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Corporate taxes, productivity, and business dynamism

Working paper 780
Working Papers

Published: 20 June 2023

We identify the effects of corporate income tax shocks on key US macroeconomic aggregates. In response to a corporate income tax cut, we find that: (i) labor productivity increases; (ii) entry increases with delay; (iii) exit increases; (iv) total labor increases by more than production labor. To rationalize these empirical findings, we build a New Keynesian model with idiosyncratic firm productivity, and entry and exit. Our model features productivity gains due to selection and cleansing along the entry and exit margins. Models with homogeneous firms fail to account for the selection and cleansing process and produce counterfactual results.

Keywords: corporate taxation; productivity; firm entry and exit
JEL codes E62; E32; H25

Working paper no. 780

780 - Corporate taxes, productivity, and business dynamism

Download 780 - Corporate taxes, productivity, and business dynamism

Research Highlights

  • In this paper, we analyze how corporate income tax shocks affect labor productivity and business dynamism in the Unites States.
  • In the empirical analysis we use both aggregate data, in a vector autoregression (VAR) framework, and exploit variations in state-level corporate income taxes across US states.
  • We find that an unexpected cut in the corporate tax rate has immediate beneficial effects on productivity, GDP, and pre-tax profits. Also, it leads to a delayed surge in entry, and to an increase in exit of firms from the market. 
  • Exploiting a New Keynesian general equilibrium model with endogenous firm entry and exit, we find that selection and cleansing effects are paramount to capture the dynamic effects of corporate tax cuts identified in the data.
  • Further, we show that the critical nominal friction to address the empirical responses of productivity and profits to a tax shock is wage contracts, not price contracts.  


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