Personal Taxes and Corporate Cash Holdings

Dividends are taxed at the investor level, but injecting funds into firms does not offer investors the symmetric tax benefit. Hence, there is a tax saving incentive to retain cash in the firm. We theoretically and empirically show that this tax saving motive is important for corporate cash holdings. We develop a dynamic corporate finance model of liquidity management, in which the firm's liquidity policy trades off precaution and saved personal taxes against agency and corporate tax costs. The model implies that corporate cash holdings are substantial and increasing with the dividend tax rate. To identify the empirical relation between dividend taxes and corporate cash accumulation, we use the 2003 dividend tax cut. Consistent with a reduction of the tax saving motive owing to lower dividend taxes, treated firms reduce their cash accumulation after the cut