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Optimal Corporate Taxation Under Financial Frictions

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  • Eduardo Dávila
  • Benjamin M. Hébert

Abstract

This paper studies the optimal design of corporate taxes when firms have private information about future investment opportunities and face financial constraints. A government whose goal is to efficiently raise a given amount of revenue from its corporate sector should attempt to tax unconstrained firms, which value resources inside the firm less than financially constrained firms. We show that a corporate payout tax (a tax on dividends and share repurchases) can both separate constrained and unconstrained firms and raise revenue, and is therefore optimal. Our quantitative analysis implies that a revenue-neutral switch from profit taxation to payout taxation would increase the overall value of existing firms and new entrants by 7%. This switch could be implemented in the current U.S. tax system by making retained earnings fully deductible.

Suggested Citation

  • Eduardo Dávila & Benjamin M. Hébert, 2019. "Optimal Corporate Taxation Under Financial Frictions," NBER Working Papers 25520, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:25520
    Note: CF EFG PE
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    References listed on IDEAS

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    1. Alessandro Pavan & Ilya Segal & Juuso Toikka, 2008. "Dynamic Mechanism Design: Incentive Compatibility, Profit Maximization and Information Disclosure," Carlo Alberto Notebooks 84, Collegio Carlo Alberto.
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    4. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
    5. Golosov, M. & Tsyvinski, A. & Werquin, N., 2016. "Recursive Contracts and Endogenously Incomplete Markets," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 725-841, Elsevier.
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    More about this item

    JEL classification:

    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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