Asymmetric Treatment of Tax Losses and Corporate Investment

Abstract

In a sample of European private firms, we find that a less restrictive allocation of tax refunds to loss firms arising from loss carrybacks vis-a-vis carryforwards increases loss firms’ investment. However, only a third of the tax refund from loss carryback is invested. The other two-thirds are set aside as cash or returned to shareholders. We also find a delayed exit of loss firms with low productivity indicating that a less restrictive allocation of tax benefits to loss firms increases misallocation risk. While loss firms generate higher output under carryback regimes, the output gains from their investment are substantially smaller than for profitable firms. Taken together, these results suggest that a less asymmetric treatment of tax losses relative to profits increases investment and output at the cost of distorting the competitive selection of firms.