The effect of corporate taxes on investment and the capital stock

Nick Draper () and Fré Huizinga ()

CPB Memoranda from CPB Netherlands Bureau for Economic Policy Analysis

Abstract: This paper analyses the effect of the corporate tax rate on the cost of capital and investment through two different channels. The first one concerns the fairly standard change in the user cost of capital, which determines a firm's optimal capital stock given that the firm is located in the Netherlands. The paper demonstrates that a reduction in the corporate tax rate reduces the user cost of capital because cost of capital is not fully deductible. The second channel deals with the direct effect of corporate taxation on profits. If capital is sufficiently mobile, the after tax profit margin cannot be affected by the corporate tax rate in equilibrium. Therefore, a rise in the corporate tax rate must be compensated by a compensating rise in the markup. We have assumed that only 35% of necessary markup rise will actually be established. To get a feel for the quantitative effects of these two channels, they have been incorporated into the JADE model, the econometric macro model of CPB. The results suggest that only considering the user cost of capital approach ignores an important aspect of the impact of a change in corporate taxation.

Keywords: investment; cost of capital; corporate taxation; taxation; tax (search for similar items in EconPapers)
JEL-codes: E22 H25 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-pbe
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Persistent link: http://EconPapers.repec.org/RePEc:cpb:memodm:13

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