Corporate Taxes and Investment: The Cash Flow Channel
40 Pages Posted: 13 Mar 2006 Last revised: 1 Feb 2011
Date Written: January 31, 2011
Abstract
Existing literature focuses on how corporate taxation affects firms' investment decisions by altering after-tax returns. This paper instead examines how corporate taxation affects investment by reducing the cash flow a firm has available to invest in the current period. I use a sharp nonlinearity in the mapping from pre-tax profitability to taxes created by the tax loss carryforward feature of the tax code to identify the cash flow effect of taxes. The results indicate that firms reduce investment when they pay more taxes, especially when unfavorable capital market conditions create a greater dependence of investment on internal sources of cash.
Keywords: investment, corporate taxation, financing constraints
JEL Classification: G31
Suggested Citation: Suggested Citation
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