Skip to main content

On investment and taxes

To follow up on Matias' last post, with all of this talk about taxes and job creators, it is worth thinking through the effects of taxes on the decision by firm to invest in new plant and equipment (thus creating jobs). Thinking through the baseline scenario, it is not immediately obvious why a capital gains tax (or even a profits tax) would discourage investment. The investor (firm) only gets taxed on gains (profit) so unless the tax is 100 per cent, they still make money. It would be hard to find a successful businessman who chooses not to make money! Of course, other costs may imply that the world is a little more complicated.

In addition, it is well known in the empirical literature on investment that the decision by to firms to expand productive capacity is quite insensitive to the cost of capital and quite sensitive to current and expected demand for the firm's output. Taxes, along with interest rates, the price of equipment, and other items form the total cost of capital. Thus, taxes are a (small) component of a group of costs that really don't matter!

Not only that, but if the taxes are on capital gains, they matter even less! In general, firms finance investment out of retained earnings first, loans second, and issuing new equity third. That is, the stock market is the last resort in paying for new plant and equipment. This is because issuing new shares may dilute the value of existing shares, and may signal to markets that the firm doesn't have the ability to finance investment out of profits and can't get a loan. So firms are particularly insensitive to stock markets! This suggests the very often, the stock market is but a sides show - a very large casino that has little to do with productive investment.

Finally, if it is the case that investment is pretty I insensitive to taxes (particularly those on capital gains) and the tax revenues are spent on the output firms (perhaps via unemployment insurance or welfare payments), we may have a large "balanced budget multiplier." In other words, we end up taking savers and transferring it to spenders, thus encouraging economic expansion. It is then likely the case that taxing the "job creators" actually creates jobs!

Comments

  1. Could a capital gains tax could serve to dampen volatility in the financial markets by discouraging the most speculative trades?

    ReplyDelete
  2. It seems like that is a long chain of events -- capital gains are very much on the back end at tax time -- to influence speculative traders.

    A Tobin style -- transaction -- tax up front I think would be far better suited to tamp down volatility induced by speculative, especially high frequency, traders.

    ReplyDelete
  3. yes, that a tobin tax would dampen volatility would go without saying.

    ReplyDelete
  4. was just imagining a similar effect as a result of capital gains tax. Seen theortically, I suppose that one would hold off on all but the most profitable trades if the tax is high enough.
    -possibly-

    ReplyDelete

Post a Comment

Popular posts from this blog

A few brief comments on Brexit and the postmortem of the European Union

Another end of the world is possible
There will be a lot of postmortems for the European Union (EU) after Brexit. Many will suggest that this was a victory against the neoliberal policies of the European Union. See, for example, the first three paragraphs of Paul Mason's column here. And it is true, large contingents of working class people, that have suffered with 'free-market' economics, voted for leaving the union. The union, rightly or wrongly, has been seen as undemocratic and responsible for the economics woes of Europe.

The problem is that while it is true that the EU leaders have been part of the problem and have pursued the neoliberal policies within the framework of the union, sometimes with treaties like the Fiscal Compact, it is far from clear that Brexit and the possible demise of the union, if the fever spreads to France, Germany and other countries with their populations demanding their own referenda, will lead to the abandonment of neoliberal policies. Aust…

A brief note on Venezuela and the turn to the right in Latin America

So besides the coup in Brazil (which was all but confirmed by the last revelations, if you had any doubts), and the electoral victory of Macri in Argentina, the crisis in Venezuela is reaching a critical level, and it would not be surprising if the Maduro administration is recalled, even though right now the referendum is not scheduled yet.

The economy in Venezuela has collapsed (GDP has fallen by about 14% or so in the last two years), inflation has accelerated (to three digit levels; 450% or so according to the IMF), there are shortages of essential goods, recurrent energy blackouts, and all of these aggravated by persistent violence. Contrary to what the press suggests, these events are not new or specific to left of center governments. Similar events occurred in the late 1980s, in the infamous Caracazo, when the fall in oil prices caused an external crisis, inflation, and food shortages, which eventually, after the announcement of a neoliberal economic package that included the i…

What is the 'Classical Dichotomy'?