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Taxation of Corporate Capital Income: Tax Revenues vs. Tax Distortions

  • Roger H. Gordon

Since the average tax rate on corporate capital income is very high, economists often conclude that taxes have caused a substantial fall in corporate investment, a movement of capital into noncorporate uses, and a fall in personal savings. The combined efficiency costs of these distortions are believed to be very important. This paper attempts to show that when uncertainty and inflation are taken into account explicitly, taxation of corporate income leaves corporate investment incentives basically unaffected, in spite of the sizable tax revenues collected. In addition, in some plausible situations, such taxes can result in a gain in efficiency. The explanation for these surprising results is that the government, by taxing capital income, absorbs a certain fraction of both the expected return and the uncertainty in the return. While investors as a result receive a lower expected return, they also bear less risk when they invest, and these two effects are largely offsetting.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0687.

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Date of creation: Jun 1981
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Publication status: published as Gordon, Roger H. "Taxation of Corporate Capital Income: Tax Revenues vs. Tax Distortions." Quarterly Journal of Economics, Vol. 100, No. 1, Feb. 1985,pp. 1-27.
Handle: RePEc:nbr:nberwo:0687
Note: PE
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  1. Martin Feldstein & Lawrence H. Summers, 1979. "Inflation and the Taxation of Capital Income in the Corporate Sector," NBER Working Papers 0312, National Bureau of Economic Research, Inc.
  2. Shoven, John B. & Whalley, John, 1972. "A general equilibrium calculation of the effects of differential taxation of income from capital in the U.S," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 281-321, November.
  3. Don Fullerton & Roger H. Gordon, 1981. "A Reexamination of Tax Distortions in General Equilibrium Models," NBER Working Papers 0673, National Bureau of Economic Research, Inc.
  4. Alan J. Auerbach & Martin Feldstein, 1978. "Inflation and the Choice of Asset Life," NBER Working Papers 0253, National Bureau of Economic Research, Inc.
  5. Martin Feldstein, 1978. "The Welfare Cost of Capital Income Taxation," NBER Chapters, in: Research in Taxation, pages 29-51 National Bureau of Economic Research, Inc.
  6. Charles L. Ballard & Don Fullerton & John B. Shoven & John Whalley, 1985. "General Equilibrium Analysis of Tax Policies," NBER Chapters, in: A General Equilibrium Model for Tax Policy Evaluation, pages 6-24 National Bureau of Economic Research, Inc.
  7. Stiglitz, Joseph E., 1973. "Taxation, corporate financial policy, and the cost of capital," Journal of Public Economics, Elsevier, vol. 2(1), pages 1-34, February.
  8. Hayne E. Leland, 1973. "Production Theory and the Stock Market," Cowles Foundation Discussion Papers 361, Cowles Foundation for Research in Economics, Yale University.
  9. David F. Bradford, 1978. "Tax Neutrality and the Investment Tax Credit," NBER Working Papers 0269, National Bureau of Economic Research, Inc.
  10. Alan J. Auerbach & Mervyn A. King, 1979. "Corporate Financial Policy, Taxes, and Uncertainty: An Integration," NBER Working Papers 0324, National Bureau of Economic Research, Inc.
  11. Arnold C. Harberger, 1962. "The Incidence of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, vol. 70, pages 215.
  12. DeAngelo, Harry & Masulis, Ronald W., 1980. "Optimal capital structure under corporate and personal taxation," Journal of Financial Economics, Elsevier, vol. 8(1), pages 3-29, March.
  13. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
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