Scandinavian Working Papers in Economics

Discussion Paper Series in Economics,
Norwegian School of Economics, Department of Economics

No 32/2014: Capital Taxation and Imperfect Competition: ACE vs. CBIT.

Kurt R. Brekke (), Armando J. Garcia Pires (), Dirk Schindler () and Guttorm Schjelderup ()
Additional contact information
Kurt R. Brekke: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Economics, Helleveien 30, N-5045 Bergen, Norway
Armando J. Garcia Pires: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: SNF, Helleveien 30, N-5045 Bergen, Norway
Dirk Schindler: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Accounting, Auditing and Law, Helleveien 30, N-5045 Bergen, Norway
Guttorm Schjelderup: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: This paper studies the market and welfare effects of two main tax reforms – the Corporate Business Income Tax (CBIT) and the Allowance for Corporate Equity tax (ACE). Using an imperfect-competition model for a small open economy, it is shown that the well-known neutrality property of ACE does not hold. Both corporate tax regimes distort market entry and equilibrium prices. A main result is that a small open economy should levy a positive source tax on capital in markets with free firm entry. Which tax system is better from a welfare point of view, depends on production technology, the competitive effects of ACE and CBIT, and whether entry is excessive or suboptimal at the given corporate tax rate. Imposing tax income neutrality yields a higher corporate tax rate with ACE, which increases the scope for CBIT to be welfare improving.

Keywords: Optimal corporate taxation; Corporate tax reform; Imperfect competition; ACE; CBIT.

JEL-codes: D43; H25

26 pages, November 3, 2014

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