Profit Taxation and Finance Constraints

29 Pages Posted: 7 Oct 2009

See all articles by Christian Keuschnigg

Christian Keuschnigg

University of St. Gallen – Department of Economics (FGN-HSG); CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Evelyn Ribi

University of St. Gallen

Multiple version iconThere are 2 versions of this paper

Date Written: August 2009

Abstract

In the absence of financing frictions, profit taxes reduce investment by their effect on the user cost of capital. With finance constraints due to moral hazard, investment becomes sensitive to cash-flow and own equity of firms. We propose a corporate finance model of investment and derive three central results: (i) Even small taxes impose first order welfare losses on financially constrained firms; (ii) ACE and cash-flow tax systems, which are investment neutral in the neoclassical model, are no longer neutral when firms are finance constrained. (iii) When banks are active and provide external finance together with monitoring services, the two systems not only reduce investment, but are also no longer equivalent. With active banks, investment is subject to double moral hazard and the timing of tax payments becomes important. The ACE system gives tax relief at the return stage and provides better incentives than a cash-flow tax which gives tax relief upfront.

Keywords: ACE tax, cash-flow tax, Finance constraints, profit tax

JEL Classification: G38, H25

Suggested Citation

Keuschnigg, Christian and Ribi, Evelyn, Profit Taxation and Finance Constraints (August 2009). CEPR Discussion Paper No. DP7433. Available at SSRN: https://ssrn.com/abstract=1484465

Christian Keuschnigg (Contact Author)

University of St. Gallen – Department of Economics (FGN-HSG) ( email )

Varnbuelstrasse 19
St. Gallen, 9000
Switzerland

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Evelyn Ribi

University of St. Gallen ( email )

Varnbuelstr. 14
Saint Gallen, St. Gallen CH-9000
Switzerland

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