Why is there Corporate Taxation? The Role of Limited Liability Revisited

Most economists reject the idea that corporate taxation should be interpreted as a price for the privilege of limited liability. In this paper, we reconsider this idea and show that limited liability can lead to overinvestment if information is incomplete. In this setting, introducing an additional tax on limited liability contracts is welfare-enhancing. Our model thus offers an explanation for the nexus between double taxation and limited liability observed in many existing tax systems.      

Why is the corporate tax rate lower than the personal tax rate?: The role of new firms

In many OECD countries, statutory corporate tax rates are lower than personal income tax rates. This tax rate difference is often particularly large for small firms. The present paper argues that a reduction of the corporate tax rate below the personal tax rate is an optimal tax policy if there are problems of asymmetric information between investors and firms in the capital market. The reduction of the corporate tax rate below the personal tax rate encourages equity financing and thus mitigates the excessive use of debt financing induced by asymmetric information. Our main theoretical result stands in marked contrast to the traditional view of corporate taxation and corporate finance theory, according to which there is a tax disadvantage to equity financing. More recent empirical evidence on this issue, however, is in line with our result.     

Adverse selection,asymmetric information,and foreign investment policies

This paper explores the welfare consequences of foreign investment taxation in a small open economy, based on the notion that the true productivity of imported capital may be unknown to policy-makers. It is shown that while asymmetric information between capital importers and the host government precludes the use of a productivity specific policy measure, an across-the-board policy suffers from the problem of adverse selection among capital imports of differential productivities. Conditions under which a reversal of the optimal foreign investment policy in the face of asymmetric information are examined.     

Public capital, asymmetric information, and economic growth

Abstract.  We investigate the provision of public capital in an endogenous growth model with asymmetric information. In a credit market with costly screening, we show that the equilibrium contracts are characterized by the self‐selection of borrowers. Through identifying an additional adverse effect of taxation on growth, we show that the optimal tax rate in our model is smaller than the output elasticity of public capital. Therefore, our analysis justifies a more conservative tax policy in the presence of asymmetric information. Furthermore, our model suggests a number of implications that appear to be well supported by preliminary evidence in cross‐country data. JEL classification: D82, H21, O41     

科技型企业创业风险、堑壕效应与控制权配置

将创业者事后敲竹杠和创业成功后堑壕效应的前向延伸作为影响因素，构建模型对科技型企业创业过程中投资者和创业者之间风险分担、收益分配及控制权配置的影响进行分析。结果发现：完全信息下创业者最优努力水平和帕累托最优风险分担可以实现，投资者和创业者主要矛盾前移至创业开始前的收益分担；信息不对称下帕累托最优风险分担不可能实现，创业者有动机通过采取降低努力水平、事后敲竹杠和事前堑壕效应行为取得额外收益，以此分散人力资本风险；创业者首先倾向于选择后两种行为获取更高的控制权配置收益，失败时将倾向于回到降低努力水平选择上。因此，投资者适度分权可避免创业者出现降低努力水平的行为，从而提升创业成功概率。     

Dividends, safety and liquidation when liabilities are long-term and stochastic

This paper investigates the optimal management of a firm faced with a long-term liability that occurs at a random date. Three issues are analysed: The optimal dividend policy; optimal expenditure on safety to delay the occurrence of the liability; and the optimal liquidation date of the firm. An owner faced with dynamic unlimited liability never liquidates and therefore accumulates capital to the golden rule level. For long-term liabilities, dividend payments and safety expenditure are non-decreasing over time. The owner protected by limited liability may liquidate the firm in finite time in order to avoid paying the liability. If this is the case, then it accumulates less capital than the dynamic unlimited liability owner; and may decrease dividend payments and safety expenditure over time. The paper shows that a finite liquidation date is more likely to be optimal when the arrival rate of the liability occurrence increases over time.     

Subsidy design: wealth versus benefits

A government would like to subsidize an indivisible good. Consumers’ valuations of the good vary according to their wealth and benefits from the good. A subsidy scheme may be based on consumers’ wealth or benefit information. We translate a wealth-based policy to a benefit-based policy, and vice versa, and give a necessary and sufficient condition for the pair of policies to implement the same assignment: consumers choose to purchase the good under the wealth-based policy if and only if they choose to do so under the translated benefit-based policy. General taxation allows equivalent policies to require the same budget.     

Optimal environmental taxation and enforcement policy

We study the optimal environmental taxation and enforcement policy when (i) the regulator does not know the firms’ abatement costs, (ii) penalties for tax evasion are limited, and (iii) monitoring of pollution is costly. We show that the threat of being audited alter the usual firms’ incentives to over-estimate their abatement costs. In particular, depending on the firms’ abatement costs, the optimal policy may involve over or under-deterrence compared to the full information outcome. We then investigate the properties of a pollution standard. We show that this policy comes close to an environmental tax once the economic incentives of the accompanying enforcement policy are considered.     

Worksharing and Access Discounts in the Postal Sector with Asymmetric Information*

This paper analyzes the optimal worksharing and access amounts granted to mailers and entrants in a liberalized postal sector when there is asymmetric information about the Post Office’s (PO) costs. I show that when the regulator is unable to ascertain which part of the total cost of sorting has to be attributed to each sorting facility, the optimal “access discount” given to entrants is set in a pro-competitive way. This facilitates the entry of firms that are less efficient than the PO. However, the optimal “worksharing discount” may prevent the entry of mailers that are more efficient than the PO.     

Estate taxation with warm-glow altruism

This article examines the properties of the optimal fiscal policy in an economy with warm-glow altruism (utility interdependence) and heterogeneous individuals. We propose a new efficiency concept, D-efficiency, that considers an implicit constraint in the act of giving: Donors cannot bequeath to donees more than their existing resources. Considering this constraint, we show that the market equilibrium is not socially efficient. The efficient level of bequest transfers can be implemented by the market with estate and labor-income subsidies and a capital-income tax. In the absence of lump-sum taxation, the government faces a trade-off between minimizing distortions and eliminating external effects. The implied tax policy differs from Pigovian taxation since the government’s ability to correct the external effects is limited. Finally, we show that the efficiency-equity trade-off does not affect the qualitative features of the optimal distortionary fiscal policy.

Informational externalities,strategic delay,and optimal investment subsidies

Abstract This paper examines optimal government policy when private investment generates information, but investors cannot internalize the informational value their actions have to others. Equilibrium exhibits inefficient delay, as investors adopt a wait‐and‐see approach. The government can alter incentives via an investment subsidy, but complications arise, since future subsidies may induce investors to disregard current policy initiatives. The paper shows that the government achieves its desired outcome only when the the investment subsidy is financed by a non‐distortionary, lump‐sum tax. When taxation is distortionary, the government faces a time inconsistency problem that may prevent effective policy.     

Production and financial policies under asymmetric information

We propose an extension of the standard general equilibrium model with production and incomplete markets to situations in which (i) private investors have limited information on the returns of specific assets, (ii) managers of firms have limited information on the preferences of individual shareholders. The extension is obtained by the assumption that firms are not traded directly but grouped into ‘sectorial’ funds. In our model the financial policy of the firm is not irrelevant. We establish the existence of equilibria and discuss the nature of the inefficiencies introduced by the presence of asymmetric information. We also illustrate the properties of the model in three simple examples. We would like to thank Alberto Bisin, Armando Dominioni, Piero Gottardi, Tito Pietra, Paolo Siconolfi, and an anonymous referee for useful suggestions and comments.     

Foreign direct investment under oligopoly: Profit shifting or profit capturing?

In this paper a model of taxation of foreign source corporate income is developed when the output market is not perfectly competitive. Profit shifting policies, similar to those in the new trade literature, are also present in the case of foreign direct investment (FDI). There are, however, important differences to the new trade theory since in case of FDI, (i) corporate taxation and double taxation relief are the policy instruments rather than output or revenue taxes, (ii) countries are not symmetric in the sense that the host country has the first right to tax the multinational's profit and the home country reacts by providing double taxation relief, and (iii) output but not corporate taxation is specific to imperfectly competitive industries. It is argued that (a) variants of a tax credit are analogous to export subsidies, (b) when the home country operates a tax credit system the host country's incentive to capture the multinational's profit is bounded under imperfect competition, (c) when the host country offers a tax holiday the home country should imitate this policy, and (d) in the presence of perfect competitive industries, double taxation relief is a good instrument to target imperfectly competitive industries.     

Consumption taxation, social status and indeterminacy in models of endogenous growth with elastic labor supply

In this paper, we examine the effects of consumption taxation on long-run growth in an infinitely lived representative-agent model of endogenous growth with endogenous labor supply in which the desire for social status induces private agents to care about others’ wealth or consumption levels. This analysis shows that the increase in consumption taxation raises (reduces) the long-run growth rate when the equilibrium path is locally indeterminate (determinate), provided the desire for social status is not too strong in the relative wealth model. By contrast, in the consumption externalities model, the same result holds, if the Frisch labor supply and labor demand curves have the ‘normal’ slopes at their intersection point, while the result is reversed if these two curves have the ‘wrong’ slopes.     

Taxes versus quantities for a stock pollutant with endogenous abatement costs and asymmetric information

We compare emissions taxes and quotas when a (strategic) regulator and (non-strategic) firms have asymmetric information about abatement costs, and all agents use Markov perfect decision rules. Firms make investment decisions that affect their future abatement costs. For general functional forms, firms’ investment policy is information-constrained efficient when the regulator uses a quota, but not when the regulator uses an emissions tax. This advantage of quotas over emissions taxes has not previously been recognized. For a special functional form (linear–quadratic) both policies are constrained efficient. Using numerical methods, we find that a tax has some advantages in this case.     

Regulating a risk-averse firm under incomplete information

We examine the optimal regulatory policy for a risk-averse firm when the firm is imperfectly informed about its efficiency parameter for a project at the time of contracting. The firm’s risk aversion shifts the optimal regulatory policy from a fixed-price contract to a cost-plus contract. The optimal regulatory policy entails undereffort by an inefficient firm as in Laffont and Tirole (J Polit Econ 94(3):614–641, 1986) and the effort distortion increases as the firm becomes more risk-averse. Further, the regulator benefits from sequential contracting with the firm where the firm chooses contract terms gradually as it acquires information, albeit the benefit diminishes as the firm becomes more risk-averse.      

Markets as beneficial constraints on the government

We study the role of anonymous markets in which trades cannot be monitored by the government. We adopt a Mirrlees approach to analyze economies in which agents have private information and a benevolent government controls optimal redistributive tax policy. While unrestricted access to anonymous markets reduces the set of policy instruments available to the government, it also limits the scope of inefficient redistributive policies when the government lacks commitment. Indeed, the restrictions that anonymous markets impose on the optimal fiscal policy, especially on capital taxation and the history-dependence of income taxation, can have positive welfare effects in this case.     

Intergenerational policy and the measurement of tax incidence

We evaluate the ability of generational accounting to assess the potential welfare implications of policy reforms. In an intergenerational context policy reforms usually have redistributive, efficiency, and general equilibrium implications. Our analysis shows that when the policy reform implies changes in economic efficiency, generational accounts can be misleading not only about the magnitude of welfare changes, but also about the identity of who wins and who losses. In contrast, the generational accounts correctly identify welfare changes when the policy reform has only a pure intergenerational redistribution component. We illustrate and quantify this issue in the context of widely considered policy reforms (substitution of consumption for labor taxation, and the increase of retirement age) and in a more general context of optimal policy.     

Asymmetric monetary policy and the effective lower bound

We use the canonical New Keynesian model to study optimal discretionary policy when the nominal interest rate is constrained by the effective lower bound (ELB). We show that policymakers who seek to minimize a (symmetric) quadratic loss function involving deviations of inflation and output from targets will achieve an average inflation rate below target due to the contractionary effects associated with hitting the ELB. We also characterize optimal discretionary policy for policymakers who view output losses as asymmetric: they place weight on the output gap when output is below potential but place little or no weight on the gap when output is above potential. In comparison to optimal policy using the symmetric loss function, the average inflation rate is higher and closer to the central banks target. Moreover, in response to contractionary demand shocks that push the nominal interest rate to the effective lower bound, policymakers with an asymmetric loss function adopt a policy rate path that remains at the ELB longer but eventually rises more quickly than the path adopted by a policymaker with a symmetric loss function.     

Good Jobs,Bad Jobs and Redistribution*

We analyse the question of optimal taxation in a dual economy, when the policy‐maker is concerned about the distribution of labour income. Income inequality is caused by the presence of sunk capital investments, which creates a “good jobs” sector due to the capture of quasi‐rents by trade unions. With strong unions and high planner preference for income equality, the optimal policy is a combination of investment subsidies and progressive income taxation. If unions are weaker, the policy‐maker may instead choose to tax investment.