Working Paper: CEPR ID: DP18335
Authors: Vincenzo Cuciniello; Claudio Michelacci; Luigi Paciello
Abstract: Business creation subsidies are a means to reduce firm debt and bankruptcy risk. Do they work? To answer the question, we consider a general equilibrium model where firms are financially constrained at entry and borrow in a competitive market issuing long-term debt. The subsidy stimulates entry and market competition, which increases the bankruptcy rate of incumbent firms. If the subsidy is paid out ex-ante to finance start-up expenditures, the subsidy reduces the debt and the bankruptcy rate of start-ups; if paid out ex-post as a refund of start-up expenditures, the subsidy crowds out the equity rather than the debt of start-ups and their bankruptcy rate also increases. The model is calibrated to match North-South differences across Italian provinces. The optimal subsidy in the South is paid out entirely ex-ante and yields an increase in welfare equivalent to almost one percentage point of consumption. When the same subsidy is paid out ex-post in a proportion of 60 percent, it results in a welfare loss of a similar amount. We discuss implications for the "I Stay in the South" policy recently introduced in Italy.
Keywords: business taxation; bankruptcy; firm dynamics
JEL Codes: E1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ex-ante subsidy (H23) | reduces startup debt (G32) |
| ex-ante subsidy (H23) | reduces bankruptcy risk (G33) |
| ex-ante subsidy (H23) | stimulates entry (Y20) |
| stimulates entry (Y20) | increases bankruptcy rate of incumbent firms (G33) |
| ex-post subsidy (H23) | increases bankruptcy risk of startups (G33) |
| ex-post subsidy (H23) | crowds out equity (G19) |
| crowds out equity (G19) | increases bankruptcy risk of startups (G33) |
| ex-post subsidy (H23) | higher leverage ratios (G32) |
| higher leverage ratios (G32) | decreases profitability (L21) |
| ex-ante subsidy (H23) | optimal subsidy in the south increases welfare (D69) |
| ex-post subsidy (H23) | welfare loss (D69) |