Distortions, efficiency and the size distribution of firms

• Published in: Journal of macroeconomics 2015-09, Vol.45, p.202-221
• Main Authors: Goyette, Jonathan, Gallipoli, Giovanni
• Format: Article
• Language: English
• Subjects: Benchmarking; Business growth; Calibration; Capital costs; Corporate taxes; Cost of capital; Credit; Credit control; Developing countries; Distribution; Financial frictions; Growth; LDCs; Size distribution of firms; Studies; Taxation; Taxes
• ISSN: 0164-0704; 1873-152X
• DOI: 10.1016/j.jmacro.2015.04.008

•We build a firms’ growth model with tax and financial distortions using Ugandan data.•Tax distortions generate a missing middle in firms’ size distribution.•Tax distortions account for 13% of the gap in output-per-worker with First-Best.•Credit constraints generate a highly right-skewed firms’ size distribution.•Interaction of capital cost and quantity constraints explains 85% of the FB gap. We develop a model of firms’ growth in which the tax and credit environments act as selection mechanisms. Such a model, parametrized and validated using a variety of data restrictions, can rationalize observations about input choices and size patterns typical of many developing countries. Using counterfactual experiments, we show that firms’ optimal responses to the tax environment are effective in reducing efficiency losses. As a consequence, tax distortions only account for 13% of the gap in output per worker between an undistorted economy and the benchmark. Credit constraints account for 44% of this gap. However, the interaction between the cost of capital and credit constraints appears to be the most important source of misallocation and can explain up to 85% of the difference in output per worker between the benchmark and first-best.