The Role of Taxes in the Disconnect Between Corporate Performance and Economic Growth

Urooj  Khan; Suresh  Nallareddy; Ethan  Rouen

Article | Management Science | November 2020

The Role of Taxes in the Disconnect Between Corporate Performance and Economic Growth

by Urooj Khan, Suresh Nallareddy and Ethan Rouen

Abstract

We investigate the relation between the growth in corporate profits and the overall U.S. economy, focusing on the impact of the U.S. corporate tax regime on this relation. We document that the growth of corporate profits, on average, has outpaced the growth of the economy, and this disconnect increases as the difference between the corporate income tax rate of the U.S. and the other OECD countries increases. The underlying mechanism is fewer corporate profits being channeled into subsequent domestic investments when the U.S. tax rate is relatively higher, leading to lower economic growth. Our findings have implications for policy setters.

Keywords: taxes; gdp; Corporate profits; American jobs creation Act of 2004; Taxation; Economic Growth; Profit; United States;

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Khan, Urooj, Suresh Nallareddy, and Ethan Rouen. "The Role of Taxes in the Disconnect Between Corporate Performance and Economic Growth." Management Science 66, no. 11 (November 2020): 5427–5447.

We develop measures of firm-level human capital creation from publicly disclosed personnel expenses (PE) and examine the stock market valuation of these characteristics. Separately measuring human capital creation efficacy and opportunity, we first show that efficacy is positively associated with characteristics of human-capital-intensive firms and employee productivity growth. Next, we find that efficacy has a positive pricing coefficient, implying that the market recognizes some of its variation. In our main analysis, long-short portfolios based on the human capital creation efficacy (opportunity) produce annualized abnormal returns of 4.0 to 5.4% (6.0 to 7.5%). Portfolios formed on the combination of efficacy and opportunities produce the strongest abnormal returns of 6.3 to 9.3% in annualized terms. Our results provide evidence of the importance to valuation of accurate human capital measurement.

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The Role of Taxes in the Disconnect Between Corporate Performance and Economic Growth

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