Abstract
This paper employs a novel firm-level dataset that combines financial accounts of German firms with data from a business survey to shed new light on the demand for capital. The empirical analysis employs firm-specific indicators in order to explore the effects of sales, the cost of capital and indicators of the business climate, which are used by the ifo Institute to provide a leading indicator for the German economy. The empirical results support a robust significant effect of a firm’s cost of capital on the stock of capital with an elasticity not significantly different from –1. Controlling for sales, a good rather than normal business situation is found to be associated with about 8 % higher investment.
Acknowledgements
For comments on an earlier draft we are indebted to two anonymous referees, Martin Falk, Simon Loretz, Joachim Winter, and participants at conferences and seminars in Uppsala, Munich, and Mannheim. All errors remain the authors’ sole responsibility.
Appendix
6.1 Corporate tax parameters in Germany
During the period 1994–2007 corporations were subject to various income taxes, namely the corporate income tax (
Table 8 displays the tax parameters for the cost of capital calculations. Besides the headline rates on retained earnings (and distributed profits until 2000 shown in brackets), we report the solidarity surcharge and the average business tax in our sample for each year. The latter is calculated as an unweighted average of the business tax rates of all municipalities in period
Year | Corporate tax rate retained (distributed) profits in % ( |
Solidarity surcharge in % ( |
Business tax in %, average ( |
---|---|---|---|
1994 | 45.0 (30.0) | 0 | 15.94 |
1995 | 45.0 (30.0) | 7.5 | 15.95 |
1996 | 45.0 (30.0) | 7.5 | 16.17 |
1997 | 45.0 (30.0) | 7.5 | 16.30 |
1998 | 45.0 (30.0) | 5.5 | 16.41 |
1999 | 40.0 (30.0) | 5.5 | 16.45 |
2000 | 40.0 (30.0) | 5.5 | 16.17 |
2001 | 25.0 | 5.5 | 16.40 |
2002 | 25.0 | 5.5 | 16.20 |
2003 | 26.5 | 5.5 | 16.00 |
2004 | 25.0 | 5.5 | 15.91 |
2005 | 25.0 | 5.5 | 15.99 |
2006 | 25.0 | 5.5 | 16.01 |
2007 | 25.0 | 5.5 | 16.13 |
Number of years | Number of firms | Percentage |
---|---|---|
14 | 46 | 7.76 |
13 | 12 | 2.02 |
12 | 10 | 1.69 |
11 | 10 | 1.69 |
10 | 26 | 4.38 |
9 | 19 | 3.20 |
8 | 21 | 3.54 |
7 | 30 | 5.06 |
6 | 42 | 7.08 |
5 | 48 | 8.09 |
4 | 89 | 15.01 |
3 | 119 | 20.07 |
2 | 121 | 20.40 |
Total | 593 | 100 |
Source: Number of firms with no missing values in the number of years indicated.
Tax rates on corporate income declined substantially during the period 1994–2007. Moreover, there was a major change in the tax law with the full imputation and split rate system being replaced in 2001 by the so-called half-income system (Tax Relief Act 2001). This implied the replacement of two corporate tax rates – one on retained earnings (
6.2 Cost of capital and the firms’ capital and asset structures
6.2.1 Cost of capital and the firm’s capital structure
To account for the fact that firms not only use internal funds, but also external funds in the form of debt, we assume that each firm has a specific target value for the share of debt. This target value will presumably be based on incentive considerations, since debt payments constitute a business expense that shields revenues from taxes. Let us denote the target level with
Then, with a share
where
6.2.2 Cost of capital and the firm’s asset structure
To further determine the cost of capital for a specific firm, we calculate tax-depreciation allowances for each firm by considering firms’ asset structures.
[18] Taking two types of assets into account, namely industrial buildings (IB) and plant/machinery (M) as part of a firm’s fixed assets, we construct weights
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