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Could Higher Taxes Increase the Long-Run Demand for Capital?: Theory and Evidence for Chile

By Eduardo M. Engel, Alvaro Bustos and Alexander Galetovic

Abstract

On theoretical grounds alone, there is no a priori reason why higher taxes should reduce the desired capital stock, since a tax increase reduces marginal returns but also increases depreciation and interest payment allowances. Using a panel of Chilean corporations, this paper estimates a long-run demand for capital valid for a general adjustment-cost structure. Changes in the corporate tax rate are found to have no effect on the long run demand for capital. Furthermore, when making investment decisions, firms ignore the marginal rates paid by their stockholders, suggesting the presence of a corporate veil.Adjustment Costs, Corporate Veil, Demand for Capital, Depreciation Allowances, User Cost of Capital

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