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Profit Taxation and Finance Constraints

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  • Christian Keuschnigg
  • Evelyn Ribi

Abstract

In the absence of financing frictions, profit taxes reduce investment by their effect on the user cost of capital. With finance constraints due to moral hazard, investment becomes sensitive to cash-flow and own equity of firms. We propose a corporate finance model of investment and derive three central results: (i) Even small taxes impose first order welfare losses on financially constrained firms; (ii) ACE and cashflow tax systems, which are investment neutral in the neoclassical model, are no longer neutral when firms are finance constrained. (iii) When banks are active and provide external finance together with monitoring services, the two systems not only reduce investment, but are also no longer equivalent. With active banks, investment is subject to double moral hazard and the timing of tax payments becomes important. The ACE system gives tax relief at the return stage and provides better incentives than a cash-flow tax which gives tax relief upfront.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2914.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_2914

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Keywords: finance constraints; profit tax; cash-flow tax; ACE tax;

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References

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Citations

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Cited by:
  1. Magnus Henrekson & Tino Sanandaji, 2011. "Entrepreneurship and the theory of taxation," Small Business Economics, Springer, Springer, vol. 37(2), pages 167-185, September.
  2. Edgerton, Jesse, 2010. "Investment incentives and corporate tax asymmetries," Journal of Public Economics, Elsevier, Elsevier, vol. 94(11-12), pages 936-952, December.
  3. Christian Keuschnigg, 2010. "Die volkswirtschaftliche Bedeutung des Accounting," University of St. Gallen Department of Economics working paper series 2010, Department of Economics, University of St. Gallen 2010-03, Department of Economics, University of St. Gallen.
  4. Ruud Mooij & Michael Devereux, 2011. "An applied analysis of ACE and CBIT reforms in the EU," International Tax and Public Finance, Springer, Springer, vol. 18(1), pages 93-120, February.
  5. Marko Köthenbürger & Michael Stimmelmayr, 2009. "Corporate Taxation and Corporate Governance," CESifo Working Paper Series, CESifo Group Munich 2881, CESifo Group Munich.
  6. Andreas Haufler & Marco Runkel, 2008. "Firms’ Financial Choices and Thin Capitalization Rules under Corporate Tax Competition," CESifo Working Paper Series, CESifo Group Munich 2429, CESifo Group Munich.

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