A model to measure the effects of taxes on the real and financial decisions of the firm

ABSTRACT tion through a framework relating the real This paper presents a model for the and financial decisions, the most ambi-analysis of the joint effects of taxation on tious are those of Brimmer and Sinai the real and financial decisions of the firm. (1976), and of Sinai et al. (1982). In these The model is composed of three recursive studies, the integration of the firm's real equations: a dividend payout rate equa- and financial decisions is made by incor-porating financial flow-of-funds con-tion, an external financing-mix equation ' straints into a Jorgensonian model of in-and an investment equation. The link be- 4 tween the real and financial decisions is vestment behavior. Unfortunately, established via the cost of capital and cash however, the studies are unclear as to the flow. The model is empirically tractable. form and the extent to which taxation af-The empirical analysis shows, in partic- fects the firm's financing decisions and, ular, that linking the real and financial as a consequence, the cost of capital and decisions helps explain corporate invest the flow of funds. For example, it is un-ment behavior, and that personal income clear how changes in the capital gains tax rate affect the firm's cost of capital, thetaxation affects corporate investment., through its effect on dividend payout. iirms cash flow and, ultimately, the firm's real capital investment. Another criti-cism of the models is that they rely heavily on accounting identities. This make