Paper #1813

Title:

The long-run effects of corporate tax reforms

Authors:

Isaac Baley and Andrés Blanco

Date:

January 2022

Abstract:

We investigate the long-run effects of permanent corporate tax reforms on aggregate capital behavior. In an investment model with fixed adjustment costs and partial irreversibility, we show that corporate taxes and investment frictions jointly determine three interconnected macroeconomic outcomes: (i) capital allocation, (ii) capital valuation, and (iii) capital fluctuations around steady-state. Using corporate tax and firm-level investment data from Chile, we discover that a lower corporate income tax improves the allocation of capital, reduces capital valuation, and accelerates capital fluctuations.

Keywords:

corporate taxes, investment frictions, fixed adjustment costs, irreversibility, lumpiness, capital misallocation, Tobin’s q, transitional dynamics, inaction, propagation

JEL codes:

D30, D80, E20, E30

Area of Research:

Macroeconomics and International Economics

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