Effects of Corporate Tax Rate Cuts on Firms’ Investment and Valuation: A Microsimulation Approach - Advances in Social Simulation - page 153

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

Keiichi Kubota 1 and Hitoshi Takehara 2

1 Chuo University, Tokyo, Japan
[e-mail]
2 Waseda University, Tokyo, Japan
takehara@waseda.j p

Abstract. This paper investigates changes in firm values triggered by a
hypothetical corporate tax rate cut for Japan. We use multiplicative production
functions and firms' investment decision changes over time via the accumulated
process of retained earnings on the simulated path. We find changes in
corporate tax rates can enhance the market value of firm equity in most cases,
while there are some cases in which the effects are neutral or even detrimental
for firm value. We interpret that these mixed results are caused by joint effects
of current provisions of tax loss carry-forward and the net balance of tax
deferred accounts. We find that past profitability and variability of each firm is
crucial to hit exact threshold points at which firms experience value
appreciations or not. The results possess important implications to both
regulators and corporate financial managers.

Keywords: corporate taxation, tax loss carry-forward, deferred tax assets and
liabilities, retained earnings, earnings variability.

1 Introduction

The analyses on changes in firm value from tax rate changes present important
implications for policy makers as well as corporate managers. In the current paper we
employ a microsimulation approach (Shahnazarian, 2011), in which we assume a
multiplicative production function for each individual firm and simulate the
evolvement of accounting accounts of firms. Based on hypothetical corporate tax rates
we compute fundamental values of firms with the residual income valuation model of
Ohlson (1995) and assess effects of tax rate cuts utilizing a simulation method in which
each firm's past data at the micro level are used to obtain the necessary parameter
values.
In this paper we focus primarily on the corporate tax rate cut case 1 , because it is
widely known that the corporate tax rate in Japan is much higher than in other
1 The analysis of effects of tax rate changes on individual financial income is our ongoing
work. After the East Japan Big earthquake, the government has considered an increase in
overall individual tax rate. Also, even though the corporate tax rate had been cut 5% in fiscal
year 2012, an additional recovery special tax was levied and the net tax cut became smaller.