Working Paper: CEPR ID: DP12932
Authors: Willem H. Buiter; Anne Sibert
Abstract: The recent reduction in the US corporate profit tax rate from 35 percent to 21 percent has triggered renewed interest in the impact of a cut in the corporate tax rate on capital accumulation and real wages. This theoretical contribution demonstrates that the familiar proposition that a cut in the corporate profit tax rate boosts the capital intensity of production and the real wage is sensitive to a number of key assumptions. Even when the real interest rate is exogenously given, full deductibility of capital expenditure from the corporate profit tax base will result in no impact of a corporate profit tax rate cut on the incentive to invest. Adding deductibility of interest can result in a negative effect on the capital intensity of production of a corporate profit tax rate cut.When the real interest rate is endogenous, we use the “perpetual youth” OLG model to demonstrate that the effects on consumption demand of a corporate profit tax cut will reduce the impact on capital intensity of a corporate profit tax cut if the tax cut is funded by higher lump-sum taxes on “permanent income” households. We have not been able to find examples where the capital intensity impact is reversed. Alternative funding rules (e.g. lower public consumption purchases) and the introduction of “Keynesian” consumers could lead to a larger positive effect on capital intensity from a cut in the corporate profit tax rate.
Keywords: Taxation; Public Finance; Corporate Profit Tax; Expensing; Capital Expenditure; OLG Model
JEL Codes: E21; E22; E62; E63; H2; H3; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Corporate profit tax cut (H32) | Capital intensity (E22) |
| Corporate profit tax cut (H32) | Real wages (J31) |
| Full deductibility of capital expenditures (G31) | Corporate profit tax cut does not incentivize investment (G31) |
| Endogeneity of the real interest rate (E43) | Negative impact on capital intensity (G31) |
| Higher lump-sum taxes (H29) | Diminished positive effects on capital intensity (D25) |
| Reduced public consumption or Keynesian consumers (E21) | Amplified positive effects of tax cuts on capital intensity (H32) |