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

  • Chang-Tai Hsieh

    ()

  • Jonathan A. Parker

    ()

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

Volume (Year): (2007)
Issue (Month): (August)
Pages:

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Handle: RePEc:col:000425:008638
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  2. Ricardo J. Caballero, 2000. "Structural Volatility in Chile: A Policy Report," Research Department Publications 4211, Inter-American Development Bank, Research Department.
  3. Francisco A. Gallego & Norman Loayza, 2000. "Financial Structure in Chile: Macroeconomic Developments and Microeconomic Effects," Econometric Society World Congress 2000 Contributed Papers 1115, Econometric Society.
  4. Jonathan Gruber, 1995. "The Incidence of Payroll Taxation: Evidence from Chile," NBER Working Papers 5053, National Bureau of Economic Research, Inc.
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  8. Raghuram G. Rajan & Luigi Zingales, 1996. "Financial Dependence and Growth," NBER Working Papers 5758, National Bureau of Economic Research, Inc.
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  12. 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.
  13. Morande, Felipe G., 1998. "Savings in Chile. What went right?," Journal of Development Economics, Elsevier, vol. 57(1), pages 201-228, October.
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  15. Peter Diamond, 1993. "Privatization of Social Security: Lessons from Chile," NBER Working Papers 4510, National Bureau of Economic Research, Inc.
  16. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  17. 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.
  18. Felipe Morandé, 1996. "Savings in Chile: What Went Right?," IDB Publications (Working Papers) 5922, Inter-American Development Bank.
  19. 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.
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