Isaac Baley (UPF and BSE) wants to understand how tax policies affect the investments that companies make, which in turn affect the business cycle and the long-run growth of the economy.

In this Barcelona School of Economics Research Video, Baley explains why this is the right moment to study corporate tax reform, and what new insights he hopes to bring to researchers and policy makers through his European Research Council (ERC) Starting Grant project, “The Macroeconomic Effects of Corporate Tax Reforms.”

The following text is adapted from the video interview with Professor Baley that was conducted in May 2023.

How do taxes paid by individual companies affect the economy as a whole?

Corporate taxes, the taxes paid by companies, are not only a source of revenue for governments, but also a key policy tool as they directly impact the way firms make their decisions, in particular, their investments: how much machinery or equipment to purchase, how much R&D to conduct… All of these investment choices are directly affected by corporate taxation.

From a macroeconomic perspective, we care about corporate taxes because they affect investment, and investment is one of the key drivers of the business cycle and long-run growth of an economy. Therefore, to think about the design and implementations of policies for stabilization or long-run growth, we need to understand the exact effects of corporate taxation on investment.

Why is now the right moment to think about how governments tax companies?

In the last four decades, we have seen a global decline in the corporate income tax paid by companies. For instance, in OECD countries, the median tax rate has gone down from 42% to 25%. However, recent developments such as the massive increase in government debt after the pandemic, the transition towards the green economy, and secular trends in market power and business profits have put corporate taxes back into the spotlight.

This is the right moment to think about corporate tax policies as there’s an active debate about changing the corporate tax structure and big macro questions that still need to be answered.

The objective of my ERC project is to inform this policy debate by understanding the macro dimensions that are mainly affected by corporate taxation, quantifying the trade-offs associated with different reforms and evaluating policy with a macroeconomic and a long-term perspective. At the core of all of these questions is the elasticity or sensitivity of aggregate investment to corporate tax reforms.

How do economists measure the impact of tax policy on corporate investment?

On the one hand, there is vast theoretical literature that has studied this question in environments with representative firms and without any frictions to invest or disinvest. Even though we have good macro insights from this literature, they’re lacking the richness of the microdata.

On the other hand, there is empirical literature that exploits this microdata in order to bring estimates of this elasticity. However, due to its nature, they’re hard to scale and think about the macro effects or the long-term stimulus.

In my project, I will combine these two perspectives by developing new structural frameworks that are informed with the microdata and that embed the following elements: rich firm heterogeneity, empirically relevant investment frictions, general equilibrium forces and a long-term perspective.

What will your research add to the debate on corporate tax reforms?

I’m going to study the aggregate implications in terms of misallocation, productivity, business cycle fluctuations and, last but not least, interaction with other types of policies such as monetary policies.

Corporate tax reforms will be a key component of fiscal policy in the years to come, and I hope my frameworks will be used by researchers and policy makers in order to make better and more informed policies.