Why is the corporate tax rate lower than the personal tax rate ? + by Clemens

In many OECD countries, statutory corporate tax rates are lower than personal income tax rates. The present paper argues that this tax rate differentiation is an optimal tax policy if there are problems of asymmetric information between investors and firms in the capital market. The reduction of the corporate tax rate below the personal tax rate encourages equity financing and thus mitigates the excessive use of debt financing induced by asymmetric information. Our main theoretical result stands in marked contrast to the traditional view of corporate taxation and corporate finance theory, according to which there is a tax disadvantage to equity financing. More recent empirical evidence on this issue, however, is in line with our result. This Version: July 2000 JEL: H21, G14, G32 An earlier version of this paper was presented at the NBER Trans-Atlantic Public Economics Seminar (TAPES) on „The Taxation of Financial Income“ at the Studienzentrum Gerzensee, May 22-24, 2000. We would like to thank our two discussants, Lars Feld and Roger Gordon, for very helpful comments and suggestions. We are also indebted to Alan Auerbach, Philippe Bacchetta, Lans Bovenberg and Thomas Gehrig and other conference participants. The usual disclaimer applies. *Universität München, Staatswirtschaftliches Institut, Ludwigstr. 28, VG, D-80539 München, Germany. e-mail: [email protected] **Universität München, Staatswirtschaftliches Institut, Ludwigstr. 28, VG, D-80539 München, Germany, e-mail: [email protected] ***Economic Policy Research Unit and Copenhagen Business School, Solbjerg Plads 3, DK2000, Frederiksberg, Denmark, e-mail: [email protected]