The Neoclassical Theory of Firm Investment and Taxes: A Reassessment

Drawing on decades of research in public and macroeconomics, this article offers a neoclassical synthesis of the effect of corporate taxation on firm investment and aggregate outcomes. The microeconometric literature has (often unwittingly) studied two distinct comparative statics of the firm’s first order condition for capital. The first holds output fixed and identifies the capital-labor substitution elasticity (Eisner and Nadiri, 1968). The other holds fixed variables external to the firm (Coen, 1969). A consensus range for the Coen short-run relationship implies plausible values for parameters of the firm’s revenue function, validating the neoclassical theory. The long-run, general equilibrium elasticity of capital instead involves a third comparative static, holding labor fixed. This elasticity depends on the parameters identified from the firm-level regressions, connecting the microeconometric evidence to macroeconomic questions. Using this framework, I quantitatively assess the effect of corporate taxation on aggregate capital, output, wages, and tax revenue, and compare to existing approaches including policy models.