Capital Taxation and Imperfect Competition: ACE vs. CBIT

27 Pages Posted: 20 Nov 2014

See all articles by Kurt Richard Brekke

Kurt Richard Brekke

Norwegian School of Economics (NHH) - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Armando José Garcia Pires

Norwegian School of Economics (NHH) - Department of Economics

Dirk Schindler

Erasmus School of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Guttorm Schjelderup

Norwegian School of Economics (NHH) - Department of Business and Management Science

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Date Written: November 14, 2014

Abstract

This paper studies the market and welfare effects of two main tax reforms – the Corporate Business Income Tax (CBIT) and the Allowance for Corporate Equity tax (ACE). Using an imperfect-competition model for a small open economy, it is shown that the well-known neutrality property of ACE does not hold. Both corporate tax regimes distort market entry and equilibrium prices. A main result is that a small open economy should levy a positive source tax on capital in markets with free firm entry. Which tax system is better from a welfare point of view, depends on production technology, the competitive effects of ACE and CBIT, and whether entry is excessive or suboptimal at the given corporate tax rate. Imposing tax income neutrality yields a higher corporate tax rate with ACE, which increases the scope for CBIT to be welfare improving.

Keywords: Optimal corporate taxation, Corporate tax reform, Imperfect competition, ACE, CBIT

JEL Classification: D43, H25

Suggested Citation

Brekke, Kurt Richard and Garcia Pires, Armando José and Schindler, Dirk and Schjelderup, Guttorm, Capital Taxation and Imperfect Competition: ACE vs. CBIT (November 14, 2014). NHH Dept. of Business and Management Science Discussion Paper No. 2014/37, Available at SSRN: https://ssrn.com/abstract=2528452 or http://dx.doi.org/10.2139/ssrn.2528452

Kurt Richard Brekke

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Armando José Garcia Pires

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway
+47 5 595 9577 (Phone)
+47 5 595 9350 (Fax)

Dirk Schindler

Erasmus School of Economics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Guttorm Schjelderup (Contact Author)

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

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