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The effect of corporate taxes on investment and the capital stock

Author

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  • Nick Draper

    (CPB Netherlands Bureau for Economic Policy Analysis)

  • Free Huizinga

    () (CPB Netherlands Bureau for Economic Policy Analysis)

Abstract

This paper analyses the effect of the corporate tax rate on the cost of capital and investment through two different channels. The first one concerns the fairly standard change in the user cost of capital, which determines a firm's optimal capital stock given that the firm is located in the Netherlands. The paper demonstrates that a reduction in the corporate tax rate reduces the user cost of capital because cost of capital is not fully deductible. The second channel deals with the direct effect of corporate taxation on profits. If capital is sufficiently mobile, the after tax profit margin cannot be affected by the corporate tax rate in equilibrium. Therefore, a rise in the corporate tax rate must be compensated by a compensating rise in the markup. We have assumed that only 35% actually be established. To get a feel for the quantitative effects of these two channels, they have been incorporated into the JADE model, the econometric macro model of CPB. The results suggest that only considering the user cost of capital approach ignores an important aspect of the impact of a change in corporate taxation

Suggested Citation

  • Nick Draper & Free Huizinga, 2001. "The effect of corporate taxes on investment and the capital stock," CPB Memorandum 13, CPB Netherlands Bureau for Economic Policy Analysis.
  • Handle: RePEc:cpb:memodm:13
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    File URL: https://www.cpb.nl/sites/default/files/publicaties/download/memo130.pdf
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    References listed on IDEAS

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    1. Auerbach, Alan J, 1983. "Taxation, Corporate Financial Policy and the Cost of Capital," Journal of Economic Literature, American Economic Association, vol. 21(3), pages 905-940, September.
    2. Brock, William A & Turnovsky, Stephen J, 1981. "The Analysis of Macroeconomic Policies in Perfect Foresight Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 22(1), pages 179-209, February.
    3. Joeri Gorter & A. Parikh, 2000. "How mobile is capital within the European Union?," CPB Research Memorandum 172, CPB Netherlands Bureau for Economic Policy Analysis.
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    Cited by:

    1. Nick Draper & Alex Armstrong, 2007. "GAMMA; a simulation model for ageing, pensions and public finances," CPB Document 147, CPB Netherlands Bureau for Economic Policy Analysis.
    2. Henk Kranendonk & Johan Verbruggen, 2007. "SAFFIER; a multi-purpose model of the Dutch economy for short-term and medium-term analyses," CPB Document 144, CPB Netherlands Bureau for Economic Policy Analysis.

    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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