The Effect of Taxation on Corporate Financing and Investment

Abstract

Extensive empirical research into the impact of taxes on corporate investment has had trouble identifying unambiguous effects. We build a model with taxes on the household/investor and on the firm, to study the tax effects. A key idea is that the firm maximizes the after-tax wealth of the household and therefore chooses an efficient level of production. Corporate tax reduces optimal physical capital despite interest deductibility, and produces a Laffer curve. The model generates a number of tax irrelevance results that may help explain why it has been so difficult to find clear evidence of tax effects.

Keywords: corporate tax, dividend tax, consumption tax, dividend policy, equity, debt, investment, Laffer curve

JEL Classification: G31, G32, G35, D92, H25