Inventory Management under Corporate Income Tax

Description

Income tax represents a significant cost for most corporations and is an important input into many corporate decisions. In the United States, a tax rate ranging from 15% to 35% is imposed on the profits of US resident corporations and most corporate income is taxed at the maximum rate. The corporate income tax (CIT) is the third largest source of federal revenue, and raised $343.8 billion in fiscal 2015. The corporate income tax system has been a focus of many recent debates about tax reform that calls for a tax cut for business. Corporate income tax has a significant impact on a firm’s operating and financial decisions. As documented in a world bank report, the amount of the tax cost for businesses matters for investment and growth. A recent study shows that higher tax rates are associated with fewer formal businesses and lower private investment. A 10% increase in the effective corporate income tax rate is associated with a reduction in the ratio of investment to GDP of up to 2% and a decrease in the business entry rate of about 1% (Djankov et al. 2010). A tax increase equivalent to 1% of GDP reduces output over the next 3 years by nearly 3% (Romer and Romer 2010). Therefore, it is more accurate to use net operating profit after tax as opposed to net income when making investment and operational decisions, and it gives a better picture of a company's operational efficiencies. Corporate income tax structure is quite complex in industry. There are three tax structures in practice: progressive, proportional, and regressive tax. Different tax structures have different implications on companies’ operational decisions. However, in the operations management literature, there is only a limited study on the effect of taxation on firms' operational decisions. The proposed project attempts to fill this gap by considering inventory decisions under taxation. Starting from the newsvendor setting, we examine the structure of the optimal inventory policies under various tax functions that are prevalent in the real world, and how a firm’s inventory decision is affected by different tax structure and business environment. We then plan to generalize our analysis to dynamic settings, including dynamic inventory models with a single accounting period and multiple accounting periods. We will also consider the case with loss carry forward.