Working Paper: NBER ID: w0687
Authors: Roger H. Gordon
Abstract: Since the average tax rate on corporate capital income is very high, economists often conclude that taxes have caused a substantial fall in corporate investment, a movement of capital into noncorporate uses, and a fall in personal savings. The combined efficiency costs of these distortions are believed to be very important. This paper attempts to show that when uncertainty and inflation are taken into account explicitly, taxation of corporate income leaves corporate investment incentives basically unaffected, in spite of the sizable tax revenues collected. In addition, in some plausible situations, such taxes can result in a gain in efficiency. The explanation for these surprising results is that the government, by taxing capital income, absorbs a certain fraction of both the expected return and the uncertainty in the return. While investors as a result receive a lower expected return, they also bear less risk when they invest, and these two effects are largely offsetting.
Keywords: Corporate Taxation; Capital Income; Investment Incentives; Efficiency Costs; Inflation
JEL Codes: H25; H32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Corporate income taxation (H24) | Corporate investment incentives (G31) |
| Corporate taxes (H29) | Expected return on investment (G11) |
| Corporate taxes (H29) | Risk associated with investment (G11) |
| High average tax rates (H29) | Expected after-tax return (G19) |
| Tax revenues (H29) | Distorting investment behavior (G40) |
| Taxation (H20) | Government absorption of risk (H12) |