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Title: Profit Taxation, Innovation and the Financing of Heterogeneous Firms

Author(s): Christian Keuschnigg and Evelyn Ribi

Publication Date: January 2010

Keyword(s): credit constraints, innovation, investment, profit taxes and R&D subsidies

Programme Area(s): Public Economics

Abstract: 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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Bibliographic Reference

Keuschnigg, C and Ribi, E. 2010. 'Profit Taxation, Innovation and the Financing of Heterogeneous Firms'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7626