Taxation and finance constrained firms

Vol: 
20/2006
Author name: 
Claus I
Year: 
2006
Month: 
August
Abstract: 

This paper develops an open economy model to assess the long-run effects of taxation when firms are finance constrained. Finance constraints arise because of imperfect information between borrowers and lenders. Only borrowers (firms) can costlessly observe actual returns from production. Imperfect information and finance constraints magnify the effects of taxation. A reduction (rise) in income taxation increases (lowers) firms’ internal funds and their ability to access external finance to expand production. The findings thus underline the importance of incorporating access to finance into models that assess the impact of taxation.

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