The Effect of Taxation on Corporate Financing and Investment

Abstract

Extensive empirical research concerning the impact of taxes on corporate decisions has had trouble identifying seemingly obvious effects. Perhaps the problem is that the seemingly obvious tax predictions are not quite right. We provide an equilibrium model with both corporate and personal taxes. In steady state equilibrium, the level of production is affected by the corporate tax rate despite interest deductibility at the firm level; but not by the household level taxes on interest earnings or dividends. Several other tax irrelevance results are also proved. There is a Laffer curve in the corporate tax rate.

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

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