Could Higher Taxes Increase the Long-Run Demand for Capital? Theory and Evidence for Chile"
Is a tax increase always detrimental for capital formation? This paper estimates a long-run demand for capital in Chile, and studies the responsiveness of firms’ desired capital stock to variations in tax rates. We combine the neoclassical model with a cointegration argument to obtain a long-run demand for capital that is valid for a general adjustment-cost structure. On theoretical grounds alone, there is no a priori reason why higher taxes should reduce the desired capital stock. Higher taxes reduce returns but simultaneously increase depreciation and interest payment allowances. When the sum of increased allowances is large enough, a higher corporate tax rate may reduce the cost of capital. We show that this result continues holding when the corporate veil is lifted and firms consider the income tax paid by its stockholders. The model is estimated with a panel of Chilean corporations with annual data between 1985 and 1995. The results we obtain suggest that changes in the corporate tax rate have almost no effect on the long run demand for capital: in 10 of the 11 years in our sample an increase in the corporate tax rate leads to a negligible increase in the desired capital stock. We also find that firms ignore the marginal rates their stockholders pay when they make investment decisions,i.e. there is a corporate veil.
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|Date of creation:||Jul 2003|
|Date of revision:|
|Publication status:||Published in Journal of Development, Vol. 73, No. 2, 2004|
|Contact details of provider:|| Postal: PO Box 8269, New Haven CT 06520-8269|
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ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION,
ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, August.
- Chang-Tai Hsieh & Jonathan A. Parker, 2006. "Taxes and Growth in a Financially Underdeveloped Country: Evidence from the Chilean Investment Boom," NBER Working Papers 12104, National Bureau of Economic Research, Inc.
- Alan J. Auerbach, 1983. "Corporate Taxation in the United States," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(2), pages 451-514.
- Mervyn A. King, 1974. "Taxation and the Cost of Capital," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 21-35.
- Jorgenson, D.W., 1992. "Tax Reform and the Cost of Capital : An International Comparison," Harvard Institute of Economic Research Working Papers 1621, Harvard - Institute of Economic Research.
- Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
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