On Financial Adjustment and Investment Booms: Lessons from Tax Reforms
AbstractThe US and US tax reforms of the 1980s created tendencies in the OECD countries to cut tax rates and broaden tax bases. Though several studies have indicated the efficiency gains of such reforms, our results suggest that a policy of rate-cut-cum-base-broadening may actually reduce long-run capital formation. Moreover, given that a tax reform is anticipated, there is room for speculative investment behaviou. We suggest hence that there may be a trade-off between long-run efficiency gains and short-run costs in terms of additional volatility and increased indebtedness. Our model assumes constant returns and convex costs of adjustment. The financial and investment policy of firm is studied under various constraints on dividend policy, arising from the existing reporting conventions. It is shown that under uniform reporting requirement, an internal financial equilibrium exists and that the corporation income tax is equivalent to a cash-flow tax while under separate reporting, it is optimal to finance by debt and tax debt only. Some positive implications for international capital flows are pointed out and some normative issues are raised.
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Bibliographic InfoPaper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 95-01.
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Other versions of this item:
- Kanniainen, V. & Sodersten, J., 1995. "On Financial Adjustment and Investment Booms: Lessons from Tax Reforms," Papers 1995-19, Uppsala - Working Paper Series.
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- Alvarez, Luis H. R. & Kanniainen, Vesa & Sodersten, Jan, 1998. "Tax policy uncertainty and corporate investment: A theory of tax-induced investment spurts," Journal of Public Economics, Elsevier, vol. 69(1), pages 17-48, July.
- Alvarez JR, Luis & Kanniainen, Vesa & Södersten, Jan, 2000.
"Why is the Corporation Tax Not Neutral? Anticipated Tax Reform, Investment Spurts and Corporate Borrowing,"
Working Paper Series
2000:4, Uppsala University, Department of Economics.
- Luis Alvarez & Vesa Kanniainen & Jan Södersten, 1999. "Why is the Corporation Tax Not Neutral?. Anticipated Tax Reform, Investment Spurts and Corporate Borrowing," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 56(3/4), pages 285-, July.
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