NCPA - National Center for Policy Analysis


August 14, 2008

Determining how taxes -- particularly tax reforms -- influence portfolio choice has been difficult to identify.  However, a new study by the National Bureau of Economic Research (NBER) overcomes many of these obstacles by analyzing the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003, which allowed for dividend tax relief to U.S. investors who owned stock in countries with suitable tax treaties with the United States.

Under JGTRRA, dividends were taxed at the same rate as capital gains, a reduced maximum rate of 15 percent.  This lower rate applied to dividends paid by domestic corporations and by "qualified" foreign corporations - a foreign corporation that satisfied at least one of several tests, including the "Treaty Test," which encompassed corporations resident in countries with which the United States had a tax treaty. 

The study was based upon 52 countries that satisfied the "Treaty Test" and represented 82 percent of U.S. outbound equity in foreign portfolio investments (FPI) in 2001.  Researchers found:

  • The positive effect of JGTRRA was quite large; the U.S. equity FPI holdings in the average treaty country rose by over 90 percent relative to U.S. equity holdings in the average non-treaty country.
  • The rate for treaty countries fell from 38.6 percent to 15 percent while the rate for non-treaty countries fell to 35 percent.
  • American investors' holdings of lightly taxed foreign equities increased significantly in a manner consistent with an implied elasticity of asset holdings.

The results suggest that taxes can play a large role in shaping international portfolio choices, and the researchers claim that they have implications for tax policies aimed at corporate tax integration.  If dividend relief is not fully extended to foreign dividends, tax integration may cause significant distortions in international portfolios resulting in welfare losses. Such effects could be considerable, say researchers.

Source: Mihir Desai and Dhammika Dharmapala, "Taxes and Portfolio Choice: Evidence from JGTRRA's Treatment of International Dividends," National Bureau of Economic Research, Working Paper, No. 13281, July 2007.

For text:  


Browse more articles on Tax and Spending Issues