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Taxes and Growth in a Financially Underdeveloped Country: Evidence from the Chilean Investment Boom

58 Pages Posted: 14 May 2006 Last revised: 30 Jul 2010

Chang-Tai Hsieh

University of Chicago - Booth School of Business; University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Jonathan A. Parker

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: March 2006

Abstract

This paper argues that taxation of retained profits is particularly distortionary in an economy with good growth prospects and poorly developed financial markets because it primarily reduces the investment of financially constrained firms, investment that has marginal product greater than the after-tax market real interest rate. Contrarily, taxes on distributed profits or capital gains primarily reduce the investment of financially unconstrained firms. Chile experienced a banking crisis over the period from 1982 to 1986 and in 1984 reduced its tax rate on retained profits from 50 percent to 10 percent. We show that, consistent with our theory, there was a large increase in aggregate investment after the reform which was entirely funded by an increase in retained profits. Further, we show that investment grew by more in industries that depend more on external financing, according to the Rajan and Zingales (1998) measure. Finally, we present some weak evidence from comparisons of investment rates across firms for several different measures of their likelihood of being financially constrained.

Suggested Citation

Hsieh, Chang-Tai and Parker, Jonathan A., Taxes and Growth in a Financially Underdeveloped Country: Evidence from the Chilean Investment Boom (March 2006). NBER Working Paper No. w12104. Available at SSRN: https://ssrn.com/abstract=892129

Chang-Tai Hsieh (Contact Author)

University of Chicago - Booth School of Business ( email )

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University of California, Berkeley - Department of Economics ( email )

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Berkeley, CA 94720-3880
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National Bureau of Economic Research (NBER)

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Jonathan A. Parker

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Cambridge, MA
United States
617-253-7218 (Phone)

National Bureau of Economic Research (NBER)

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United States

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