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Corporate Income Taxation and Signaling

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  • Kwang Soo Cheong

Abstract

A signalling model is developed to investigate the consequences of corporate income taxation in the presence of adverse selection in the equity market. The model obtains a unique, informationally-constrained efficient equilibrium in which a better quality firm retains more inside-equity, and, as in the complete information case, only profitable firms are supported. The corporate income tax affects signalling costs as well as the profitability of projects. Numerical experiments with exponential utility functions find that the inside-equity position of a better quality firm increases as the corporate income tax rate rises. This reaction is, however, insensitive to the tax rate change due to the risk-sharing with the government, which leads to the interesting result that the corporate income tax only incurs a lower welfare cost than the lump sum tax with the same tax revenue.

Suggested Citation

  • Kwang Soo Cheong, 1997. "Corporate Income Taxation and Signaling," Working Papers 199713, University of Hawaii at Manoa, Department of Economics.
  • Handle: RePEc:hai:wpaper:199713
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    File URL: http://www.economics.hawaii.edu/research/workingpapers/88-98/WP_97-13.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    corporate income taxation; excess burden; signalling;

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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