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Profit Taxation and Finance Constraints

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  • Keuschnigg, Christian
  • Ribi, Evelyn

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 cash-flow 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 C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7433.

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Date of creation: Aug 2009
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Handle: RePEc:cpr:ceprdp:7433

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

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Citations

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Cited by:
  1. 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.
  2. Edgerton, Jesse, 2010. "Investment incentives and corporate tax asymmetries," Journal of Public Economics, Elsevier, vol. 94(11-12), pages 936-952, December.
  3. Haufler, Andreas & Runkel, Marco, 2012. "Firms’ financial choices and thin capitalization rules under corporate tax competition," Munich Reprints in Economics, University of Munich, Department of Economics 20421, University of Munich, Department of Economics.
  4. 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.
  5. Henrekson, Magnus & Sanandaji, Tino, 2008. "Entrepreneurship and the Theory of Taxation," Working Paper Series, Research Institute of Industrial Economics 732, Research Institute of Industrial Economics, revised 19 Aug 2009.
  6. Marko Köthenbürger & Michael Stimmelmayr, 2009. "Corporate Taxation and Corporate Governance," CESifo Working Paper Series 2881, CESifo Group Munich.

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