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Fiscal Policy and the Cost of External Finance to Firms

Cristina Badarau () and Andreea Semenescu ()

Emerging Markets Finance and Trade, 2010, vol. 46, issue 0, 36-50

Abstract: This study has two objectives. First, it analyzes the influence of corporate income taxes on the cost of external finance to firms in imperfect financial markets, and second, it evaluates the transmission of monetary and tax shocks in this framework. A model is proposed providing evidence on two opposite effects of corporate tax on a firm's external financing cost: a positive effect is induced by the traditional tax shield channel, while a negative effect comes from the firm's balance sheet channel. The dominance of one of these effects depends on firms' financial health. In a simple dynamic stochastic general equilibrium (DSGE) model, the presence of taxes amplifies the macroeconomic reaction of the real variables to monetary shocks, thus amplifying the financial accelerator role of the firm's balance sheet. As in the case of monetary shocks, the balance sheet channel acts equally in the model as an accelerator for the transmission of tax shocks.

Keywords: corporate tax; external finance premium; financial accelerator; imperfect credit market; investment decision of firms (search for similar items in EconPapers)
Date: 2010
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