, Volume 20, Issue 5, pp 808-826
Date: 17 Aug 2012

Profit taxes and financing constraints

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Abstract

Without financing frictions, profit taxes reduce investment by their effect on the user cost of capital. With financing constraints, investment becomes sensitive to cash-flow. In this situation, even small taxes impose first order welfare losses, and ACE and cash-flow tax systems are no longer neutral. When banks become active and provide monitoring services in addition to finance, an ACE tax yields larger investment and welfare than an equal yield cash-flow tax.

The paper was presented in research seminars of the Universities of Munich and St. Gallen and the Institute for Advanced Studies, at the Journées Louis-André Gérard-Varet in Marseille, the annual symposium of the Oxford Center for Business Taxation, the workshop ‘Economics of Ownership, Organization and Industrial Development’ in Stockholm, and the German Norwegian Seminar in Public Economics in Munich. We benefited from constructive comments by seminar participants, Alan Auerbach, Steven Bond, Mihir Desai, Michael Devereux and, in particular, our discussants Christian Traxler, Mikael Stenkula and Johannes Becker. We are particularly grateful for detailed suggestions and constructive comments by two anonymous referees and the editor, Eckhard Janeba.