Dividend tax credits and the elasticity of taxable income: evidence from small businesses

We assess firms’ taxable income response to a dividend tax credit increase whencorporate and personal taxes are integrated. First, we theoretically show that, in anintegrated tax system, welfare changes stemming from a rise in corporate taxes dependon two parameters: the elasticity of taxable income with respect to the corporate taxrate and with respect to the dividend tax credit. Second, to estimate both parameters,we propose an identification strategy that relies on the bunching methodology and theexcess bunching difference before and after a tax reform that increased the dividendtax credit. Using Canadian administrative tax data and the presence of a kink inthe corporate tax system, we estimate these elasticities and empirically show that theincrease in the dividend tax credit reduced the deadweight loss associated with anincrease in the corporate tax by more than 50%. Our results are robust to a battery ofrobustness checks, including nonparametric estimates of the counterfactual densityin the bunching procedure.