Do Corporate Tax Cuts Increase Investments?

Accounting and Business Research, Forthcoming

53 Pages Posted: 3 Dec 2013 Last revised: 6 Jun 2016

Laura Dobbins

Free University of Berlin (FUB)

Martin Jacob

WHU - Otto Beisheim School of Management

Date Written: May 2016

Abstract

This paper studies the effect of corporate taxes on investment. Since firms with a foreign parent have more cross-country profit shifting opportunities than domestically owned firms do, their effective tax rate and, consequently, their tax-induced costs to investment are lower. We therefore expect capital investment responses to a corporate tax cut to be heterogeneous across firms. Using firm-level data on German corporations, we exploit the 2008 tax reform, which substantially cut corporate taxes as an exogenous policy shock and expect domestically owned firms' investments to be more responsive to the reform. We show exactly this in a difference-in-differences setting. We find that the reduction in corporate tax payments led to a one-to-one increase in the real investments of domestic firms. The effect is stronger for domestic firms relying more on internal funds. Correspondingly, labor investment increased more for domestic firms, ensuring a constant mix of input factors. In addition, we show that domestic firms' sales grew faster after the tax cut than the sales of foreign-owned firms. Our results imply that corporate tax changes can increase corporate investment but that domestic firms benefit more than foreign-owned firms from a tax cut through higher investment responses resulting in greater sales growth.

Keywords: Corporate taxation, Investment

JEL Classification: G31, H24, H25

Suggested Citation

Dobbins, Laura and Jacob, Martin, Do Corporate Tax Cuts Increase Investments? (May 2016). Accounting and Business Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2362258 or http://dx.doi.org/10.2139/ssrn.2362258

Laura Dobbins

Free University of Berlin (FUB) ( email )

Kaiserswerther Str. 16-18
Berlin, Berlin 14195
Germany

Martin Jacob (Contact Author)

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
D-56179 Vallendar, 56179
Germany

HOME PAGE: http://www.whu.edu/steuer

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