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Research Review 2010 RESEA R CH REVIEW Contents Spring 2010 Recent Discussion Papers Page #191 Lumpy Investment and Corporate Tax Policy 2 Jianjun Miao and Pengfei Wang #192 Transitional Dynamics of Dividend Tax Reform 2 Francois Gourio and Jianjun Miao #193 Input Sourcing and Multinational Production 3 Stefania Garetto #194 On Measuring Vulnerability to Poverty 4 Indranil Dutta, James Foster and Ajit Mishra #195 Poverty and Disequalization 4 Dilip Mookherjee and Debraj Ray #196 Impact of Political Reservations in West Bengal Local Governments on Anti-Poverty Targeting 5 Pranab K. Bardhan, Dilip Mookherjee and Monica Parra Torrado #197 Social Interactions and Segregation in Skill Accumulation 6 Dilip Mookherjee, Stefan Napel and Debraj Ray #198 Loopholes: Social Learning and the Evolution of Contract Form 7 Philippe Jehiel and Andrew F. Newman #199 Trade Policy and Firm Boundaries 8 Laura Alfaro, Paola Conconi, Harald Fadinger and Andrew F. Newman #200 Prohibitions on Punishments in Private Contracts 8 Philip Bond and Andrew F. Newman #201 Risk Adjustment, Innovation and Prevention 9 Karen Eggleston, Randall P. Ellis and Mingshan Lu #202 Cross-Validation Methods for Risk Adjustment Models 10 Randall P. Ellis and Pooja G. Mookim #203 Infertility Treatment, ART and IUI Procedures and Delivery Outcomes: How Important is Selection? 10 Pooja G. Mookim, Randall P. Ellis and Ariella Kahn-Lang #204 The Impact of Access to Rail Transportation on Agricultural Improvement: The American Midwest as a Test Case, 1850-1860 11 Jeremy Atack and Robert A. Margo #205 Correcting the Bias in the Estimation of a Dynamic Ordered Probit with Fixed Effects of Self-assessed Health Status 12 Jesus M. Carro and Alejandra Traferri #206 Intertemporal Substitution or Reference-Dependent Preferences? 12 Xavier Giné, Mónica Martínez-Bravo and Marian Vidal-Fernández #207 Self-fulfilling Traps with Money as a Medium of Exchange 13 Christophe Chamley #208 Poverty and Informal Employment in Argentina 14 Patricio Millan-Smitmans IED New Initiatives 15 Faculty Profiles 16 Rosenstein-Rodan Prize 18 Seminars 19 Visiting Scholars 19 The Institute for Economic Development (IED) is a research center within Boston University’s Department of Economics focusing on the economic problems of developing countries and related fields of finance, trade, foreign investment, health, education, economic history and institutions. The Institute for Economic Development at Boston University LUMPY INVESTMENT AND CO R PO R ATE TAX PO L ICY on the size and timing of investment. At the macro-level, it affects each adjusting firm’s investment size and the number By Jianjun Miao and Pengfei Wang of adjusting firms. Its impact is determined largely by the Discussion Paper 191 strength of the extensive margin effect, which in turn depends Corporate tax policy is an important instrument to influence on the cross-sectional distribution of firms. Depending on the firms’ capital investment decisions and hence to stimulate initial distribution of firms, the economy displays asymmetric the economy. Its transmission channel is through either the responses to tax changes. In addition, they show that an user cost of capital according to the neoclassical theory of anticipated decrease in the future corporate income tax rate investment or Tobin’s marginal Q according to the q-theory raises investment and adjustment rate immediately, while of investment. The neoclassical theory assumes that firms an anticipated increase in the future investment tax credit do not face any investment frictions, while the q-theory takes reduces investment and adjustment rate initially. Their general into account of convex capital adjustment costs. However, equilibrium analysis demonstrates that analyses using partial recent empirical evidence documents that investment at the equilibrium models of tax policy (as in the existing literature) plant level is lumpy and infrequent, indicating the existence can be misleading both quantitatively and qualitatively. of nonconvex capital adjustment costs. Motivated by this evidence, this paper addresses two central questions: (i) How does corporate tax policy affect investment at both the macro- and micro-levels in the presence of nonconvex capital adjustment costs? (ii) Is lumpy investment important quantitatively in determining the impact of tax policy on the economy in the short and long run? TR ANSITIONA L DYNAMICS OF DIVIDEND The authors adopt a novel approach in answering these TAX REFO R M two questions, which allows them to overcome two major By François Gourio and Jianjun Miao difficulties faced by the existing literature. First, in the Discussion Paper 192 presence of nonconvex adjustment costs, the standard q-theory Dividend taxation may distort investment efficiency. Partly widely used in the analysis of tax policy fails in the sense that motivated by this consideration, the Bush administration investment may not be monotonically related to marginal Q. enacted the Jobs and Growth Tax Relief Reconciliation Second, investment at the micro-level is nonlinear, which Act (JGTRRA) in 2003. This act reduced the tax rates makes aggregation difficult, a problem that is especially on dividends and capital gains and eliminated the wedge severe in a dynamic general equilibrium context. To address between these two tax rates through 2008. These tax cuts the first problem, the authors assume firm’s face both flow were extended through 2010, but may be repealed in the convex and stochastic fixed adjustment costs. As a result, at future. In this paper, the authors ask the following question: the micro-level, a modified q-theory applies in that investment What are the dynamic effects of temporary and permanent is a nondecreasing function of marginal Q. To resolve the dividend tax policies on the economy? second problem of dimensionality, the authors make two assumptions: (i) firms’ production technology has constant To answer this, the authors of this paper build a dynamic returns to scale, and (ii) fixed capital adjustment costs are general equilibrium model with firm heterogeneity in proportional to the capital stock. They show that under these productivity. They consider a tax system with corporate two assumptions, they obtain exact aggregation in the sense and personal income taxes, dividend tax, and capital gains that the cross-sectional distribution of capital matters only to tax. Firms decide how much to invest and how to finance the extent of its mean. They then characterize equilibrium investment subject to equity issuance costs, collateral by a system of nonlinear difference equations, which can be constraints, and capital adjustment costs. When making tractably solved numerically. financing decisions, firms decide whether to use internal funds, debt, or external equity. Firms can borrow or save The authors find that corporate tax policy generates both and may be in one of three finance regimes in which only intensive and extensive margin effects via the channel of the nonnegative dividend constraint binds, only the share- marginal Q. At the micro-level, it affects a firm’s decision repurchase constraint binds, or both constraints bind. As a 2 Research Review 2010 result, in any period, there is a cross sectional distribution INPUT SOU R CING AND MU L TINATIONA L PR ODUCTION of firms that have different behaviors. Firms are forward- looking and have perfect foresight about future course of tax By Stefania Garetto policies, when making investment and financing decisions. Discussion Paper 193 Globalization has expanded the scope of trade, as trade The model presented in this paper differs from the in finished products is being gradually outpaced by trade existing literature in two key respects. First, most existing in intermediates, taking place both within and across the studies analyze a single firm’s decision problem in partial boundaries of the firm. This paper proposes an innovative equilibrium. These studies ignore firm heterogeneity which general equilibrium framework to explain the decisions of may be important for understanding the economic effects of firms to fragment their production processes across national dividend taxation. Second, most existing studies focus on borders, both in terms of location and organizational struc- the effects of permanent dividend tax changes. However, the ture, through the choice of outsourcing versus in sourcing 2003 dividend tax cuts may be temporary. This paper studies input production. the transitional dynamics for the case of a permanent or temporary tax cut. Moreover, the authors endogenize firms’ The model assumes that firms need to acquire a set of trade- choices between debt financing and equity financing. able inputs in order to produce a non-tradeable consumption good. Input production can be outsourced to unaffiliated The authors find that the economic effects of dividend tax suppliers, thus generating trade in intermediates, or can be cuts are distinct, depending on whether the tax cuts are integrated (i.e., insourced) by the firm itself. When a firm permanent or temporary. When the tax cuts are permanent, decides to insource production, it sets up a new plant, pos- aggregate capital, investment, consumption, output, labor, sibly in another country where factor costs are lower. This and total factor productivity (TFP) all increase in the steady choice gives rise endogenously to the creation of multina- state. Aggregate dividend payments and equity issuance tional firms and vertical foreign direct investment (FDI) in also increase in the steady
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