Working papers

Dynamics of Financing Frictions for Investment in R&D

Measurement and identification issues constitute a challenge in our understanding of the extent of financing constraints as a barrier to investment and innovation. Governments try to alleviate liquidity constraints of innovative firms by providing a range of support schemes, but there is limited evidence on their effectiveness. A special UK policy provides new insights and offers the possibility of carrying out counterfactual policy experiments in a setting with small and medium sized innovating firms that face financing constraints. Firms are offered incentives for R&D, giving loss-makers a choice between taking a cash injection from the government immediately or when they become profitable in the future. Claiming the cash immediately comes at a cost; the rate at which the government pays cash to loss-making firms is significantly lower than a future deduction. Different choices made by the firms are informative about heterogeneities in financing constraints and productivity across firms. The exogenous variation across firms and over time in deduction rates and the availability of the cash option identifies the effects of policy changes on cash flow, and consequently, outcomes of interest such as R&D investment and output.

(formerly "Quantifying and Alleviating Financing Constraints: Structural Evidence from a Policy Experiment")

Tax Policy, Investment and Profit-Shifting

with Katarzyna Bilicka and Michael Devereux

Multinational firms (MNEs) often pay no tax in high-tax countries because they shift a large fraction of their taxable income to tax havens. We build a model of tax policy and investment that incorporates unobserved heterogeneity in MNEs' profit-shifting capability and different costs of setting up a tax minimization network. The model matches the distribution of taxable profit and investment in detailed UK tax returns data. We use the model to quantify the policy tradeoff between raising tax revenue by combating tax avoidance (via, for example, a Global Minimum Tax) and attracting investment. The results solve a longstanding puzzle in the existing profit-shifting literature: our model reconciles the differences between previous micro- and macro-level estimates of profit-shifting elasticities by accounting for extensive margin decisions (to report positive or no taxable profit in a jurisdiction). We test the model's predictions using a reform in Italy that limited the profit-shifting activities of Italian MNEs as a quasi-natural experiment.

(This paper was previously titled 'Optimization Frictions and the Fixed Cost of Profit-Shifting')

Business Location Decisions with a Global Minimum Tax

with Francois Bares and Michael Devereux

In an historic agreement in 2021, 141 countries agreed on imposing a global minimum tax (GMT) on the profits of multinational corporations. Proponents of the GMT argue that the measure will reduce the distortion to businesses' location decisions by reducing the dispersion in tax rates internationally. We investigate the impact of the GMT on business location and investment decisions. To do this, we develop a location choice model based on effective average tax rates (EATRs) augmented with incentives for profit-shifting to low-tax jurisdictions. GMT affects the dispersion of EATRs for new investment in different countries, but its impact is non-monotonic in the threshold rate. For low values of the GMT threshold, the introduction of a minimum tax increases EATRs more in high-tax countries relative to low tax countries, increasing the dispersion of EATRs. As the statutory minimum rate increases, more low-tax countries begin to set their tax rate at the threshold, reducing the dispersion. An increased threshold has heterogeneous cost of capital effects for different countries; we find that a high threshold rate may substantially depress capital accumulation in investment hubs. This analysis provides a novel contribution to the literature on the relationship between taxation and corporate decisions on real activity.

Dividend Taxation and Firm Performance with Heterogeneous Payout Responses

with Katarzyna Bilicka and Evangelos Koumanakos

We analyze the short and long-run performance of firms that were differentially affected by a new tax on dividends in the lead-up to the Global Financial Crisis. We use exogenous policy variation for firms with different legal statuses and financial year-end dates to causally identify the policy impact. Consistent with intertemporal tax arbitrage, immediately-affected firms significantly reduce payouts. At a time of severe liquidity shortage, the average firm uses the undistributed cash to pay back debt. In the long run, the allocation of undistributed cash to investment, retained earnings, and debt repayment predicts growth and the likelihood of bankruptcy.