The Effects of Tax Penalty on Retained Earnings: Evidence from Quasi-Natural Experiment in South Korea

Abstract This paper evaluated how the tax penalty, corporate income feedback tax (CIFT), on retained earnings affected firms’ managerial decisions in South Korea. We focused on how the firms allocated the retained earnings to minimize the additional tax liability. We employed a quasi-natural experiment design resulting from the enactment of the CIFT in 2015 to identify how the tax penalty on earning retention affected investment, dividend, and employment. We took advantage of the eligibility condition of the CIFT to construct a quasi-natural experimental design. Our estimation results show that most firms subject to the CIFT paid out dividends to equity holders to avoid additional tax liabilities despite of modest increase of investment. They did not change wages much. Rather, they decreased wage payment. In sum, the CIFT was not as successful as Korean government wished.