The political economy of corporate taxation

Theory: We propose a theory of corporate taxation in the United States that builds on dynamic optimal taxation models. The theory is consistent with structural dependence theories (Lindblom 1977) in that expectations by investors of future tax policy limit policy maker options, primarily because corporate tax policy is time inconsistent. This theory contrasts with pluralistic models of corporate taxation because it recognizes the collective action problem facing business. Hypotheses: We offer three propositions. First, effective corporate tax rates will be exogenous to aggregate business interests, and instead should cause the organization and activity of business. Second, a shock in effective tax rates will reduce relative levels of investment. Third, effective corporate tax rates will be exogenous to real income and real investment. Methods: Exogeneity tests and the moving average representation from several vector autoregressions are used to evaluate the propositions. Results: All three propositions are supported. Dynamics in the effective corporate tax policy are consistent with an optimal model of taxation, at least for the period 1977-94.