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Corporate Tax Policy and Long-Run Capital Formation: The Role of Irreversibility and Fixed Costs

  • Jianjun Miao

    ()

    (Department of Economics, Boston University)

This paper presents an analytically tractable continuous-time general equilibrium model with investment irreversibility and fixed adjustment costs. In the model, there is a continuum of firms that are subject to idiosyncratic shocks to capital. Although the presence of investment frictions lowers consumer welfare, it may raise or reduce the long-run average capital stock, depending on the degree of idiosyncratic uncertainty. An increase in this uncertainty may raise equilibrium aggregate capital, but reduce welfare. An unexpected permanent change in the corporate income tax rate affects the investment trigger and target values, and hence the size and rate of capital adjustment. Following this tax policy, the percentage changes in equilibrium quantities are larger when fixed adjustment costs are larger. These changes are significantly smaller in a general equilibrium model than in a partial equilibrium model.

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File URL: http://www.bu.edu/econ/ied/dp/papers/dp181.pdf
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Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - The Institute for Economic Development Working Papers Series with number dp-181.

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Length: 40
Date of creation: Apr 2009
Date of revision:
Handle: RePEc:bos:iedwpr:dp-181
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  1. Jianjun Miao, 2011. "Optimal Capital Structure and Industry Dynamics," CEMA Working Papers 440, China Economics and Management Academy, Central University of Finance and Economics.
  2. Alan J. Auerbach, 1986. "Tax Reform and Adjustment Costs: The Impact on Investment and Market Value," NBER Working Papers 2103, National Bureau of Economic Research, Inc.
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  15. Christopher A. Hennessy & Toni M. Whited, 2007. "How Costly Is External Financing? Evidence from a Structural Estimation," Journal of Finance, American Finance Association, vol. 62(4), pages 1705-1745, 08.
  16. Marcelo L. Veracierto, 2002. "Plant-Level Irreversible Investment and Equilibrium Business Cycles," American Economic Review, American Economic Association, vol. 92(1), pages 181-197, March.
  17. Abel, Andrew B., 1982. "Dynamic effects of permanent and temporary tax policies in a q model of investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 353-373.
  18. Samuel Bentolila & Giuseppe Bertola, 1990. "Firing Costs and Labour Demand: How Bad is Eurosclerosis?," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 381-402.
  19. Giuseppe Bertola & Ricardo J. Caballero, 1991. "Irreversibility and Aggregate Investment," NBER Working Papers 3865, National Bureau of Economic Research, Inc.
  20. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-38, October.
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