Graduate Public Finance -...
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Graduate Public FinanceBusiness Taxation Part III: Investment and Corporate Financial Policy
Owen ZidarPrincetonFall 2018
Lecture 10
Thanks to Alan Auerbach, Raj Chetty, Jim Poterba, Danny Yagan, and Terry Moon forproviding their notes, some of which are reproduced here.
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Outline
1 User CostImpact of TCJA (Barro Furman, BPEA 2018)
2 Corporate Finance and Investment Incentives
3 Payout Policy: Dividend Taxation
4 Payout Policy: Capital Gains Taxation
5 APPENDIX: Payout model and Old vs New View
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Outline
1 User CostImpact of TCJA (Barro Furman, BPEA 2018)
2 Corporate Finance and Investment Incentives
3 Payout Policy: Dividend Taxation
4 Payout Policy: Capital Gains Taxation
5 APPENDIX: Payout model and Old vs New View
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User Cost expression with taxes
Jorgenson’s (1963) user cost of capital Rt is the classic way to analyze theeffect of taxation on investment
R =q(1 − τz)(r + δ − π)
1 − τ
q is the price of capital goods and π is the corresponding inflation rate
τ is the corporate tax rate
z is the present value of depreciation deductions per dollar of newcapital
Can also include an investment tax credit term (which would enter,e.g., z = ITC/τ)
r is the firm’s nominal cost of funds (presumably a weighted avg ofdebat and equity costs)
δ is the rate at which capital depreciates
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Comments on User Cost expression with taxes
With immediate expensing, z = 1 so the tax terms cancel, yielding:
R = q(r + δ − π)
This expression is the continuous time version of what we had beforewithout taxes
Dynamics/expectations re path of q, τ, z , ITC change the expression
See Hall and Jorgenson (AER,1967) for derivations or more recentnotes by Poterba (MIT open course web 14.471 Fall 2012) orAuerbach (2005) paper “Taxation and Capital Spending”
See Yagan (AER, 2015) appendix D for empirical implementation
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Measuring User Cost in Practice
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Measuring User Cost (Barro Furman, BPEA 2018)
Start by ignoring debt financing and assume τ and z are constant:
R =(1 − τz)(r + δ)
1 − τ
τ and z summarize the tax system (note λ ≡ z in BF)
r is set to 8.2 (see paper for discussion); implicitly assumes horizontalsupply of capital
δ is the rate at which capital depreciates
Equipment δ = 8.8%Structures δ = 2.0%Rental residential property δ = 2.7%R&D intellectual property δ = 12.3%Other intellectual property δ = 19.5%
BF then add debt financing tradeoff between tax advantage and cost ofhigher default probabilityGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 7 / 68
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Measuring User Cost (Barro Furman, BPEA 2018)
Adding this extra term for debt financing gives:
R =(1 − τz)(r + δ)
1 − τ− 1
2
(τ
1 − τ
)debtshare × i
12 is from calibrated marginal cost of debt financing (see eq 5; fn 14)
debtshare is the share of financing from debt, which they set to 1/3
i is the nominal interest rate on corporate bonds
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TCJA effect on C-corp tax ratesBarro and Furman (BPEA, 2018)
BF consider three scenarios:1 Baseline in 2017: τ = 38%
Federal ( 23 )35% + ( 1
3 )31.85% (from DPAD) = 34%Add 4% for state corporate tax
2 Law as written (applicable as of 2027): τ = 27%
Federal = 21%Adjust to reflect NOL limitations and smaller offsets (1.5pp)Add 4% for state corporate tax
3 Provisions permanent (applicable as of 2019): τ = 26%
Federal = 21%Adjust to reflect NOL limitations and smaller offsets (0.25pp)Add 4% for state corporate tax
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TCJA effect on C-corp user costsBarro and Furman (BPEA, 2018)
Source: (Barro Furman, BPEA 2018)
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TCJA effect on pass-through tax ratesBarro and Furman (BPEA, 2018)
BF consider three scenarios:1 Baseline in 2017: τ = 35.2%
Assumed value for average marginal tax rate for owners ofnon-C-corporate businesses
2 Law as written (applicable as of 2027): τ = 35.5%
Reflects elimination of DPAD and some bracket creep due to shiftingto chained CPI
3 Provisions permanent (applicable as of 2019): τ = 31.1%
Reflects reduction in individual tax rates and allowable part of the 20percent pass-through deductionPartially offset with higher marginal rates from capping SALT
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TCJA effect on pass-through user costsBarro and Furman (BPEA, 2018)
Source: (Barro Furman, BPEA 2018)
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Economic Impacts
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From user cost changes to impacts on economic activityBarro and Furman (BPEA, 2018)
1 Production FunctionY = AKαL1−α where α = .38Kα = Kα1
1 Kα22 Kα3
3 Kα44 Kα5
5 for each type of capital
2 Elasticity of capital labor ratio (K/L) w.r.t user cost
MPK = αA(KL
)−(1−α)
Implies that the elasticity of (K/L) to user cost is −1/(1 − α) ≈ 1.6
3 Output per workerElasticity of (Y/L) to user cost is −α/(1 − α) ≈ .6With 5 types of capital, numerator is αk -weighted average of user costchangeAlso note that wages are proportional to Y /L from labor FOC
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TCJA effect on C-corp economic activityBarro and Furman (BPEA, 2018)
Source: (Barro Furman, BPEA 2018)
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TCJA effect on pass-through economic activityBarro and Furman (BPEA, 2018)
Source: (Barro Furman, BPEA 2018)
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TCJA effect on overall economic activity, switchingBarro and Furman (BPEA, 2018)
Source: (Barro Furman, BPEA 2018)
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Open Questions from Barro Furman
1 Tax rate vs baseEffects of expensing vs interest deductibilityHow to model NOLs, etc, and their impacts on user cost and growth
2 Actual Investment responsesDo estimates line up with predictions? Heterogeneity by type of capitalWhere does investment come from? Extensive, intensive, FDI?More broadly, what are the effects on the international provisions?Crowd-out from deficits? How do responses change w/ higher r?
3 Output per worker and wagesHow do these changes impact Y/L and wages? what are thedistributional impacts?
4 OthersHow much corporate form switching was there? Are there productivitygains from switching? Tax revenue impacts?What do firms do with the windfalls to old capital?How much reallocation of capital and labor is there?
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Outline
1 User CostImpact of TCJA (Barro Furman, BPEA 2018)
2 Corporate Finance and Investment Incentives
3 Payout Policy: Dividend Taxation
4 Payout Policy: Capital Gains Taxation
5 APPENDIX: Payout model and Old vs New View
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Liquidity and Corporate Investment
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 20 / 68
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“Modern” Empirical Studies of Cash Flow and Investment
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 21 / 68
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Effects of q and Cash Flow on Investment (FHP 1988)
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 22 / 68
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Cost of Funds from Retained Earnings, Debt, and Equity
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 23 / 68
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Debt Finance
Source: Poterba
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Equity Finance: Dividend-Paying Firms
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 25 / 68
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Equity Finance: Firms That Retain Earnings
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 26 / 68
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Corner Solutions for Corporate Financial Policy
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 27 / 68
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Explaining Simultaneous Use of Debt and Equity Finance
Source: PoterbaGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 28 / 68
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Outline
1 User CostImpact of TCJA (Barro Furman, BPEA 2018)
2 Corporate Finance and Investment Incentives
3 Payout Policy: Dividend Taxation
4 Payout Policy: Capital Gains Taxation
5 APPENDIX: Payout model and Old vs New View
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Payout Taxes
Source: Yagan
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Evidence
Source: Yagan
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Chetty-Saez (2005)
Source: Yagan
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Effect of 2003 dividend tax cut on dividend payouts
Source: Yagan
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Effect of ’03 div. tax cut on initiations of regular dividends
Source: Yagan
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Effect of 2003 dividend tax cut on dividend-paying fraction
Source: Yagan
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Heterogeneity suggestive of agency problems
Source: YaganGraduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 36 / 68
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Yagan (AER, 2015)
Source: Yagan (AER, 2015)
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Must control for business cycle
Source: Yagan (AER, 2015)
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Yagan (AER, 2015)
Source: Yagan (AER, 2015)
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Example: Retail hardware chains
Source: Yagan (AER, 2015)
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Example: Retail hardware chains
Source: Yagan (AER, 2015)
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Balanced across industries and size in $1m-$1bn size range
Source: Yagan (AER, 2015)
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Zero effects on investment and employee compensation
Source: Yagan (AER, 2015)
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Effects constant across firm size distribution
Source: Yagan (AER, 2015)
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Immediate financial response confirms relevance/salience
Source: Yagan (AER, 2015)
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Yagan (AER, 2015)
Source: Yagan (AER, 2015)
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Yagan (AER, 2015)
Source: Yagan (AER, 2015)
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Outline
1 User CostImpact of TCJA (Barro Furman, BPEA 2018)
2 Corporate Finance and Investment Incentives
3 Payout Policy: Dividend Taxation
4 Payout Policy: Capital Gains Taxation
5 APPENDIX: Payout model and Old vs New View
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Capital Gains Taxes and Real Corporate Investment
Moon (2018)
Question: What is the effect of capital tax cuts on firm investmentand stock prices?
Data: South Korean pubilc and private firms
Design: firm size specific capital gains tax cut from 24% to 10%
Outcomes: Investment, Stock Prices, Equity Issuance
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Moon (2018)
Source: Moon (2018)Graduate Public Finance (Econ 523) Investment and Corp Financial Policy Lecture 10 50 / 68
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Moon (2018)
Source: Moon (2018)
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Moon (2018)
Source: Moon (2018)
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Moon (2018)
Source: Moon (2018)
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Moon (2018)
Source: Moon (2018)
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Moon (2018)
Source: Moon (2018)
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How big should these effects be?
Important to think hard about magnitude of estimated effects
See appendix B.4 of Moon (2018)
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Outline
1 User CostImpact of TCJA (Barro Furman, BPEA 2018)
2 Corporate Finance and Investment Incentives
3 Payout Policy: Dividend Taxation
4 Payout Policy: Capital Gains Taxation
5 APPENDIX: Payout model and Old vs New View
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