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Taxes and Growth in a Financially Underdeveloped Country: Evidence from the Chilean Investment Boom

  • Chang-Tai Hsieh
  • Jonathan A. Parker

This paper argues that taxation of retained profits is particularly distortionary in an economy with good growth prospects and poorly developed financial markets because it primarily reduces the investment of financially constrained firms, investment that has marginal product greater than the after-tax market real interest rate. Contrarily, taxes on distributed profits or capital gains primarily reduce the investment of financially unconstrained firms. Chile experienced a banking crisis over the period from 1982 to 1986 and in 1984 reduced its tax rate on retained profits from 50 percent to 10 percent. We show that, consistent with our theory, there was a large increase in aggregate investment after the reform which was entirely funded by an increase in retained profits. Further, we show that investment grew by more in industries that depend more on external financing, according to the Rajan and Zingales (1998) measure. Finally, we present some weak evidence from comparisons of investment rates across firms for several different measures of their likelihood of being financially constrained.

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File URL: http://www.nber.org/papers/w12104.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12104.

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Date of creation: Mar 2006
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Publication status: published as Chang-Tai Hsieh & Jonathan A. Parker, 2007. "Taxes and Growth in a Financially Underdevelopped Country: Evidence from the Chilean Investment Boom," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
Handle: RePEc:nbr:nberwo:12104
Note: CF EFG PE
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  1. Nina Pavcnik, 2002. "Trade Liberalization, Exit, and Productivity Improvements: Evidence from Chilean Plants," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 245-276.
  2. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-86, June.
  3. Manuel R. Agosin & Gustavo Crespi & Leonardo Letelier, 1997. "Análisis sobre el aumento del ahorro en Chile," Research Department Publications 3008, Inter-American Development Bank, Research Department.
  4. Agosin, Manuel R, 2001. "What Accounts for the Chilean Saving 'Miracle'?," Cambridge Journal of Economics, Oxford University Press, vol. 25(4), pages 503-16, July.
  5. Kasahara, Hiroyuki, 2009. "Temporary Increases in Tariffs and Investment: The Chilean Experience," Journal of Business & Economic Statistics, American Statistical Association, vol. 27, pages 113-127.
  6. Andrew A. Samwick, 2000. "Is Pension Reform Conducive to Higher Saving?," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 264-272, May.
  7. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March.
  8. repec:idb:wpaper:322 is not listed on IDEAS
  9. Cummins, J.G. & Hassett, K.A. & Hubbard, R.G., 1995. "tax Reforms and Investment: A Cross-Country Comparison," Working Papers 95-28, C.V. Starr Center for Applied Economics, New York University.
  10. Francisco A. Gallego & Norman Loayza, 2000. "Financial Structure in Chile: Macroeconomic Developments and Microeconomic Effects," Econometric Society World Congress 2000 Contributed Papers 1115, Econometric Society.
  11. Bradford, David F., 1981. "The incidence and allocation effects of a tax on corporate distributions," Journal of Public Economics, Elsevier, vol. 15(1), pages 1-22, February.
  12. Gilchrist, S. & Himmelberg, C.P., 1995. "Evidence on the Role of Cash Flow for Investment," Papers 95-29, Columbia - Graduate School of Business.
  13. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  14. Ricardo J. Caballero, 2000. "Structural Volatility in Chile: A Policy Report," Research Department Publications 4211, Inter-American Development Bank, Research Department.
  15. Felipe Morandé, 1996. "Savings in Chile: What Went Right?," IDB Publications (Working Papers) 5922, Inter-American Development Bank.
  16. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  17. Jonathan Gruber, 1995. "The Incidence of Payroll Taxation: Evidence from Chile," NBER Working Papers 5053, National Bureau of Economic Research, Inc.
  18. Sebastian Edwards, 1998. "The Chilean Pension Reform: A Pioneering Program," NBER Chapters, in: Privatizing Social Security, pages 33-62 National Bureau of Economic Research, Inc.
  19. Cristián Larroulet Vignau, 1987. "Endeudamiento interno: orígenes, soluciones y perspectivas," Past Working Papers 27, Universidad del Desarrollo, School of Business and Economics.
  20. Sebastian Edwards & Alejandra Cox Edwards, 2000. "Economic Reforms and Labor Markets: Policy Issues and Lessons from Chile," NBER Working Papers 7646, National Bureau of Economic Research, Inc.
  21. Hassett, Kevin A. & Hubbard, R. Glenn, 2002. "Tax policy and business investment," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 20, pages 1293-1343 Elsevier.
  22. Felipe G. Morandé, 1996. "Savings in Chile: What Went Right?," Research Department Publications 4030, Inter-American Development Bank, Research Department.
  23. Peter Diamond, 1993. "Privatization of Social Security: Lessons from Chile," NBER Working Papers 4510, National Bureau of Economic Research, Inc.
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