Taxes and Privatization

Why were state-owned firms so common in the past, even in Western countries, and why were many of them privatized during the past two decades? Some recent papers argue that through state ownership the government can avoid the distortions to managerial incentives created by the corporate income tax. When the corporate tax rate is high enough, state ownership may be less inefficient than private ownership. If this argument were right, then the capital intensity of state-owned firms should fall with privatization. However, the data show instead that firms lay off a sizable fraction of their work force when they are privatized, suggesting that state firms are unusually labor intensive. This paper proposes an explanation for these observations. It argues to begin with that the government can use cheap loans from state-owned banks rather than state ownership of firms more generally to maintain the capital stock at an efficient level, in spite of a high corporate tax rate. With state banks, therefore, there is no reason to expect that state-owned firms will be more capital intensive than equivalent privately owned firms. The paper then argues that many other distortions to a firm’s incentives, e.g. the minimum wage and unemployment insurance programs, result in private firms employing too few workers, and particularly too few low-skilled workers. State-owned firms can then compensate for the resulting misallocations by hiring relatively more low-skilled workers than would an equivalent privately owned firm. Address. Corresponding author: Roger Gordon, Department of Economics 0508, University of California, 9500 Gilman Drive, La Jolla, CA 92093-0508. Fax: 1-858-534-7040. Telephone: 1-858-534-4828. Email: [email protected]. TAXES AND PRIVATIZATION