Empirical Analysis of Corporate Tax Reforms: What is the Null and Where Did it Come from?

77 Pages Posted: 14 Mar 2018

See all articles by Chris Hennessy

Chris Hennessy

London Business School

Akitada Kasahara

Stanford University, Graduate School of Business, Students

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Date Written: March 12, 2018

Abstract

Absent theoretical guidance, empiricists have been forced to rely upon numerical comparative statics from constant tax rate models in formulating testable implications of tradeoff theory in the context of natural experiments. We fill the theoretical void by solving in closed-form a dynamic tradeoff theoretic model in which corporate taxes follow a Markov process with exogenous rate changes. We simulate ideal difference-in-differences estimations, finding that constant tax rate models offer poor guidance regarding testable implications. While constant rate models predict large symmetric responses to rate changes, our model with stochastic tax rates predicts small, asymmetric, and often statistically insignificant responses. Even with very long regimes (one decade), under plausible parameterizations, the true underlying theory -- that taxes matter -- is incorrectly rejected in about half the simulated natural experiments. Moreover, tax response coefficients are actually smaller in simulated economies with larger tax-induced welfare losses.

Keywords: Corporate finance, tax reforms, tax regimes, empirical tests, difference-in-differences estimation

JEL Classification: G32, G35, H25

Suggested Citation

Hennessy, Christopher and Kasahara, Akitada and Strebulaev, Ilya A., Empirical Analysis of Corporate Tax Reforms: What is the Null and Where Did it Come from? (March 12, 2018). Stanford University Graduate School of Business Research Paper No. 18-14. Available at SSRN: https://ssrn.com/abstract=3138793 or http://dx.doi.org/10.2139/ssrn.3138793

Christopher Hennessy

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Akitada Kasahara

Stanford University, Graduate School of Business, Students ( email )

Stanford, CA
United States

Ilya A. Strebulaev (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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