The impact of investor-level taxation on mergers and acquisitions

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.