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Profit Taxation, Innovation and the Financing of Heterogeneous Firms

  • Keuschnigg, Christian
  • Ribi, Evelyn

Credit constraints are more frequent among growth companies with large investment opportunities. For the same reason, profit taxes may harm innovative firms more than standard ones. This paper develops a model of heterogeneous firms where an endogenous share opts for innovation and faces credit constraints in the subsequent expansion phase. We emphasize four results: (i) R&D subsidies not only encourage innovation but also relax finance constraints and help innovative firms to exploit investment opportunities to a larger extent. (ii) Taxes which are neutral in a neoclassical world, still restrict expansion investment of constrained firms by reducing free cash-flow and thereby discourage innovation. (iii) A revenue neutral increase in profit taxes to finance larger R&D subsidies redistributes towards innovative firms and boosts aggregate productivity and welfare. (iv) A revenue neutral tax cut cum base broadening policy similarly boosts innovation and welfare.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7626.

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Date of creation: Jan 2010
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Handle: RePEc:cpr:ceprdp:7626
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