Corporate Limited Liability and the Design of Corporate Taxation

Posted: 6 Aug 1999

See all articles by Kose John

Kose John

New York University (NYU) - Department of Finance

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Anant K. Sundaram

Tuck School of Business at Dartmouth

Date Written: July 1994

Abstract

Corporate limited liability can create agency conflicts between the public and private sectors. The resulting distortion may induce overinvestment in risky technologies relative to the social optimum. This paper examines the role of a well-designed corporate tax structure in aligning private investment choices with socially optimal levels. An appropriate constant tax rate imposed on the positive cash flows provides sufficient investment disincentives to offset the overinvestment incentives of limited liability. However, the optimal tax rate is specific to the technology of individual firms. It is shown that a tax structure designed with an economy-side single tax rate when combined with other features such as an initial zero tax bracket, investment-based deductions, tax credits and tax deductibility of debt can replicate the same incentives as that of an economy with multiple technology-specific tax rates. Institutional features observed in many advanced economies are consistent with such a design of taxation.

JEL Classification: G30, G38, H21

Suggested Citation

John, Kose and Senbet, Lemma W. and Sundaram, Anant K., Corporate Limited Liability and the Design of Corporate Taxation (July 1994). Available at SSRN: https://ssrn.com/abstract=5761

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Lemma W. Senbet (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

Anant K. Sundaram

Tuck School of Business at Dartmouth ( email )

100 Tuck Hall
Hanover, NH 03755
United States
603-646-8248 (Phone)
603-646-1308 (Fax)

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