Miller’s contribution to financial theory is beyond any shadow of doubt. Starting from the well-known model elaborated with its partner Franco Modigliani, he consolidated a theoretical framework, which bears its name that partially offsets the original. TMiller’s model, personal taxation, Romania flat tax

Lazar Sebastian

English

Research Papers in Economics

242 
 
AN ASSESMENT OF THE MILLER’S MODEL ON ROMANIAN FISCAL 
FRAMEWORK 
 
Lazăr Sebastian  
Universiy „Al.I. Cuza” Iaşi, Romania Facultaty de Economics and Business Administration Bl. 
Carol I, No. 22, C Building, 801 E-mail: slazar@uaic.ro Tel.: 0770 357 579 
 
Miller’s contribution to financial theory is beyond any shadow of doubt. Starting from the well-known 
model elaborated with its partner Franco Modigliani, he consolidated a theoretical framework, which 
bears  its  name  that  partially  offsets  the  original.  Taking  into  consideration  personal  taxation  of 
shareholders and debt holders, he extended the Modigliani-Miller’s model into what is today simply called, 
the  Miller’s  model.  The  present  paper  evaluates  the  basic  element  of  the  Miller  model,  the  Miller’s 
condition, under Romanian fiscal framework and tries to formulate some conclusions regarding the flat tax 
adoption. 
 
Keywords: Miller’s model, personal taxation, Romania flat tax 
 
JEL classification: G38, H24 
 
The model of  Modigliani and  Miller did not take into  consideration personal taxes of 
individual investors, either shareholders or debt holders. Accordingly, the model says that 
the value of a leveraged firmed is greater than the value of an unleveraged firm due to the 
tax savings determined by the deductibility of interest:  
( )
D t V t D
U K
t EBIT
V c
U
c U
ec
L * *
) 1 (
+ = +
-
=  
EBIT = earnings before interests and taxes; 
tc = corporate income tax rate; 
D = debt; 
V
L = value of the leveraged firm; 
V
U = value of the unleveraged firm; 
 
Based on some restrictive assumptions, the model shed a new light not only on the market 
value of the firm, but also on the incidence of taxation on business. Economists have 
begun to take into consideration taxes paid by businesses and investors in order to design 
the  optimal  corporate  financial  policy.  Farrar  and  Selwyn,  than  Miller  approach  the 
incidence of personal taxation on investors streams of revenues in order to evaluate the 
impact at corporate at personal level. Miller argued that the marginal costs of equity and 
debt after corporate and personal taxes should be equal in equilibrium, so corporate tax 
savings related to debt could be offset by the personal tax disadvantage of holding debt 
instead of equity. This will cause investors to ask higher pretax returns on debt relative to 
equity, and that, from the company’s point of view, will offset the tax advantage of using 
debt financing. 
In  these  circumstances,  the  Miller  model  reconsidered  the  Modigliani-Miller  one,  by 
taking into consideration the personal taxes on shareholders and debt holders. 
If the streams of revenues for shareholders were (EBIT-Interest)(1-tc)(1-ts) the streams of 
revenues for debt holders were Interest(1-td), the value of the leveraged firm is determined 
by capitalization of these  streams of revenues at specific rates, so: 
d
d
d
s c
p
s c L
K
) t - Interest(1
K
) t - )(1 t - Interest(1
K
) t - )(1 t - EBIT(1
V + - =  243 
 
d
d
d
s c U L
K
) t - Interest(1
K
) t - )(1 t - Interest(1
- V V + =  
d
d
d)
s c U L
K
) t - Interest(1
 x  ]
t - (1
) t - )(1 t - (1
- [1 V V + =  
D  x  ]
t - (1
) t - )(1 t - (1
- [1 V V
d)
s c U L + =  
ts = tax rate on shareholders income; 
td =  tax rate on debt holders income; 
The expression  
( )
DAT  x  ]
t - 1
) t - )(1 t - (1
- [1
d
s c  represents the advantage for the shareholders as a 
result of debt financing, or, in other words, the leverage in the presence of personal taxes 
(the gain from the leverage
171). It is a real advantage as long as  ( )( )
( )
1
1
1 1
<
-
- -
d
s c
t
t t , otherwise it 
will be a loss for the shareholders. This fundamental condition is known as the Miller 
condition. 
The  Miller  model  represents  an  extension  of  the  Modigliani-Miller  model,  in  some 
particular circumstances, both being equivalent (ts = td = 0). In conclusion, the increase of 
the leverage will determine the augmentation of the firm’s value if and only if (1-td) > (1-
tc)(1-ts). Otherwise, the tax savings at the firm’s level resulted from the deductibility of 
interest will be offset by the fiscal disadvantage of the shareholders resulted from personal 
taxation. In fact, as Miller noted “for a wide range of values for tc, ts, td, the gain from 
leverage vanishes entirely or even turns negative!”
172. When (1-td) = (1-tc)(1-ts) the offset 
is one-to-one and “the owners of the corporation reap no gain whatever from their use of 
tax-deductible debt rather than equity capital”
173. But, Miller went further and makes some 
assertions valid in a progressive taxation framework: “any situation in which the owners 
of corporations could increase their wealth by substituting debt for equity (or vice versa) 
will be incompatible with market equilibrium. Their attempts to these opportunities would 
lead, in a world with progressive income taxes, to changes in the yields on stocks and 
bonds and in their ownership patterns. These changes, in turn, restore the equilibrium and 
remove the incentives to issue more debt, even without invoking the bankruptcy costs or 
lending costs as a deux ex machina”
174. 
In these circumstances, we tried to asses the Miller model on Romania’s fiscal framework, 
by taking into consideration the tax rates for individual gains from interest and dividends, 
all  along  the  period  that  started  in  1990,  and  to  reflect  the  impact  of  flat  tax 
implementation at the beginning of 2005.  
Our task was facilitated by the similar tax systems used both in Romania and in USA, 
regarding the taxation of dividends (the so-called classical systems in which the company 
is subject to corporate income tax, dividends distributed to shareholders being taxed again 
under  personal  income  tax)  and  was  based  on  the  total  deductibility  of  interest  in 
computing taxable corporate income (an assumption which not was always true, because 
of the partial deductibility of interest depending on the leveraged ratio of the firm). 
In these conditions, a brief history of taxation of dividends and interest in Romania is 
more than useful. 
                                                       
171 Merton Miller – “Debt and Taxes”, Journal of Finance, No. 2, May 1977, p. 267. 
172 ibid. 
173 ibid, p. 268. 
174 ibid. 244 
 
The taxation of dividends was introduced in Romania at the beginning of 1992. The tax 
rate varied considerably along the period as table no. 1 shows: 
 
Table no.1. The tax rate for individual dividend gains 
Period  Individual tax rate (%) 
01.01.1992 – 31.12.1999  10 
01.01.2000 – 31.12.2003  5 
01.01.2004 – 31.12.2005  10 
01.01.2006 – present  16 
Source: Fiscal legislation 
 
One can notice the relative stability of the tax rate, which was at 10% for a period of ten 
years (1992 – 1999, and 2004 – 2005), interrupted by a period of four years (2000  – 
2003), when it dropped to 5%. 
As for interest taxation, it came into practice at the beginning of 1998, with a symbolic tax 
rate of 1%, which gradually reached the actual level of 16%, as table no.2 shows: 
 
Table no. 2. The tax rate for individual interest gains 
Period  Individual tax rate (%) 
01.01.1998 – 30.04.2005  1 
01.05.2005 – 31.12.2005  10 
01.01.2006 – present  16 
Source: Fiscal legislation 
One can notice the very low level of tax rate for individual interest gains, which determine 
the  individual  preference  for debt  buying  rather than  equity  buying, a  fact that  in  the 
Romania’s condition at that time, was not quite desirable. 
In order to asses the Miller’s model in the fiscal framework of Romania, it is useful to 
aggregate the data by taking into consideration the corporate income tax rate for different 
periods, as in table no. 3. 
 
Table no. 3. The tax rates for individual dividend gains, individual interest gains, 
corporate income and the Miller’s condition in Romania 
Period  Tax rate for 
individual 
interest gains 
(%) 
Tax rate for 
individual 
dividend gains 
(%) 
Corporate 
income tax rate 
(%) 
Miller’s condition 
( )( )
( )
1
1
1 1
<
-
- -
d
s c
t
t t  
01.01.1998 – 31.12.1999  1%  10%  38%  0,563 < 1 
01.01.2000 – 31.12.2003  1%  5%  25%  0,7196 < 1 
01.01.2004 – 31.12.2004  1%  10%  25%  0,681 < 1 
01.01.2005 – 30.04.2005  1%  5%  16%  0,806 < 1 
01.05.2005 – 31.12.2005  10%  10%  16%  0,84 < 1 
01.01.2006 - prezent  16%  16%  16%  0,84 < 1 
Source: Fiscal legislation 
 245 
 
As the table no. 3 shows, the Miller condition is fulfilled through the entire period taken 
into consideration. For the maximization of the leveraged firm’s value from individual’s 
perspective, it is necessary to minimize the Miller’s condition. This was accomplished in 
the  first  two  years  of  the  period,  respectively  1998  and  1999,  when  the  tax  rate  for 
individual gains was almost insignificant (1%), especially by comparison with corporate 
income tax rate (38%). In the next four years (2000 – 2003), Miller’s condition increased 
from 0,563 to 0,7196 (27,81%), due to conjugated effects of both decreasing individual dividend 
gains and corporate income tax rates. In the following year (2004) the increasing of the tax rate 
applied for dividend led to the decrease of Miller’s condition to 0,681. As for the last years of the 
period,  the  value  for  Miller’s  condition  have  continuously  increased,  mainly  due  to  the 
equalization of the tax rates applied (td = ts in 2005; td = ts = tc from 2006).  
One  can  notice  that  the  fiscal  reform  implied  by  the  implementation  of  the  flat  tax  at  the 
beginning of 2005 had led to the increase of the Miller’s condition, respectively to the reduction 
of the leveraged firm compared to the unleveraged firm. The flat tax has reduced the appetite of 
the shareholders for debt financing, as long as td = ts. In these conditions, the Miller’s model 
became identical with the Modigliani-Miller model: 
( ) [ ] xD t V xD c U + = + = + = c
U
d)
s c U L t - 1 - 1   V     D  x  ]
t - (1
) t - )(1 t - (1
- [1 V V  
Thus, the flat tax not only increases the Miller’s condition, diminishing its appeal, but also 
makes  the  model  equivalent  with  the  Modigliani-Miller’s  model,  rendering  the  model 
obsolete. This is a supplementary evidence for the neutrality of the flat tax, which does not 
offset  the  fiscal  advantage  of  the  debt  financing  at  the  corporate  level  and  the  fiscal 
disadvantage at the personal level.  
 
BIBLOGRAPHY 
1. Graham, John R.  – „A Review of Taxes and Corporate Finance”,  Foundations and 
Trends in Finance, Vol. 1, No. 7 (2006); 
2. Miller, Merton,  Modigliani Franco – „Dividend Policy, Growth, and the Valuation of 
Shares”, The Journal of Business, Vol. 34, No. 4. (Oct., 1961); 
3. Miller, Merton – „Debt and Taxes”, Journal of Finance, No. 2, May 1977, pp. 261-275; 
4. Modigliani, Franco, Miller Merton H.,  - „The Cost of Capital, Corporation Finance and 
the Theory of Investments”, American Economic Review, No. 3, 1958, pp.261-297; 
5. Modigliani, Franco, Miller Merton H.,   - „Corporate Income Taxes and the Cost of 
Capital : A Correction”, American Economic Review, No. 53, 1963, pp. 433-443; 
   

AN ASSESMENT OF THE MILLER’S MODEL ON ROMANIAN FISCAL FRAMEWORK

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AN ASSESMENT OF THE MILLER’S MODEL ON ROMANIAN FISCAL FRAMEWORK

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