CORPORATE TAX RATE POLICY AND PUBLIC AND PRIVATE EMPLOYMENT

Abstract

High tax revenues give the government the opportunity to create public employment. However, if the government tries to increase total tax revenues by increasing the corporate tax rate, two negative effects are invoked. Investment decreases, so that generally future tax revenues and private employment decrease. With the purpose to analyse this trade-off a dynamic game between the government and a representative firm is formulated. The government's objective is maximal total employment and the government's instrument is a corporate tax rate policy. The firm's objective is maximal total dividends and the firm's instrument is an investment rate policy. In general it is optimal for the government to start with a low corporate tax rate and to end with a high corporate tax rate. However, the switching time depends on the credibility and reputation of the government. If the government is committed to an announced policy, even if this announced policy becomes suboptimal over time, and if the firm is expected to believe so, the open-loop Stackelberg outcome of the game results. If the government is not committed to an announced policy and if the firm expects rational behaviour of the government at all times, the feedback Stackelberg outcome results. It is shown that in the open-loop outcome the switch in policy occurs later and the results are better for both the government and the firm than in the feedback outcome. Finally, the sensitivity of this switching time with respect to the capital/labour intensiveness is investigated.