20.06.2023 |
Research
Corporate tax rate cut does not increase investments, but increases business activity
A study by Jarkko Harju , Aliisa Koivisto, and Tuomas Matikka investigates how a corporate tax cut affects the behavior of small firms in Finland.
During recent years, several developed countries have reduced their corporate tax rates to stimulate firm-level investment and economic activity. These types of reforms reduce the cost of capital and relax the financial constraints of firms.
A study by Jarkko Harju (Tampere University, VATT Institute of Economic Research), Aliisa Koivisto (VATT), and Tuomas Matikka (VATT) investigates how a corporate tax cut affects the behavior of small firms in Finland. The study utilizes two Finnish corporate tax reforms in 2012 and 2014, where the tax rate on corporate profits was first reduced from 26% to 24.5% in 2012 and then further to 20% in 2014. The changes were accompanied by a dividend tax rate increase, leaving the effective dividend tax rate unchanged. The study utilizes administrative data and difference-in-differences method comparing small privately held corporations affected by tax rate cuts to similar partnerships that faced no change in taxes.
The study finds no changes in investments among small firms. However, the paper reports a moderate average increase in sales and variable costs for the treated corporations, which implies that the overall business activity of small firms increased after the reform. The observed sales and input responses were driven by cash-constrained firms and firms owned by active owner-managers, which suggests that the availability of cash resources and the role and effort of the main owner are important factors in explaining how small firms respond to changes in financial incentives. This provides new evidence of the mechanisms behind firm responses to corporate taxes. Moreover, the study finds no significant effects on firm entry or dividend payouts.
The findings illustrate that small firms can respond to tax cuts on other relevant margins than capital investments. The results further suggest that the additional cash resources provided by the tax cut are important in explaining these findings. Overall, the study provides novel evidence of the effects of a reform including an actively debated shift of the tax burden from corporate taxes toward the personal income taxes of owners.
The article The Effects of Corporate Taxes on Small Firms has been published in Journal of Public Economics, Volume 212, August 2022 (behind a paywall).
