Optimal Debt Bias in Corporate Income Taxation

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dc.contributor.author SIMON, Jenny
dc.date.accessioned 2012-07-18T09:53:04Z
dc.date.available 2012-07-18T09:53:04Z
dc.date.issued 2012
dc.identifier.issn 1830-7728
dc.identifier.uri http://hdl.handle.net/1814/22795
dc.description.abstract I present a rationale for a government to discriminate between debt and equity financing when taxing corporate income. For risk-averse entrepreneurs, equity generates more surplus than debt, because it provides financing and insurance. A government seeking to extract surplus from entrepreneurs would naturally tax equity-generated income more than debt-generated income. I also establish a less obvious reason why the government might want to extract surplus from entrepreneurs. It is well understood that when the quality of projects is unobservable to investors, risk-averse entrepreneurs with higherreturn projects might retain a larger share of equity to signal their type (Leland and Pyle (1977)). I show that in such an adverse selection setting, while competitive investors are constrained to offer actuarially fair terms, the government can use taxes to discriminate between types. This degree of freedom allows manipulation of the relevant incentive constraints so that a lower level of debt suffices for separation, and an increase in overall efficiency can be obtained. Since entrepreneurs separate along their debt-to-equity ratios, the optimal non-linear tax schedule to achieve the desired discrimination is isomorphic to one that taxes debt-generated income at a lower rate than equitygenerated income. en
dc.format.mimetype application/pdf
dc.language.iso en en
dc.relation.ispartofseries EUI MWP en
dc.relation.ispartofseries 2012/13 en
dc.rights info:eu-repo/semantics/openAccess
dc.subject Corporate Taxation en
dc.subject Debt Bias en
dc.subject Investment Decision under Asymmetric Information en
dc.subject G18 en
dc.subject G11 en
dc.subject H25 en
dc.subject D82 en
dc.title Optimal Debt Bias in Corporate Income Taxation en
dc.type Working Paper en
dc.neeo.contributor SIMON|Jenny|aut|
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