Corporate tax cuts in a Schumpeterian growth model with an endogenous market structure

Abstract

AbstractSchumpeterian theory simply predicts a negative relationship between corporate income tax and the economic growth rate because this tax decreases innovation rewards. However, empirical evidence for the effect of corporate tax on the growth rate is mixed. To fill this gap, this paper presents a Schumpeterian growth model with an endogenous market structure that generates an ambiguous relationship between the corporate tax rate and the growth rate. We analytically find that the relationship between the corporate tax rate and the growth rate can be either inverted U‐shaped or negative. In our endogenous market structure model, corporate tax cuts make the market more competitive and increase the costs of employing researchers through labor market equilibrium. Consequently, these two effects may dominate the Schumpeterian effect. In this case, a corporate tax cut may decrease economic growth.