Abstract We compile a comprehensive international dividend and capital gains tax data set to study tax-based explanations of corporate payout for a panel of 6,035 firms from 25 countries for the period 1990–2008. We find robust evidence that the tax penalty on dividends versus capital gains corresponds closely with firms’ propensity to pay dividends and repurchase shares, and with the amount of dividends and shares repurchased. Our coefficient estimates suggest a smaller tax effect than reported in recent single-country, single-event studies. Instead, our results correspond more closely with historic long-term estimates of the elasticity of dividends.

When corporate payout is taxed, internal equity (retained earnings) is cheaper than external equity (share issues). If there are no perfect substitutes for equity finance, payout taxes may therefore have an effect on the investment of firms. High taxes will favor investment by firms who can finance internally. Using an international panel with many changes in payout taxes, we show that this prediction holds well. Payout taxes have a large impact on the dynamics of corporate investment and growth. Investment is “locked in” in profitable firms when payout is heavily taxed. Thus, apart from any level effects, payout taxes change the allocation of capital.