Tax Loss Carrybacks: Investment Stimulus versus Misallocation

Abstract

Tax regimes treat losses and profits asymmetrically when profits are immediately taxed, but losses are not immediately refunded. We find that treating losses less asymmetrically by granting refunds less restrictively increases loss firms' investment: A third of the refund is invested and the rest is held as cash or returned to shareholders. However, the investment response is driven primarily by firms prone to engage in risky overinvestment. Consistent with the risk of misallocation, we find a delayed exit of low-productivity loss firms receiving less restrictive refunds, indicating potential distortion of the competitive selection of firms. This distortion also negatively affects aggregate output and productivity. Our results suggest that stimulating loss firms' investment with refunds unconditional on their future prospects comes at the risk of misallocation. JEL Classifications: G31; H21; H25.

Do Country Risk Factors Attenuate the Effect of Taxes on Corporate Risk-taking?

“…Although of similar sign, we predict a stronger effect if a loss carryback is in place (Bethmann et al 2018;Langenmayr and Lester 2018). Second, CTRStdj,t captures the standardized corporate tax rate of country j in year t. 23 We use the top bracket corporate tax rate of country standardize -21 -tax rate CTRStdj,t across the sample and expect a negative coefficient (β2 < 0).…”

“…Our study contributes to research that investigates the effects of tax policy on corporate risk-taking (Langenmayr and Lester 2018;Ljungqvist et al 2017) and investment (Djankov et al 2010;Edgerton 2010;Dobridge 2016;Bethmann, Jacob, Müller 2018;Zwick and Mahon 2017).…”

“…Two major characteristics of tax systems that affect corporate risk-taking are the tax rate and loss offset rules (Bethmann et al 2018;Langenmayr and Lester 2018). The tax rate is the percentage of corporations' income that is owed to or refunded by the government.…”

“…For unlimited loss carryforward periods, we use 20 years (maximum for limited LCF periods). 22 For loss carrybacks, we use an indicator variable that equals one if the country offers a loss carryback and zero if the country does not (Bethmann et al 2018).…”

“…-24 -profitability and potential changes in carryforward rules (Langenmayr and Lester 2018;Bethmann et al 2018).…”