Corporate Tax System Complexity and Investment

Abstract

Effective policymakers must balance the demands of formulating a corporate tax system that spurs economic activity while promoting a “level playing field” across firms. However, tax systems have become more complex over time, increasing firms’ difficulty in understanding and complying with tax regulations. We explore the role of corporate tax system complexity in both objectives, using an international sample and measuring tax system complexity based on the average time firms spend to comply with the country’s tax regulations. Examining both capital and labor investment, we document two key findings. First, firm-level investment is less sensitive to changes in corporate income tax rates when tax system complexity is higher, suggesting that such complexity can undermine the ability of tax policy to stimulate investment. Second, the impact of complexity on the sensitivity of investment to the tax rate varies significantly across firms, with domestic-owned, smaller, and private firms being more negatively affected by tax system complexity. The cross-sectional disparity in the effect suggests such complexity could undermine tax system parity. Our findings collectively suggest that corporate tax system complexity can negatively affect the ability of fiscal policy to encourage investment and leads to heterogeneous tax policy responses across firms.

Keywords: Tax complexity, tax rates, investment, employment, competition

JEL Classification: D25, F23, H23, H25, G31