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Public, Health and Welfare Economics

KDI Policy Forum

Impact of Corporate Tax Cuts on Corporate Investment

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  • Author NAM. Changwoo
  • Date 2016/11/28
  • Series No. KDI Policy Forum No. 264 (2016-01), eng.
  • Language English
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SUMMARY □ There has been growing public support for a tax hike as corporate investment remains stagnant despite the recent cut in the corporate tax rate. Accordingly, this study aims to closely examine the impact of the corporate tax rate on investment.

○ Managerial decisions, including those on investment, are based on a diverse range of factors, encompassing not only the corporate tax rate but also financial conditions and investment uncertainties. As such, corporate characteristics must be controlled, when possible, before estimating the impact of corporate tax change on investment.

□ An empirical analysis found that Korea’s listed companies expand their investment significantly when the corporate tax rate is reduced.

○ For the robustness of the analysis results, this study adopted various models and methodologies to analyze listed companies in 2002-2014 and found that a 1%p cut in the average effective corporate tax rate caused the investment rate to increase by 0.2%p.

○ In particular, it can be assumed that such an increase in investment may have been higher if the managements‘ tunneling activities were curtailed.

- An analysis, using a structural model, revealed that in Korea, management sought private interests nine times more than their counterparts in the US, diminishing the effects of a tax cut by roughly 28% in the short run.

□ Therefore, the government must take a cautious approach when increasing the corporate tax rate, and also strengthen the internal and external monitoring and supervision of management to enable companies to make reasonable investment decisions.
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Managerial decisions are swayed not merely by the corporate tax rate but also by various
factors including the company’s financial condition and investment uncertainties.

Therefore, before analyzing the impact of changes in the corporate tax rate on corporate
investment, corporate characteristics must first be controlled, when possible.

According to the empirical results, there is a significant spike in the investment of Korea’s listed companies when the corporate tax rate is reduced.

Through an analysis of the listed companies in Korea from 2002 to 2014, it was found that investment rate climbed 0.2%p for every 1%p reduction in the average effective corporate tax rate.

What should be noted here is that, the boosting effect that the tax reduction has on investment would have been considerably larger if the tunneling activities of management were prevented.

This is because, investment decisions can be distorted by management
using their positions to legally pursue private interests or illegally use cash holdings,
which inevitably diminishes the effects of the tax cut.

A structural model was applied to quantitatively examine the negative effects
from such a distortion, which revealed that the degree of tunneling
by management in Korea is 9 times higher than that in the US.

According to the simulation, the presence of management’s tunneling activities reduces
the tax cut effect by 28% in the short-term.

Under the circumstances, a hike in the corporate tax rate would intensify
the tunneling activities of management, which would in turn,
exacerbate the downturn in employment and investment and even weaken the effect of income distribution.

Consequently, the government must take a cautious approach with regards to a corporate
tax hike while also making efforts to strengthen both the internal and external supervision
and monitoring of the management level to curtail their tunneling activities.

As a result, this would enable and encourage management to make reasonable,
sound decisions including those on employment and investment.
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