Capital-Based Corporate Tax Benefits: Endogenous Misallocation through Lobbying

The dominant issue of corporate lobbying in the U.S. is taxation. Firms that lobby are granted tax benefits and enjoy systematically lower effective tax rates than non-politically active firms, even after controlling by firm characteristics. Because most of these tax benefits are tied to capital holding, corporate lobbying could distort the allocation of capital in the economy. A heterogeneous firm dynamics model with endogenous lobbying decisions is presented to study the macroeconomic effects of capital-based tax benefits and their interaction with endogenous corporate lobbying behavior. The model is calibrated to U.S. firm-level data. The model suggests that the increase in corporate lobbying and the decrease in effective corporate tax rates between 1998-99 and 2010-11 are mostly due to the increase in the availability of political rents. Moreover, rent-seeking by firms explains more than 20% of the dispersion in the marginal product of capital, the main measure used in the literature to quantify the misallocation of capital.