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The global economy has emerged from a multi-year convalescence, but maintaining the momentum will require sustained investment growth. In fast-growing Asia, gross capital formation remained high at an average of 33 percent of GDP during 2011–2015.

However, there is still considerable variation in private fixed investments across these countries. Since fixed investment is a key driver of economic performance, understanding its dynamics is crucial, particularly the dynamics of corporate investment, which constitutes the lion’s share of private investment. Empirical studies suggest that profitability, growth prospects and leverage are important in shaping firm-level investment behavior, while macrofinancial and institutional factors determine the conduciveness of the business climate.

Using firm-level balance sheet data for a large sample of nonfinancial firms over 1990–2014, we investigate the determinants of business investment decisions. We focus on the role of taxation among member states of the Association of Southeast Asian Nations (ASEAN).

The ambiguous impact of taxation on corporate investment

While there is extensive literature on the potential determinants of corporate investment dynamics, empirical results differ substantially. On the one hand, corporate income taxes are expected to lower firms’ capital investment (and total factor productivity) by raising the user cost of capital, distorting factor prices, and reducing after-tax return on investment. On the other hand, taxation provides resources for public infrastructure investments and the proper functioning of government institutions, which are key to a firm’s success.

The overall impact of taxation on firm performance therefore depends on the relative weights of these opposing effects. This can vary depending on the size of the government and the composition and efficiency of taxation and spending.

To investigate these complex relationships, we adopt a model incorporating firm characteristics (such as age, size, sales, profitability, and leverage), and control for macroeconomic and structural differences across ASEAN countries. Our model includes lagged investment and the square values of explanatory variables to capture persistency and nonlinear behavior in corporate investment decisions. We use firm-level data on corporate taxation, as gauged by the ratio of corporate income tax expense to profits before tax, not the standard corporate income tax rate at the country level.

We estimate both static and dynamic models of firm-level investment in physical capital, using an unbalanced panel of 799,328 companies during the period 1990–2014. We employ alternative methods to address estimation biases resulting from the inclusion of the lagged dependent variable, as well as the potential endogeneity of the explanatory variables.

More granular analysis reveals nonlinear patterns

We find that a moderate level of taxation does not hinder business investment. But this effect turns negative as the higher tax burden raises the user cost of capital and distorts resource allocations.

As for firm size, our estimates show that large companies undertake significantly fewer investments than smaller enterprises. However, this is not a linear relationship, as very large companies tend to invest more than others.

We observe similar nonlinear behavior with the impact of sales on capital spending, with a negative coefficient for its square term. This may reflect an increase in operating costs with higher sales, which partly depends on the ratio of fixed to variable costs and varies with company-specific and, sometimes, sector-specific factors. On the other hand, we find the opposite dynamics with profitability, as higher profitability leads to more fixed investment. Finally, our results show an intricate pattern of nonlinear behavior in relation to leverage, as greater levels of indebtedness become increasingly detrimental for new fixed investments.

Policy options

A fair and efficient tax system is key to promoting private investment and concurrently raising resources for public investment. A simpler corporate taxation code with a lower tax burden can encourage entrepreneurial activity by new and existing firms, and reduce compliance costs across all segments of the corporate sector. This would, in turn, stimulate business investment and attract foreign direct investment.

While there is room to reduce the statutory corporate income tax rate in some ASEAN countries, an alternative reform option is to limit the corporate income tax on “excess returns” on equity, which would reduce tax-induced investment distortions and promote balanced investment growth. However, given the fact that ASEAN countries have relatively low tax-revenue-to-GDP ratios, it is necessary to develop a comprehensive strategy for corporate tax reform with the aim of strengthening tax compliance and broadening the tax base, while reducing the tax burden on the corporate sector.


This blog post is based on an IMF Working Paper by Serhan Cevik and Fedor Miryugin, “Does Taxation Stifle Corporate Investment? Firm-Level Evidence from ASEAN Countries,” which is a forthcoming article in the Australian Economic Review.

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