Working Paper: CEPR ID: DP4816
Authors: Mihir Desai; Alexander Dyck; Luigi Zingales
Abstract: This Paper analyses the interaction between corporate taxes and corporate governance. We show that the characteristics of a taxation system affect the extraction of private benefits by company insiders. A higher tax rate increases the amount of income insiders divert and thus worsens governance outcomes. In contrast, stronger tax enforcement reduces diversion and, in so doing, can raise the stock market value of a company in spite of the increase in the tax burden. We also show that the corporate governance system affects the level of tax revenues and the sensitivity of tax revenues to tax changes. When the corporate governance system is ineffective (i.e., when it is easy to divert income), an increase in the tax rate can reduce tax revenues. We test this prediction in a panel of countries. Consistent with the model, we find that corporate tax rate increases have smaller (in fact, negative) effects on revenues when corporate governance is weaker. Finally, this approach provides a novel justification for the existence of a separate corporate tax based on profits.
Keywords: corporate governance; corporate taxation
JEL Codes: G30; H25; H26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher corporate tax rate (G38) | increases income diverted by insiders (G35) |
| increases income diverted by insiders (G35) | worse governance outcomes (D73) |
| stronger tax enforcement (H26) | reduces income diverted by insiders (G35) |
| reduces income diverted by insiders (G35) | increases stock market value (G10) |
| weaker corporate governance (G38) | increases tax rates associated with lower tax revenues (H29) |
| strong corporate governance (G38) | revenue-maximizing tax rate is higher (H21) |
| introduction of corporate tax system (H25) | improves governance when enforcement exceeds critical level (H11) |