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Profit Taxation, Innovation and the Financing of Heterogeneous Firms

  • Christian Keuschnigg


  • Evelyn Ribi


Credit constraints are more frequent among growth companies with large investment opportunities. For the same reason, profit taxes may harm innovative firms more than standard ones. This paper develops a model of heterogeneous firms where an endogenous share opts for innovation and faces credit constraints in the subsequent expansion phase. We emphasize four results: (i) R&D subsidies not only encourage innovation but also relax finance constraints and help innovative firms to exploit investment opportunities to a larger extent. (ii) Taxes which are neutral in a neoclassical world, still restrict expansion investment of constrained firms by reducing free cash-flow and thereby discourage innovation. (iii) A revenue neutral increase in profit taxes to finance larger R&D subsidies redistributes towards innovative firms and boosts aggregate productivity and welfare. (iv) A revenue neutral tax cut cum base broadening policy similarly boosts innovation and welfare

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Paper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2010 with number 2010-01.

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Length: 35 pages
Date of creation: Jan 2010
Date of revision:
Handle: RePEc:usg:dp2010:2010-01
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