Working Paper: CEPR ID: DP7626
Authors: Christian Keuschnigg; Evelyn Ribi
Abstract: Credit constraints are more frequent among growth companies with large investment opportunities. For the same reason, profit taxes may harm innovative firms more than standard ones. This paper develops a model of heterogeneous firms where an endogenous share opts for innovation and faces credit constraints in the subsequent expansion phase. We emphasize four results: (i) R&D subsidies not only encourage innovation but also relax finance constraints and help innovative firms to exploit investment opportunities to a larger extent. (ii) Taxes which are neutral in a neoclassical world, still restrict expansion investment of constrained firms by reducing free cash-flow and thereby discourage innovation. (iii) A revenue neutral increase in profit taxes to finance larger R&D subsidies redistributes towards innovative firms and boosts aggregate productivity and welfare. (iv) A revenue neutral tax cut cum base broadening policy similarly boosts innovation and welfare.
Keywords: credit constraints; innovation; investment; profit taxes; RD subsidies
JEL Codes: G38; H25; L26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| RD subsidies (H23) | innovation (O35) |
| RD subsidies (H23) | alleviate financial constraints (G51) |
| alleviate financial constraints (G51) | exploit investment opportunities (G11) |
| profit taxes (H25) | restrict investment expansion (G31) |
| restrict investment expansion (G31) | diminish free cash flow (D25) |
| diminish free cash flow (D25) | discourage innovation (O31) |
| increase profit taxes (H29) | redistribute resources towards innovative firms (O31) |
| redistribute resources towards innovative firms (O31) | boost aggregate productivity and welfare (O49) |
| tax cut + base broadening (H29) | enhance innovation and welfare (O35) |