Policy Effects of International Taxation on Firm Dynamics and Capital Structure

Abstract

I develop and calibrate an industry equilibrium model with heterogeneous multinational firms to study the impact of a potential policy change from the current U.S. worldwide taxation system to a territorial system on firm investment, capital structure, payout policy and tax revenues. Firms in the model make both intensive and extensive margin decisions in terms of overseas investment. They optimally choose dividend payments to shareholders, holdings of riskless debt securities and earnings repatriations from the subsidiary to the parent in each period. To estimate the impact of the policy change, I solve the model under both worldwide and territorial systems and compare the stationary equilibria. The results show that the policy change causes both domestic and overseas production by U.S. firms to rise. In addition, firms borrow more and pay larger dividends to shareholders. These effects on firm variables are coupled with a rise in U.S. Government tax collections. * I thank Oliver Levine and my advisor, Dean Corbae, for some valuable discussions that helped me to develop this project and to get it off the ground. Comments received by Mark Ready, Michael Gofman and David Brown have also been particularly helpful. I'm grateful to participants at the 2017 Midwest Finance Association Annual Meeting and in particular, thankful to Joseph Farhat for giving a helpful discussion. I'm also appreciative for suggestions during the Spring 2016 Midwest Macro Meeting at Purdue University in addition to those provided during the macroeconomics brownbag, the macro-finance reading group and the finance brownbag all at UW -Madison. I am also thankful for funding provided by the Culbertson Prize, the Richard E. Stockwell Fellowship and a Summer Research Fellowship awarded by the economics department and generous support from the finance department at UW -Madison. I'm also fortunate to have received outstanding computational support from the Center for High Throughput Computing (CHTC). All remaining errors are my own. (HM Government, 2013). The Japanese reasons for change were more related to fear over funds being trapped overseas. The idea was that the policy change would result in more funds being brought back to Japan, resulting in higher domestic investment and employment (Altshuler, Shay and Toder, 2015).There has been an ongoing debate in the U.S. in recent years surrounding the need for this potential tax policy change. It is an issue, which has been debated by academics, politicians and the media. One major point of controversy in the debate surrounds the deferrability of active foreign earnings in the current system, (see section II for more details). This particular aspect of the U.S. tax code has allowed many large firms to hold-off on repatriating their overseas earnings and to accumulate large amounts of funds abroad.U.S. politicians have expressed concern regarding this behaviour by firms along the dimension that it may be serving the firms at the expense of domestic economic activity. In response, the 2004 Ho...