Broad or narrow base

My name is Kristoffer Berg, and I'm a lecturer at Trinity College, University of Cambridge.

We're back for our third lecture on business taxation, and we saw in the last lecture that the corporate income tax can, in some cases, distort the investment decisions of Firms. The question is how could we think about designing the corporate income tax in a way that may be able to avoid these types of distortions. One important factor to keep in mind here is that firms in practice do rely on multiple forms of financing of their investment. So investment could be financed by using equity, for example, from their shareholders, other shareholders using their own personal wealth and investing in the company. Firms could rely on debt so they could raise debt for example, from banks, to make new investments. Thirdly, and quite importantly for large businesses, is that they can finance investment by withheld profits. If the firm has been making profits in the past, they can use these profits that they have kept back in the business to invest. Now, there are many reasons why firms and companies choose different forms of financing for their investments, so there are many non-tax considerations as well. Key concern could be the risk of bankruptcy. If there is a very high debt-to-equity ratio that increases the risk that the firm might go bankrupt. Then it could also be what we call agency costs. These arise from conflict interests between managers and shareholders in firms. If shareholders are more influential, then there could be more equity financing because then they have a larger stake in the firm and might be able to have a larger share of control over what the manager is doing compared to if the firm is more financed from debt from banks, for example. One key feature when we think about taxation is that tax that is neutral towards financing doesn't affect the choice of financing for the firm.