Stimulative Effects of Temporary Corporate Tax Cuts

Policymakers often rely on temporary corporate tax cuts in order to provide incentives for business investment in recession times. A common motivation is that such policies help relax financing frictions, which might bind more during recessions. Our aim is to assess whether this mechanism is effective at raising aggregate investment and output. We consider an industry equilibrium model where some firms are financially constrained, and therefore have high marginal propensities to invest. By increasing current cash flows, corporate tax cuts are effective at stimulating investment. We quantify by how much aggregate investment and output increase, and describe the effects in the cross-section of firms. We find that, on impact, a temporary reduction in corporate taxation increases aggregate investment by 26 cents per dollar of tax stimulus, and aggregate output by 3.5 cents. The cumulative effect multipliers yield increases of investment and output of 4.6 and 7.2 cents, respectively. A major factor preventing larger effects is that this policy tends to significantly crowd out investment among the larger, unconstrained firms.