The Macroeconomic Effects of Corporate Tax Reforms

Project Information

MacroTaxReforms

Grant agreement ID: 101041334

DOI

10.3030/101041334

EC signature date 23 May 2022

Start date 1 September 2022

End date 31 August 2027

Funded under

• European Research Council (ERC)

Total cost

€ 1 077 500,00

EU contribution

€ 1 077 500,00

Coordinated by

UNIVERSIDAD POMPEU FABRA
Spain

Periodic Reporting for period 1 - MacroTaxReforms (The Macroeconomic Effects of Corporate Tax Reforms)

Reporting period: 2022-09-01 to 2025-02-28

Summary of the context and overall objectives of the project

Taxes influence the world around us—from the decisions firms make about investments to the resources governments use to fund public services. Corporate taxes are especially impactful among all types of taxes, as they affect not only public revenue but also business behavior, business cycles, and economic growth. However, understanding the full consequences of corporate tax reforms is complex. Why do some firms react sharply to tax cuts while others remain unresponsive? How do tax policies interact with interest rates set by central banks? And how can we design tax policies that foster prosperity without creating economic instability?

The MacroTaxReforms project addresses these questions by combining cutting-edge economic theory with global data to study the effects of corporate tax reforms on investment, labor markets, and the broader economy. By focusing on real-world constraints, this research highlights how corporate taxes shape not only firm behavior but also the long-term dynamics of the economy.

The project seeks to improve our understanding by addressing three key objectives:
1. Theoretical Foundations: Develop new economic models incorporating investment frictions and firm-level constraints.
2. Empirical Analysis: Create a comprehensive global dataset to evaluate the real-world impacts of corporate tax reforms.
3. Policy Interaction: Using new empirical and quantitative tools, study how corporate tax reforms influence and are influenced by monetary policy.

By meeting these objectives, MacroTaxReforms offers insights for better policy design, helping governments implement tax policies that balance public needs with economic growth and macroeconomic stability. This evidence-based approach aims to equip policymakers with the tools to create more effective and fair corporate tax policies.

Work performed from the beginning of the project to the end of the period covered by the report and main results achieved so far

1. Theoretical Model Development
I developed a micro-founded economic model that captures key features of firm investment behavior, including fixed capital adjustment costs, partial irreversibility, and a comprehensive tax schedule that reflects real-world complexities. By incorporating these elements, the model provides a detailed understanding of how firms adjust their capital in response to economic shocks and corporate tax reforms. The analysis demonstrates how these frictions interact with corporate taxes to amplify or dampen firms investment responses, resulting in persistent fluctuations in aggregate capital and economic cycles.

2. Empirical Dataset on Corporate Tax Reforms
I ensembled a comprehensive global dataset covering over 60 years of corporate tax reforms across 55 countries. This dataset distinguishes between permanent tax reforms, driven by long-term policy objectives like economic growth, and temporary changes aimed at short-term economic stabilization. By separating these categories, the dataset enhances the ability to identify causal effects and provides insights into how corporate tax cuts influence firm-level behavior and macroeconomic outcomes.

3- Exploration of Fiscal-Monetary Interactions
I employ state-of-the-art empirical techniques, such as local projections, to study how monetary authorities adjust policy in response to corporate tax reforms. The analysis revealed that substantial corporate tax cuts could lead to increases in interest rates as central banks respond to heightened economic activity. Additionally, the research uses a New Keynesian framework to explore the optimal coordination between fiscal and monetary policy, shedding light on how these policies influence inflation and output.

4. Forecasting and Information Frictions
This project examines how economic forecasters update their predictions in response to policy changes. The analysis showed that forecasters tend to make infrequent but significant revisions, influenced by adjustment costs and strategic considerations. This research underscores the importance of understanding how expectations and information frictions shape economic responses, particularly in the context of fiscal and monetary policy interactions.

Progress beyond the state of the art and expected potential impact (including the socio-economic impact and the wider societal implications of the project so far)

The MacroTaxReforms project addresses critical gaps in economic theory and policy analysis, offering actionable insights that can support sustainable economic growth, resilience, and informed decision-making at the national and international levels.

I. Deeper Understanding of Investment Frictions and Corporate Taxation
The project’s models understand how investment frictions and taxation shape firms’ investment behavior. By capturing the constraints firms face when adjusting their capital, the models explain why firms’ responses to tax policy changes are often gradual and path-dependent, leading to more persistent economic cycles. This approach helps policymakers anticipate and design tax reforms that mitigate distortions and avoid amplifying economic volatility.

II. Improved Empirical Identification of Policy Effects
The project’s global dataset distinguishes between permanent reforms aimed at long-term growth and temporary changes driven by short-term needs. This distinction enhances the precision of policy evaluations and addresses common empirical challenges. These findings support the development of robust fiscal policies by providing clear evidence of the causal impacts of tax reforms on investment and macroeconomic outcomes.

III. Fiscal-Monetary Coordination
The research demonstrates that corporate tax reforms can significantly influence monetary policy decisions as central banks adjust interest rates in response to changes in economic activity. This highlights the importance of coordinating fiscal and monetary policies to prevent unintended economic fluctuations. Future research and policy dialogue are essential to refining guidelines for fiscal-monetary coordination, particularly in environments with limited monetary policy tools.

4. Insights into Forecasting Dynamics
The project’s analysis of forecasting behavior reveals that forecasters often make infrequent but significant revisions due to costs and strategic pressures, such as aligning with consensus expectations. This research proposes a methodology for “cleansing” forecasts to isolate underlying economic beliefs better, improving the accuracy of policy decisions that rely on forecast data. To support practical adoption, further research and collaborations with forecasting institutions and central banks could refine and these methods on a larger scale.

Potential Impacts and Future Needs
• Further Research and Demonstration: Expanding the application of the project’s models to diverse economic contexts could validate and extend the findings.
• Data Accessibility: Open access to the project’s empirical datasets would enhance collaboration across institutions and support broader use by policymakers and academics.
• Policy Guidance: Collaborations with government agencies and international organizations can help translate the findings into actionable fiscal guidelines, particularly regarding fiscal-monetary policy coordination.
• Forecasting Innovation: Partnerships with forecasting platforms and financial institutions could support the implementation of refined forecasting methods, improving economic predictions and risk assessments.