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How Do Taxes Affect Investment When Firms Face Financial Constraints?

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  • Martin Simmler

Abstract

This study uses a switching regression framework with known sample separation to analyze the effects of corporate income taxation on investment in case of binding and non-binding financial constraints. By employing two different sample splitting criteria, payout behavior and the ratio of liabilities to total assets, I show that the elasticity of capital to its user costs in an auto-distributed-lag model is underestimated in case of neglecting the presence of financial constraints. For unconstrained firms, the elasticity of capital to its user costs is around -1. For financially constrained firms the elasticity is statistically not different from zero. For the latter group instead, the results prevail by using the effective average tax rate to measure liquidity outflow through taxation that corporate taxation affects investment through changing internal finance. In addition, this study helps to understand the methodological differences between auto-distributed-lag and error-correction models.

Suggested Citation

  • Martin Simmler, 2012. "How Do Taxes Affect Investment When Firms Face Financial Constraints?," Discussion Papers of DIW Berlin 1181, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp1181
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    File URL: https://www.diw.de/documents/publikationen/73/diw_01.c.391198.de/dp1181.pdf
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    Citations

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    Cited by:

    1. Marina Riem, 2016. "Corporate investment decisions under political uncertainty," ifo Working Paper Series 221, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    2. Matjaž Črnigoj, 2016. "The Responsiveness of Corporate Investments to Changes in Corporate Income Taxation During the Financial Crisis: Empirical Evidence from Slovenian Firms," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 52(9), pages 2165-2177, September.
    3. Bournakis, Ioannis & Mallick, Sushanta, 2018. "TFP estimation at firm level: The fiscal aspect of productivity convergence in the UK," Economic Modelling, Elsevier, vol. 70(C), pages 579-590.
    4. Nadja Dwenger, 2014. "User Cost Elasticity of Capital Revisited," Economica, London School of Economics and Political Science, vol. 81(321), pages 161-186, January.

    More about this item

    Keywords

    Investment cash flow sensitivity; financial constraints; taxation; effective average tax rate; effective marginal tax rate; switching regression;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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