Corporate taxation and market power wealth

Abstract We analyze the aggregate and distributional effects of corporate tax reforms in the presence of heterogeneous market power across sectors and firms. Our study employs a life-cycle model with incomplete markets, where taxes and market power prevent capital demand and equity supply from moving in tandem. On one hand, an increase in the corporate tax rate generates the classic partial equilibrium effect of reducing capital demand. The magnitude of this effect depends on specific provisions in the tax code and sectoral characteristics, but is generally small when the tax code allows firms to deduct most of the capital costs. On the other hand, the tax substantially lowers the value of equity wealth by taxing market power rents, which shifts the aggregate equity supply downward and exerts a negative effect on equity returns. This novel general equilibrium effect, in turn, reduces the cost of capital and often has an expansionary impact. In our benchmark calibration, which reflects a realistic distribution of markups and markdowns as well as the institutional details of the USA corporate tax code, raising the corporate tax rate can stimulate aggregate investment, output, and wages. Furthermore, this reform reduces wealth inequality, as equity ownership is concentrated among the wealthiest individuals.