week 6 Flashcards
What are corporations?
A corporation is a legal entity owned by at least one shareholder . Incorporation comes with limited liability, i.e., the owners cannot be held personally responsible for the firm’s obligations. Some corporation are trade publicly on the stock exchange, others are privately held.
taxing firms is the same as taxing labor and capital? Why then not tax the production factors directly?
Pure profits taxation - Corporations with market power will make pure profits and taxing this does not distort the choice of production factors.
Retained earnings - Not taxing may lead to delayed payout of earnings to generate lower net present discounted value of the tax burden.
What is the incidence of corporate tax?
Demand for goods that the corporate sector produces is likely not perfectly elastic, so consumers will pay atlest some of the tax through higher prices
How does corporate taxation affect investment decisions of firms?
Assume a world without corporate taxation - then: MB of investment = MC
Suppose a firms think about buying machines (K) which produces MPk of additional output.
it depreciates with δ
to finance the machine, the firm issues equity shares with dividend payment p
Total marginal cost of machine: δ + p
equilibrium: δ + p = MPk
assume taxes apply to cash earnings (no tax deductions)
MB = (1-t)MPk (refer to diagram on slide 8)
What are a firms options for financing investment?
- they can use retained earnings
- they can increase debt by borrowing
- they can issue equity (ownership shares)
What did Heider and Ljungqvist study and what were their findings?
In is important to first know:
interest payments are deductible from firm income - firms can manipulate this to pay no corporate tax.
They tried to find the relation ship between changes in corporate tax rates and its effects on corporate debt levels through a DiD - look at firm 1 in state A where tax rate has changed over time relative to firm 2 in state B where tax rate did not adjust within the same industry.
Findings:
The average corporate tax increase of 13% triggers a 4.5% increase in debt (as a share of financing), but there’s no such effect for tax rate decreasing.
Given that capital gains tax rates are lower than taxes for dividends, why do firms even pay dividends (rather than reinvesting to generate capital gains) ?
Agency theory: Managers suffer from the agency problem - investors are willing to live with the tax inefficiency to get the money out of the hands of the managers.
Signaling theory: Investors have imperfect information over firm performance. By paying dividends managers show that the firm is doing well.
How do governments tax international income?
There are an ever increasing number multinationals with subsidiaries in many countries. These firms can be taxed according to two principles:
- territorial system : Earnings are taxed in the country in which they accrue
- global system : Corporations are taxed in their home country with their global earnings.
the global system can only tax income that is repatriated
for example: foreign nation 10% corporate tax, domestic 35% - by not repatriating save 25%
upon repatriation later, the PV of tax payments is lower
what is transfer pricing?
the prices with which subsidiaries reimburse each other within the same company
what are the arguments for major tax reform?
- Tax compliance
- Tax simplicity
- Tax efficiency
What are the advantages and disadvantage of a consumption tax?
Advantages:
improves capital allocation - shifting of income between
different forms would end (eg,
salary benefits etc.)
Fair treatment for savers - current system penalizes saving
more (because returns on saving
are taxed)
Simplicity - much easier to assess what people buy
Disadvantage:
Vertical equity - Causes inequality as rich save more
Transition issues - if we switch now many people who have
made decades of choices on different
rules will pay.
Compliance - strong incentives for black markets
Cascading - Businesses, who often buy inputs on retails
would also be subject to tax too.
