October 2024

IZA DP No. 17373: Capital Taxation, Retained Earnings and Inequality: Evidence from Dividend Tax Reforms

This paper studies the effects of capital tax reforms on retained earnings, dividend tax revenues, and income inequality in Israel between 2001 and 2020. We analyze two major dividend tax reforms: a permanent rate increase in 2012 and a temporary tax relief in 2017. By combining administrative income tax data, household surveys, and national accounts, we find that both permanent and temporary capital tax changes substantially affect retained earnings. The five percentage points increase in the dividend tax rate resulted in an immediate increase of over 100% in the withdrawal of retained earnings and in dividend tax revenues. While the permanent tax increase did not cause a long-term change in retained earnings withdrawals, the temporary tax relief triggered a significant increase in retained earnings after the relief period ended. Using these reforms, we improve the measurement of income inequality by directly observing the distribution of retained earnings. We find stable levels of income inequality in Israel after 2007, with a top 10% income share of around 48%, a high level by international standards.