How does corporate taxation affect business investment?
Evidence from aggregate and firm-level data
Business investment in OECD countries has remained weak, in particular since the 2008
global financial crisis. At the same time, the cost of capital has significantly and
steadily decreased over the last thirty years, reflecting a fall in both interest
rates and corporate tax rates. This raises the question of whether business investment
still responds to the cost of capital and thus whether corporate tax policy can support
investment. This paper analyses trends in business investment and in the cost of capital
in OECD countries over the past three decades. Then, it investigates empirically the
sensitivity of business investment to corporate taxation, and how this sensitivity
varies across firm, investment and tax-design characteristics. Panel regressions at
the firm and industry levels confirm that business investment rates are negatively
related to corporate taxation, measured by country-level forward-looking effective
tax rates. However, the tax sensitivity of business investment has fallen significantly
since the global financial crisis. It also differs significantly across firms, assets,
and corporate tax design characteristics. Overall, the estimation results suggest
that a nuanced and granular approach to corporate tax policy, accounting for heterogeneity
in tax sensitivity, is needed to support investment effectively. The paper discusses
possible policy options, including the reduction of non-profit taxes, the use of targeted
corporate income tax instruments, and the use of more generous capital allowances
where they may induce strong investment responses.
Published on July 19, 2023
In series:OECD Economics Department Working Papersview more titles