Mitigating Shareholder Taxation in Small Open Economies?

This article reconsiders the role of dividend taxation and its effect on the cost of capital for small firms. Using a simple portfolio model for small open economies, we show that an isolated increase in dividend taxes on large companies unambiguously decreases the required rate of return on small companies. A dividend tax increase for both large and small companies may moreover lead to the counter-intuitive result of decreasing the cost of capital for small firms. For different small open economies, we further provide statistics on the correlation between the return of large and small firms that drives the counter-intuitive result.