Managerial decisions are swayed not merely by the corporate tax rate but also by various factors including the company’s financial condition and investment uncertainties. Therefore, before analyzing the impact of changes in the corporate tax rate on corporate investment, corporate characteristics must first be controlled, when possible. According to the empirical results, there is a significant spike in the investment of Korea’s listed companies when the corporate tax rate is reduced. Through an analysis of the listed companies in Korea from 2002 to 2014, it was found that investment rate climbed 0.2%p for every 1%p reduction in the average effective corporate tax rate.
What should be noted here is that, the boosting effect that the tax reduction has on investment would have been considerably larger if the tunneling activities of management were prevented. This is because, investment decisions can be distorted by management using their positions to legally pursue private interests or illegally use cash holdings, which inevitably diminishes the effects of the tax cut. A structural model was applied to quantitatively examine the negative effects from such a distortion, which revealed that the degree of tunneling by management in Korea is 9 times higher than that in the US. According to the simulation, the presence of management’s tunneling activities reduces the tax cut effect by 28% in the short-term. Under the circumstances, a hike in the corporate tax rate would intensify the tunneling activities of management, which would in turn, exacerbate the downturn in employment and investment and even weaken the effect of income distribution.
Consequently, the government must take a cautious approach with regards to a corporate tax hike while also making efforts to strengthen both the internal and external supervision and monitoring of the management level to curtail their tunneling activities. As a result, this would enable and encourage management to make reasonable, sound decisions including those on employment and investment.