Loss-Offset Provisions in the Corporate Tax Code and Misallocation of Capital

By Baris Kaymak and Immo Schott

http://d.repec.org/n?u=RePEc:red:sed019:1177&r=dge

The corporate tax code allows corporations to write off operating losses against past or future tax obligations, resulting in effective tax rates that are firm-specific and dependent on the history of the firm’s performance. Since losses are partly an indication of a drop in productivity, which is generally persistent over time, firms with higher expected productivity face, on average, higher marginal taxes on their investment. In this paper, we analyze the distortionary effects of loss-offset provisions on investment and assess the associated aggregate output losses implied by the misallocation of capital. We find that replacing the corporate income tax with a revenue-neutral value-added tax which eliminates the firm-level differences in effective tax rates leads to a 13.9 percent increase in aggregate output.

Wow. I would never have expected 1) such a large distortion, and 2) that VAT would be so powerful.