UK – The controversial removal of tax relief on dividend payments to pension funds is estimated to have cut company dividends by 31%, according to a Bank of England study.

“In July 1997 tax credits on dividend payments to pensions funds were abolished, which made retentions a more attractive source of investment finance, since pension funds had less desire for dividends,” two BOE researchers stated in a new working paper on the central bank’s web site.

The move has been estimated to have taken around five billion pounds (7.4 billion euros) from the UK pension industry every year.

“We might therefore expect that firms would pay lower dividends as a result of this tax change,” said Philip Bunn and Garry Young of the bank’s Macro Prudential Risks Division, in a 43-page paper entitled ‘Corporate capital structure in the United Kingdom: determinants and adjustment’.

“It is estimated that in the long run the removal of tax relief on dividend payments to pension funds has reduced dividends by 31% relative to what they would otherwise have been.” The study found this was “a larger effect than might be expected” based on earlier studies.

The paper – which does not necessarily represent the views of the BOE - also found that the UK’s abolition of advance corporation tax “has had no long-run effect on dividends”.

The authors say: “Our analysis provides an empirical test of the ‘trade-off’ theory of corporate capital structure, which suggests that firms have an equilibrium level of capital gearing that is determined by trading off the advantages of holding debt against the expected costs of financial distress, which becomes more likely at high debt levels.”