DP16936 The Long-Run Effects of Corporate Tax Reforms

Author(s): Isaac Baley, Andres Blanco
Publication Date: January 2022
Keyword(s): capital misallocation, corporate taxes, fixed adjustment costs, Inaction, investment frictions, Irreversibility, Lumpiness, propagation, Tobin's q, Transitional Dynamics
JEL(s): D30, D80, E20, E30
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16936

We investigate the long-run effects of permanent corporate tax reforms on aggregate capital behavior. In an investment model with fixed adjustment costs and partial irreversibility, we show that corporate taxes and investment frictions jointly determine three interconnected macroeconomic outcomes: (i) capital allocation, (ii) capital valuation, and (iii) capital fluctuations around steady-state. Using corporate tax and firm-level investment data from Chile, we discover that a lower corporate income tax improves the allocation of capital, reduces capital valuation, and accelerates capital fluctuations.