"Increases in the progressivity of individual income tax rates are associated with statistically significant and economically meaningful increases in the diffusion of corporate ownership."

Countries differ widely in the extent to which corporate ownership is diffused and in the degree to which their populations participate in the stock market. Legal rules, politics, and behavioral factors all have been offered as explanations for these differences. The role of taxes in influencing stock ownership patterns has largely gone unexplored. This oversight is particularly surprising because Adolf Berle and Gardiner Means, who pioneered the notion of the separation of ownership and control in modern corporations, were motivated by the observation that highly progressive taxes imposed during WWI were associated with a sharp increase in the diffusion of ownership.

In Taxation and the Evolution of Aggregate Corporate Ownership Concentration (NBER Working Paper No. 11469), authors Mihir Desai, Dhammika Dharmapala, and Winnie Fung investigate how personal taxes have shaped the level of stock ownership concentration in the United States during the twentieth century. By extending the financial-equilibrium intuition developed by Merton Miller, the authors show that increases in the progressivity of a tax system lead to a greater personal tax burden on corporate debt, relative to equity. This induces more equity issuance and, consequently, a larger fraction of investors to hold equity. In short, the marginal investor becomes a lower income individual.

To test this notion, the authors develop a measure of corporate ownership concentration at the economy-wide level. They use dividend income, as reported on tax returns over the 1916-2000 period, as a proxy for stock ownership, and construct an index that summarizes the degree of concentration of stock ownership across households over this period. An alternative measure based on estate tax data provides similar results. These measures differ from those used in studies of corporate governance, which typically track the ownership concentration of a sample of large public corporations across countries or through time. As such, the authors argue that these measures are especially well suited to understanding the determinants of stock market participation across income groups and for understanding ownership concentration at the aggregate level.

In contrast to the typical portrait of the United States as having diffuse ownership patterns throughout the twentieth century, this index shows significant variation over time, with substantial diffusion of ownership after WWI and again through the 1950s. While diffusion persisted through the second half of the century, an increase in concentration of aggregate corporate ownership returned in the 1990s.

The analysis in this paper reveals that increases in the progressivity of individual income tax rates are associated with statistically significant and economically meaningful increases in the diffusion of corporate ownership. These results hold after the authors control for a variety of factors including changes in economic conditions, income distribution, stock valuation, the fraction of households filing tax returns, and corporate and capital gains tax rates. Controlling for these various factors, a single standard deviation change in the top statutory rate is associated with a close-to-one standard deviation change in the index of ownership concentration. Separate analysis by income classes confirms these results and provides only weak evidence for the role of stock valuation levels for equity market participation.

These results support the notion that taxation can affect shareholding patterns and, consequently, levels of ownership concentration and stock market participation. In particular, the findings suggest that the progressivity of the tax code may be a contributing factor in stock market participation at lower income levels. An analysis of various sub-periods confirms that these findings do not simply reflect changing patterns in tax reporting or the effects of equity ownership through tax-advantaged accounts. While the authors do not claim that taxation alone can explain variations in corporate ownership diffusion across time and countries, their results suggest that tax systems are an underappreciated determinant of patterns of stock ownership

-- Les Picker

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