Gross profit taxation versus distributed profit taxation and firm perfomance : effects of Estonia,s corporate income tax reform

This paper estimates the effect of the corporate tax reform in Estonia in the year 2000. This unique reform nullified the taxation of retained earnings and retained the corporate income tax only on distributed profits. The effect of the reform is identified by comparing the performance of Estonian firms that were affected with that of firms from Latvia and Lithuania, the two other Baltic states. We use firm-level financial data and the difference in differences and propensity score matching methods for our analysis. The results show that the corporate tax reform has resulted in increased holdings of liquid assets and lower use of debt financing. These developments have contributed positively to firms' survival during the recent global economic crisis. A positive effect on investment and labour productivity has also been found