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Capital Taxation and Imperfect Competition: ACE vs. CBIT

Brekke, Kurt; Pires, Armando José Garcia; Schindler, Dirk; Schjelderup, Guttorm
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URI
http://hdl.handle.net/11250/226131
Date
2014-11
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  • Discussion papers (FOR) [593]
Abstract
This paper studies the market and welfare effects of two main tax reforms – the

Corporate Business Income Tax (CBIT) and the Allowance for Corporate Equity

tax (ACE). Using an imperfect-competition model for a small open economy, it

is shown that the well-known neutrality property of ACE does not hold. Both

corporate tax regimes distort market entry and equilibrium prices. A main result is

that a small open economy should levy a positive source tax on capital in markets

with free firm entry. Which tax system is better from a welfare point of view,

depends on production technology, the competitive effects of ACE and CBIT, and

whether entry is excessive or suboptimal at the given corporate tax rate. Imposing

tax income neutrality yields a higher corporate tax rate with ACE, which increases

the scope for CBIT to be welfare improving.
Publisher
FOR
Series
Discussion paper;37/14

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