Pay roll taxes hamper corporate investments due to increased labor costs

Conclusion: This paper shows that personal income taxation is negatively related to corporate investment. The magnitude of the investment responses to personal tax changes at lower income levels is comparable to that of the investment responses to corporate tax changes in our sample. It further shows that the PIT–investment relation can be explained by two channels. First, higher PIT increase labor costs, which results in stronger investment responses by firms facing more elastic workers, by financially constrained firms, and by firms in industries with a strong link between capital and labor input. Second, PIT can affect investment through reduced consumption. Our findings have important implications for the debate on tax policy design, since PIT are a major revenue source for governments. Our results indicate that personal taxes can have a substantial effect on investment, particularly PIT at lower income levels. Hence, our results provide important input for tax policy considerations. The reduced magnitude of the effects at higher income levels suggests that governments could balance their budgets while avoiding negative investment effects by lowering taxes at lower income levels and financing the shortfall by implementing modest tax increases at higher income levels. Of course, we do not provide a full welfare analysis. Still, given that investment is a key driver of overall economic growth, the documented investment responses appear to be important for academics and, in particular, policymakers, as policymakers facing budget deficits may consider PIT increases to balance their budgets.