The effect of Corporate Taxes on Firm Productivity

This paper explains how marginal tax rate at the industry level affects individual firm productivity. The effect of corporate taxes on firm’s investment decision has been the main interest for long time. Besides investment decisions, however, a variety of firm behaviors can determine its productivity in the end. To investigate the effect of corporate taxes on firm productivity, I constructed the individual firm level dataset of over 1,000 firms in Korea from 1980 to 2010, and estimated an error corrected model. Estimation method is first-difference GMM. Marginal corporate tax rate at the industry level was obtained by regressing tax amounts on tax base within the industry. Firm productivity represents total factor productivity, which was derived as the residual of estimated Cobb-Douglas production function. The results show that corporate taxes have a negative effect on firm productivity. And the magnitude of productivity reduction from corporate taxes increases as the firm has higher profitability. I also found that TFP of an individual firm increases faster in the sector which reveals faster growing productivity. Finally, bigger TFP gap with technological frontier induces the firm to elevate its productivity faster. It proves that there exists convergence of total factor productivity across firms.