett (2002). Columns 9-10 repeat columns 7-8 using a fuller and more structural cost-of-capital measure
based on Auerbach and Hassett that accounts for tax-induced changes in firms' steady-state costs-of-capital and capital stocks. See Online Appendix D for full detail.

ONLINE APPENDIX TABLE 7
Effect of the 2003 Dividend Tax Cut on Investment, Net Investment, and Employee Compensation
Including Publicly Traded Corporations
A. Investment
Investment

Dependent variable:
Dep. var. winsorized at:Panel:

C-Corp × Post-2003th

95 percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(1)
(2)
(3)
-0.0023(0.0052)-0.0019(0.0050)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)-0.0768(0.0598)

99th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(4)
(5)
(6)
-0.0081(0.0076)-0.0072(0.0073)X-0.3312(0.2953)

X
X

X

R2

356,758
77,3230.01

356,758
77,3230.08

93,6218,511
0.55

356,758
77,3230.01

356,758
77,3230.06

93,621
8,511
0.60

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.24790.25320.24790.25320.30330.32270.28350.39620.28350.39620.36710.6031-0.02[-0.12, 0.07]-0.02[-0.11, 0.07]-0.59[-1.48, 0.31]-0.07[-0.19, 0.06]-0.06[-0.18, 0.06]-2.09[-5.73, 1.56]

Implied ε wrt (1-τdiv)

B. Net Investment and Employee Compensation
Net Investment

Dependent variable:
Dep. var. winsorized at:Panel:

C-Corp × Post-2003

0.0005(0.0048)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)

Employee compensation

95th percentile
Unbalanced
Balanced($ per lagged capital)($ per 96-97 cap.)
(7)
(8)
(9)
0.0011(0.0046)-0.0277(0.0119)95th percentile
Unbalanced
Balanced($ per lagged revenue)($ per 96-97 rev.)
(10)
(11)
(12)
-0.0013(0.0033)X-0.0013(0.0026)

0.0255(0.0091)

X
X

X

R2

356,758
77,323
0.02

356,758
77,3230.06

93,6218,511
0.22

356,758
77,3230.01

356,758
77,3230.38

93,621
8,511
0.86

Pre-2003 C-corp mean
Pre-2003 C-corp s.d.

0.04840.2671

0.04840.2671

0.09840.29400.18830.15510.18830.15510.20500.16890.02[-0.42, 0.47]

0.05[-0.38, 0.48]-0.65[-1.2, -0.1]-0.02[-0.1, 0.06]-0.02[-0.08, 0.05]

0.29[0.09, 0.49]

Implied ε wrt (1-τdiv)

Notes: This table replicates Table 2 except that it includes all publicly traded corporations that satisfy the sample restrictions(other than being privately held) listed in the notes to Table 1. See the notes to those tables for details. Publicly traded
corporations were omitted from the main sample because all public corporations are C-corporations and thus may have noreasonable S-corporation counterparts.

ONLINE APPENDIX TABLE 8
Effect of the 2003 Dividend Tax Cut on Total Payouts to Shareholders (Full Results)
Unbalanced

Panel:(%)(1)

Unbalanced

(%)
(2)

Balanced
(%)
(3)

(%)
(4)

(%)
(5)

Balanced
(%)
(6)

27.6
(3.3)

78.1
(8.0)

39.4
(7.3)

45.5
(6.5)

53.6
(15.1)A. Overall Difference-in-Differences Estimates
C-Corp × Post-2003

23.4
(3.6)

Lagged controls
Firm FE's
Pre-trend controls

X

X
X
X

X

X
X

N (firm-years)
Clusters (firms)
R2

333,029
73,1880.01

333,029
73,1880.13

85,6247,784
0.54

333,029
73,1880.01

333,029
73,1880.13

85,624
7,784
0.54

Pre-2003 C-corp mean($ per lagged revenue)

0.00310.00310.00610.00310.00310.00610.54[0.38, 0.7]

0.64
[0.49, 0.79]

1.81[1.44, 2.17]

0.91[0.58, 1.24]

1.05[0.76, 1.35]

1.24[0.55, 1.92]

Implied ε wrt (1-τdiv)

B. Year-by-Year Difference-in-Differences Estimates
C-Corp × Year-2003

18.1
(4.3)

21.4
(4.1)

58.5
(8.8)

26.2
(4.8)

30.5
(4.6)

45.1
(11.3)

C-Corp × Year-2004

32.1
(5.2)

35.6
(5.0)

66.6
(11.4)

43.3
(6.5)

48.3
(6.2)

48.8
(10.4)

C-Corp × Year-2005

26.8
(5.8)

29.8
(5.5)

81.4
(12.4)

41.2
(8.2)

46.0
(7.5)

59.1
(16.6)

C-Corp × Year-2006

16.5
(5.8)

21.5
(5.5)

78.5
(13.1)

34.0
(9.3)

41.2
(8.4)

51.8
(20.7)

C-Corp × Year-2007

15.4
(5.7)

21.3
(5.4)

78.1
(12.7)

36.0(10.3)

44.4
(9.2)

46.9
(23.0)

C-Corp × Year-2008

30.1
(6.2)

34.6
(5.8)

105.3
(13.9)

53.9(11.7)

61.3(10.4)

69.7(24.1)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)
R2
Implied 2003 ε wrt (1-τdiv)

X

X
X

X

333,029
73,1880.01

333,029
73,1880.13

85,6247,784
0.54

333,029
73,1880.01

333,029
73,1880.13

85,624
7,784
0.54

0.42
[0.22, 0.61]

0.49[0.31, 0.68]

1.35[0.95, 1.75]

0.61[0.39, 0.83]

0.71[0.49, 0.92]

1.04[0.53, 1.56]

Notes - This table reports full results from the regressions underlying Table 4. See the notes to that table for details.

ONLINE APPENDIX TABLE 9
Effect of the 2003 Dividend Tax Cut on Dividend Payouts to Shareholders
Unbalanced

Panel:(%)(1)

Unbalanced

(%)
(2)

Balanced
(%)
(3)

(%)
(4)

(%)
(5)

Balanced
(%)
(6)

32.7
(3.6)

76.2
(7.8)

45.5
(7.7)

52.0
(6.9)

51.7
(15.2)A. Overall Difference-in-Differences Estimates
C-Corp × Post-2003

28.5
(3.9)

Lagged controls
Firm FE's
Pre-trend controls

X

X
X
X

X

X
X

N (firm-years)
Clusters (firms)
R2

333,029
73,1880.01

333,029
73,1880.13

85,6247,784
0.57

333,029
73,1880.01

333,029
73,1880.13

85,624
7,784
0.57

Pre-2003 C-corp mean($ per lagged revenue)

0.00220.00220.00480.00220.00220.00480.66[0.48, 0.83]

0.76[0.59, 0.92]

1.76[1.41, 2.12]

1.05[0.7, 1.4]

1.20
[0.89, 1.52]

1.20[0.51, 1.89]

Implied ε wrt (1-τdiv)

B. Year-by-Year Difference-in-Differences Estimates
C-Corp × Year-2003

20.0
(4.4)

23.3
(4.3)

63.2
(9.2)

28.6
(5.0)

33.0
(4.8)

49.9
(11.4)

C-Corp × Year-2004

35.3
(5.4)

38.9
(5.2)

66.4
(11.3)

47.2
(6.8)

52.4
(6.5)

48.5
(10.6)

C-Corp × Year-2005

31.5
(6.1)

34.5
(5.8)

70.6
(11.5)

46.8
(8.6)

51.7
(8.0)

48.3
(16.3)

C-Corp × Year-2006

26.3
(6.3)

31.5
(6.0)

77.3
(12.4)

44.8
(9.9)

52.4
(9.1)

50.5
(20.2)

C-Corp × Year-2007

22.3
(6.1)

28.4
(5.8)

78.3
(12.4)

44.1(10.9)

53.0
(9.8)

47.1
(23.0)

C-Corp × Year-2008

35.5
(6.7)

40.3
(6.3)

101.6
(14.0)

60.7(12.4)

68.7(11.1)

65.9(24.5)

Lagged controls
Firm FE's
N (firm-years)
Clusters (firms)
R2
Implied 2003 ε wrt (1-τdiv)

X

X
X

X

333,029
73,1880.01

333,029
73,1880.13

85,6247,784
0.57

333,029
73,1880.01

333,029
73,1880.13

85,624
7,784
0.57

0.46
[0.26, 0.66]

0.54[0.35, 0.73]

1.46[1.05, 1.88]

0.66[0.44, 0.89]

0.76[0.55, 0.98]

1.15[0.64, 1.67]

Notes - This table replicates Online Appendix Table 5 except that it replaces the dependent variable outcome of total payouts
with the outcome of dividends only.

ONLINE APPENDIX FIGURE 1
Industry and Size Distribution of the U.S. Population of Corporations(b) Narrow Industry
Within the Most Common 3-Digit NAICS Category(a) Industry
NAICS 1: Agriculture & Forestry

NAICS 4231: Motor Vehicle Supplies

NAICS 2: Construction & Mining

NAICS 4232: Furniture

NAICS 3: Manufacturing

NAICS 4233: Lumber

NAICS 4: Retail & Wholesale Trade

NAICS 4234: Professional & Commercial Supplies

NAICS 5: Information & Professional Services

NAICS 4235: Metal and Mineral Supplies

NAICS 6: Health Care

NAICS 4236: Electrical Supplies
NAICS 4237: Hardware, Plumbing, & Heating Supplies

NAICS 7: Entertainment, Food, & Hotels

NAICS 4238: Machinery Supplies

NAICS 8: Other Services
NAICS 4239: Sports, Toys, and Jewelry Supplies
0% 10% 20% 30%

C-corporations (197k)

S-corporations (200k)(c) Revenue$500k-$5m$5m-$10m

C-corporations (197k)$10m-$50m

C-corporations (12k)

S-corporations (12k)(d) Example of Operating in the Same Local Markets$50m-$1.5bn

S-corporations (200k)

Home Depot (C-corporation)
Menard Inc. (S-corporation)

Notes: This figure plots the U.S. population distribution of C-corporations and S-corporations across broad (1-digit NAICS)
industry categories, within the most numerous narrow (3-digit NAICS) industry category, and revenue bins. Each graphs’sbars sum to 100% within corporation type. The sample underlying panels (a)-(c) comprises the universe of corporate income
tax returns from tax year 2002 that satisfy the size and industry restrictions applied to the paper’s main sample: assets between$1 million and $1 billion, revenue between $500,000 and $1.5 billion, and any industry other than finance and utilities. Thesefull-population data were drawn from unedited population data at the IRS; these data lack several of the variables necessary
for this paper’s analysis and so are used only for this figure. Panel (d) illustrates a particular C-corporation and S-corporation
operating at similar scale in the same narrow industry in the same local market (suburban Chicago) by plotting their store
locations; tax data were not used in any way to construct this panel. Home Depot, Inc., the largest U.S. home improvement
retailer, is a publicly-traded corporation and is thus a publicly-known C-corporation. Menard Inc., the third-largest U.S. home
improvement retailer, is a pubicly-known S-corporation from a 2003 press story(http://www.insidemilwaukee.com/Article/242011-BigMoney). Store locations were derived from Google Maps.