Corporate Tax System Complexity and Investment Sensitivity to Tax Policy Changes

Abstract

Effective policymakers must balance the demands of formulating a corporate tax system that raises revenue and spurs economic activity (e.g., investment) while promoting a “level playing field” across firms. Balancing these tradeoffs has likely caused tax systems to become more complex over time, increasing firms’ difficulty in understanding and complying with tax regulations. We investigate the impact of tax system complexity on the responsiveness of firm-level investment to tax policy changes. Exploiting staggered tax rate changes and variation in tax system complexity across countries, we document two key findings. First, firm-level investment is less sensitive to changes in the corporate tax rate when tax system complexity is higher, suggesting that such complexity can undermine the ability of tax policy to affect economic growth. Second, the impact of tax complexity on the sensitivity of investment to tax rate changes varies significantly across firms, with domestic-owned, smaller, and private firms being more affected. These cross-sectional disparities are consistent with tax system complexity potentially reducing tax system parity. Collectively, our findings suggest that corporate tax system complexity can negatively impact the ability of fiscal policy to affect investment and lead to heterogeneous tax policy responses across firms.