Optimal Corporate Taxation Under Financial Frictions
Eduardo Dávila , Benjamin Hébert, Optimal Corporate Taxation Under Financial Frictions, The Review of Economic Studies, Volume 90, Issue 4, July 2023, Pages 1893–1933, https://doi.org/10.1093/restud/rdac068
This article studies the optimal design of corporate taxes when firms have private information about future investment opportunities and face financial constraints. A government whose goal is to efficiently raise a given amount of revenue from its corporate sector should attempt to tax unconstrained firms, which value resources inside the firm less than financially constrained firms. We show that a corporate payout tax (a tax on dividends and share repurchases) can both separate constrained and unconstrained firms and raise revenue and is therefore optimal. Our quantitative analysis implies that a revenue-neutral switch from profit taxation to payout taxation would increase the overall value of existing firms and new entrants by 7%. This switch could be implemented in the current US tax system by making retained earnings fully deductible.