Effects of Corporate Tax Rate Cuts on Firms' Investment and Valuation: A Microsimulation Approach

This paper investigates the changes in firm value triggered by hypothetical corporate tax rate changes for which firms have balances on deferred tax allowances and deferred tax assets or liabilities. The effects on both investment to fixed assets and current assets are well taken care of with embedded production functions and firm investment decisions change over time through the accumulated process of retained earnings on the simulated future path. The study is based on micro foundation simulations of all the firms listed in Japan. The data covers the period 2000 to 2008. We note the tax loss carry-forward allowances and net changes in the deferred tax assets and liabilities affect the equity account and our simulation results demonstrate that the changes in corporate tax rates can enhance market value of firm equity in most cases, while there are some cases in which the effects are neutral or even detrimental for firm values. We interpret these mixed results are caused by joint effects of current provisions of tax loss forward and the net balance of tax deferred accounts with the trend and variability of the firm net operating profits. We emphasize that past and future profitability or non-profitability of firms is crucial to hit the exact threshold points at which firms experience value appreciation or not. With our result both firm financial managers and government regulators must watch very closely the current balance statement status of firms.