IFDP Paper: Tax Heterogeneity and Misallocation

Baris Kaymak and Immo SchottThere is substantial asymmetry in effective corporate income tax rates across firms. While tax asymmetries would reduce productivity in frictionless economies, they can improve efficiency in a distorted economy if taxes alleviate other economic frictions. We develop a framework to estimate to what extent tax asymmetries affect productivity in distorted economies. Using US firm-level balance sheet data alongside measures of effective marginal tax rates, we find a positive correlation between tax rates and factor productivity, suggesting that tax asymmetry exacerbates the distortions from other economic frictions. Eliminating tax rate asymmetries would raise aggregate productivity by 3 to 4 percent if taxes distort capital costs alone. Models where taxes also distort the marginal cost of labor predict potential gains as high as 9 percent.