The impact of investor-level taxation on mergers and acquisitions

• Published in: Journal of public economics Vol. 177; p. 104038
• Main Authors: Ohrn, Eric, Seegert, Nathan
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01.09.2019
• Subjects: Corporate taxation; Mergers and acquisitions; G35; H25; H24; Mergers and acquisitions; G30; Corporate taxation
• ISSN: 0047-2727; 1879-2316
• DOI: 10.1016/j.jpubeco.2019.06.006

When capital gains are taxed at a lower rate than dividends, the difference in rates creates a tax discount on mergers and acquisitions. The intuition is that if a target firm's assets are subject to the higher dividend tax rate, but the proceeds from the sale of these assets are taxed at the lower capital gains rate, there is a tax preference to be acquired. Using quasi-experimental variation created by the Jobs Growth and Tax Relief Reconciliation Act of 2003, we show that this tax discount increases the quantity and decreases the quality of acquisitions made by dividend-paying firms with taxable shareholders. Our estimates suggest that re-implementing the same wedge between dividend and capital gains rates that the 2003 reform eliminated would destroy approximately $59 billion of the value of mergers and acquisitions in the U.S. annually. •When dividends are taxed at a higher rate than capital gains, the after-tax cost of acquisitions made by dividend-paying firms is discounted.•This tax-discount leads dividend-paying firms to make more acquisitions that are of lower quality.•Using variation in tax rates created by The Jobs and Growth Tax Relief Reconciliation Act of 2003, we show the tax discount induced inefficient acquisitions prior to 2003.•Reintroducing the tax discount would destroy approximately $59 billion of the value of acquisitions in the United States annually.