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Taxes and Growth in a Financially Underdevelopped Country: Evidence from the Chilean Investment Boom

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  • Chang-Tai Hsieh

    ()

  • Jonathan A. Parker

    ()

Abstract

This paper argues that taxation of retained profits is particularly distortionary in an economy with good growth prospects and poorly developed financial markets because it primarily reduces the investment of financially constrained firms, investment that has marginal product greater than the after-tax market real interest rate. Contrarily, taxes on distributed profits or capital gains primarily reduce the investment of financially unconstrained firms. Chile experienced a banking crisis over the period from 1982 to 1986 and in 1984 reduced its tax rate on retained profits from 50 percent to 10 percent. We show that, consistent with our theory, there was a large increase in aggregate investment after the reform which was entirely funded by an increase in retained profits. Further, we show that investment grew by more in industries that depend more on external financing, according to the Rajan and Zingales (1998) measure. Finally, we present some weak evidence from comparisons of investment rates across firms for several different measures of their likelihood of being financially constrained.

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Bibliographic Info

Article provided by LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION in its journal JOURNAL OF LACEA ECONOMIA.

Volume (Year): (2007)
Issue (Month): ()
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Handle: RePEc:col:000425:008638

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Keywords: taxes; nondeveloped financial markets; investment; Chile;

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  1. Simon Gilchrist & Charles P. Himmelberg, 1995. "Evidence on the Role of Cash Flow for Investment," Working Papers 95-01, New York University, Leonard N. Stern School of Business, Department of Economics.
  2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  3. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
  4. Andrew A. Samwick, 2000. "Is Pension Reform Conducive to Higher Saving?," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 264-272, May.
  5. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1995. "Tax Reforms and Investment: A Cross-Country Comparison," NBER Working Papers 5232, National Bureau of Economic Research, Inc.
  6. Nina Pavcnik, 2002. "Trade Liberalization, Exit, and Productivity Improvements: Evidence from Chilean Plants," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 245-276.
  7. Jonathan Gruber, 1995. "The Incidence of Payroll Taxation: Evidence from Chile," NBER Working Papers 5053, National Bureau of Economic Research, Inc.
  8. Agosin, Manuel R, 2001. "What Accounts for the Chilean Saving 'Miracle'?," Cambridge Journal of Economics, Oxford University Press, vol. 25(4), pages 503-16, July.
  9. Francisco Gallego Y. & Norman Loayza., 2000. "Financial Structure in Chile: Macroeconomic Developments and Microeconomic Effects," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 3(2), pages 5-30, August.
  10. Manuel R. Agosin & Gustavo Crespi & Leonardo S. Letelier, 1997. "Análisis sobre el aumento del ahorro en Chile," IDB Publications 7568, Inter-American Development Bank.
  11. Sebastian Edwards & Alejandra Cox Edwards, 2000. "Economic reforms and labour markets: policy issues and lessons from Chile," Economic Policy, CEPR & CES & MSH, vol. 15(30), pages 181-230, 04.
  12. Felipe G. Morandé, 1996. "Savings in Chile: What Went Right?," Research Department Publications 4030, Inter-American Development Bank, Research Department.
  13. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers 0349, National Bureau of Economic Research, Inc.
  14. Raghuram G. Rajan & Luigi Zingales, . "Financial Dependence and Growth," CRSP working papers 344, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  15. Kasahara, Hiroyuki, 2009. "Temporary Increases in Tariffs and Investment: The Chilean Experience," Journal of Business & Economic Statistics, American Statistical Association, vol. 27, pages 113-127.
  16. Peter Diamond, 1993. "Privatization of Social Security: Lessons from Chile," NBER Working Papers 4510, National Bureau of Economic Research, Inc.
  17. R. Glenn Hubbard, 1997. "Capital-Market Imperfections and Investment," NBER Working Papers 5996, National Bureau of Economic Research, Inc.
  18. repec:fth:inadeb:322 is not listed on IDEAS
  19. Felipe Morandé, 1996. "Savings in Chile: What Went Right?," IDB Publications 5922, Inter-American Development Bank.
  20. Sebastian Edwards, 1996. "The Chilean Pension Reform: A Pioneering Program," NBER Working Papers 5811, National Bureau of Economic Research, Inc.
  21. Ricardo J. Caballero, 2000. "Structural Volatility in Chile: A Policy Report," Research Department Publications 4211, Inter-American Development Bank, Research Department.
  22. Hassett, Kevin A. & Hubbard, R. Glenn, 2002. "Tax policy and business investment," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 20, pages 1293-1343 Elsevier.
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