The Effect of Taxation on Corporate Financing and Investment

Abstract

This paper studies the impact of taxation on corporate investment, debt, equity, and dividends. There is a classical tax code in which the firm pays tax on profits and the investor pays taxes on dividends, interest, and capital gains. We find that a small increase in the dividend tax (or the capital gains tax) has no effects on consumption, production or government revenue. Instead, the firm alters the dividends and share issuance policies. A small increase in corporate profits tax (or a cut in the tax on interest) reduces consumption, increases government revenue, and for realistic tax parameters increases production. There is one approximate symmetry between the impact of corporate profits tax and interest tax, and another between dividend tax and capital gains tax.