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Business owners and income-shifting: evidence from Finland


This study examines income-shifting between tax bases among the owners of privately held businesses. The dual income tax system in Finland offers noticeable incentives for income-shifting between wages and dividends for business owners. The dividend tax reform of 2005 enables us to study how this particular form of tax avoidance reacts to an exogenous change in tax rates. Our results support highly active income-shifting behavior. We find that the income-shifting effect is homogeneous across different owners and firms. However, we find that the size of the tax incentive affects the size of the response, suggesting that costs related to income-shifting are important.

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  1. In addition to many tax bases, income-shifting can also occur in other forms. A well-known example is intertemporal income-shifting, for example, in the form of anticipating the forthcoming tax rate change [see, e.g., Goolsbee (2000) and le Maire and Schjerning (2013)]. This paper focuses on longer-run income-shifting between tax bases.

  2. Privately held corporations are defined as corporations that are not listed on a public stock exchange. In the Finnish tax system, dividends from listed and privately owned corporations are taxed at different tax rates and tax regulations. Main owners include owners who own at least 50 % of the firm alone or together with family members.

  3. A more detailed discussion on the Nordic-type DIT can be found, for example, in Nielsen and Sørensen (1997) and Sørensen (2005).

  4. Net assets is a technical term used by the Finnish Tax Administration. Net assets is calculated by subtracting liabilities from assets. Assets include items such as buildings, machinery, equipment, sales receivables and cash holdings. Importantly, assets do not include liabilities. Therefore, net assets can be zero or negative for a given firm with low assets or large liabilities. For dividend tax purposes, negative net assets are treated as zero net assets. The value of net assets is calculated based on the asset and debt values of the firm in the previous year. The individual net asset share of the owner is calculated based on the ownership share of the firm. Also, there are some individual adjustments to the net assets. For example, if the owner or her family members live in a dwelling which is owned by the firm, the value of this dwelling is not included in net assets when calculating the imputed return.

  5. Firm-level social security contribution rate is 2–6 % of wages, depending on the level of total wages paid and the depreciations made by the firm.

  6. The effective MTR for flat tax dividends above 90,000 euros are calculated as \(26\,\% + 0.7\times (1-0.26)\times 28\,\% = 40.5\,\%\), where 28 % is the flat personal capital income tax rate.

  7. For evidence of anticipation effects, see Kari et al. (2008).

  8. The limitations are the following: First, a corporation cannot distribute dividends more than it holds distributable assets. These include, for example, accumulated profits and non-tied equity. With some firms, this might limit the scope for income-shifting. Second, wages cannot be paid when there is no work contribution to the firm. Otherwise, wages may be regarded as a veiled distribution of profits. However, this is a minor issue in our empirical analysis since our sample of corporate owners holds an executive position in the firm and are thus by default assumed by the tax authorities to work for the firm. In contrast to wages and dividends, other alternatives to withdraw income from the firm are restricted. These include, for example, shareholder loans and share repurchases. In addition, one potential way to retain accumulated earnings is to sell the shares of the firm and pay the capital gains tax. However, the shares of privately held corporations do not have publicly declared prices in Finland. Capital gains are taxed as personal capital income, and there were only a minor change in the capital income tax rate from 29 to 28 % within the 2005 tax reform.

  9. In our estimation sample, approximately 4 % of the firms have zero (or negative) net assets. However, low levels of net assets are relatively common, as 10 % of the firms have net assets below 10,000 euros. Therefore, zero firm-level net assets is a relevant example for many owners with small net assets.

  10. Wage tax rates and dividend tax rates include central government taxes, average municipal taxes, individual social security contributions and all automatic deductions and tax credits on either dividend income or wage income or both. In addition, MTR on wages include firm-level social security contributions. MTR on dividends include the corporate taxes paid on dividends after the reform.

  11. There are regulations for both the lower and upper limits of YEL income, which are, however, also independent of actual taxable wage and dividend income. Insurance payments determine pensions when retired, as well as the amount of many income-bound social benefits before retirement (e.g., public health insurance). Thus, owners have incentives to report a realistic YEL income which reflects the actual income earning potential. There were no relevant changes in contribution rates or other regulation on insurance payments for YEL owners in the time period we study. The overall average rate of insurance payments on YEL income was 21.1 % in 2002 and 20.8 % in 2007.

  12. The choice of retained earnings (R) is relevant in dynamic tax optimization. R increases net assets, which are the base for determining the flat-taxed dividends in the Finnish DIT system. Other than purely tax-motivated issues also affect the amount of R (for example, essential investments and imperfect capital markets). However, the endogenous nature of R does not change the relevance of the static year-to-year tax minimization problem of choosing the tax-optimal combination of wages and dividends. Without year-to-year tax optimization, the benefits from dynamic tax avoidance diminish or vanish altogether.

  13. Also, search costs and other optimization frictions might matter in optimization behavior (Chetty 2012). Fjaerli and Lund (2001) suggest that benefits received from paying social security contributions increase wages as a form of compensation, although no compelling evidence has been found to support this view. Also, wages can be seen as a socially more acceptable form of personal compensation. All of these issues imply deviations from the optimality conditions (3) and (4).

  14. Fjaerli and Lund (2001) use a similar explanatory variable in their study.

  15. Weber (2014) studies the properties of predicted tax rate instruments when estimating the average elasticity of taxable income in the USA.

  16. On the left-hand side of Fig. 2, the additional spike in 2002 on the left to the tax-optimal income composition is due to zero realized wages, which is a relatively common observation in the data. For many owners, the tax-optimal wage is approximately 7500 euros before the reform. Because of this, we observe slightly more owners around −7500 euros in the figure in 2002.

  17. Fjaerli and Lund (2001) get qualitatively similar results in their cross-sectional analysis for Norway.

  18. The results are robust using all pairs of pre- and post-reform years. Other results are available from the authors upon request.


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Many thanks to Richard Blundell, Essi Eerola, Ari Hyytinen, Laurence Jacquet, Seppo Kari, Olli Kärkkäinen, Tuomas Kosonen, Jukka Pirttilä, Panu Poutvaara, Håkan Selin and Joel Slemrod for their very useful comments and discussion. We also thank the assigned discussants and participants in many conferences and seminars for their helpful comments. All remaining errors are our own. The authors gratefully acknowledge funding from the Nordic Tax Research Council and the Yrjö Jahnsson Foundation. Harju gratefully thanks the Alfred Kordelin Foundation, and Matikka thanks the Finnish Cultural Foundation, OP-Pohjola Group Research Foundation, the Emil Aaltonen Foundation and the Finnish Doctoral Programme in Economics for their financial support.

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Correspondence to Jarkko Harju.



See Fig. 5 and Tables 2, 3, 4, 5, 6, 7 and 8.

Fig. 5
figure 5

The distributions of wage and dividend income of the owners of privately held corporations in 2002 and 2007 (in nominal euros)

Table 2 Marginal tax rates (MTR) on wages and dividends with different levels of firm net assets, years 2002 and 2007 (in nominal euros)
Table 3 Tax-optimal gross wages before (2002, 2003) and after (2007, 2008) the 2005 tax reform with different levels of total gross income and net assets of the firm (in nominal euros)
Table 4 Descriptive statistics (2002, 2003, 2007 and 2008): main owners (in nominal euros)
Table 5 Descriptive statistics (2002, 2003, 2007 and 2008): firms (in nominal euros)
Table 6 Cross-sectional results for the years 2002, 2003, 2007 and 2008
Table 7 Results for the years 2002 and 2008
Table 8 Results for different subgroups, 2002–2008

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Harju, J., Matikka, T. Business owners and income-shifting: evidence from Finland. Small Bus Econ 46, 115–136 (2016).

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  • Business owners
  • Income-shifting
  • Income taxation
  • Dividend tax reform

JEL Classifications

  • G35
  • H24
  • H25
  • L26