Taxation and the life cycle of firms

Abstract

The Hopenhayn and Rogerson (1993) framework is extended to understand how different forms of taxing capital income affect firms' investment and financial policies over their life cycle. Relative to dividends and capital gains taxation, corporate income taxation slows down firm growth over the life cycle by reducing after-tax profits available for reinvesting. It also diminishes entry by negatively affecting the value of entrants relative to that of incumbent firms. After a tax reform eliminating the corporate income tax in a revenue neutral way, output and capital increase by 12% and 32%. The large response of firm entry is crucial.