Long-Term Effects of Distributed Profit Taxation on Firms: Evidence from Estonia

Abstract: The study contributes to a body of research on a specific corporate taxation system, distributed profit taxation, by examining whether the system has affected corporate behavior in the long term and if it has, to what extent. The results partly corroborate previous literature but provide new evidence on the long-term effects of distributed profit taxation. We show that compared to classical gross profit taxation, companies operating under distributed profit taxation system have a lower level of external financing; higher levels of cash holdings; and that both cash holdings and investments are financed more from internal cash flows. We do not find distributed profit taxation to have a significant effect on the level of investment activity. Additionally, we provide tentative evidence on dividend policy that indicates private company payout ratios may be negatively affected by the system.