Corporate taxation when firms are heterogeneous: ACE versus CBIT

This paper compares the Allowance for Corporate Equity (ACE) tax and the Comprehensive Business Income Tax (CBIT) in a general equilibrium model with firms that face entry costs, fixed production costs and increasing marginal costs. We add the empirical regularity of heterogeneity (productivity and size) among firms and thus capture selection effects based on firm profitability. Corporate taxation affects selection and consequently the industry structure. An ACE tax distorts the industry structure by permitting the survival of less productive firms. In contrast, a CBIT is neutral on selection. Aggregate real income increases for an equal yield switch from ACE to CBIT. Yet, this switch hurts small low-productivity firms, while it boosts the earnings of large high-productivity firms.