How do corporate tax bases change when corporate tax rates change? With implications for the tax rate elasticity of corporate tax revenues

Abstract

We construct a new database of extensive margin changes to multiple aspects of corporate tax bases for OECD countries between 1980 and 2004. We use our data to systematically document the tendency of countries to implement policies that both lower the corporate tax rate and broaden the corporate tax base. This correlation informs our interpretation of previous estimates of the relationship between corporate tax rates and corporate tax revenues, which typically do not include comprehensive measures of the corporate tax base definition. We then re-examine the relationship between corporate tax rates and corporate tax revenues. We find that accounting for unobserved heterogeneity attenuates the relationship between corporate tax rates and corporate tax revenues, and increases the implied revenue-maximizing tax rate. Controlling for our new tax base measures does not substantively impact the magnitude of this relationship.

Appendices

Appendix 1: Data appendix

In this Data Appendix, we provide details of the methodology employed to translate summaries of tax policy changes into indicator variables for types of changes to the corporate income tax base. These indicator variables are derived from summaries of important tax policies published in the International Bureau of Fiscal Documentation’s Annual Report publications. For each of the variables, changes that broaden the corporate tax base are coded as $+$1, while changes that shrink the tax base are coded as $-$1.

1.1 Description of corporate tax base indicator variables

• Research and development tax credit

  $-$1:

  Research and/or development credit (or deduction) was made available or extended; additional deduction of research costs was permitted.

  $+$1:

  Research and/or development credit (or deduction) was reduced.

• Credits for foreign taxes paid

  $-$1:

  Foreign tax credit was introduced or increased; the foreign tax credit became easier to obtain; ability to carry forward or back the foreign tax credit was made available or extended; losses could be used to offset foreign source income.

  $+$1:

  The scope for the foreign tax credit was reduced or denied; limitation to the offset of foreign source losses (Germany 1982).

• Tax treatment of foreign companies

  $-$1:

  Tax exemptions, deductibility of costs, or other investment incentives aimed at attracting foreign investment or multinational headquarter placement; limited taxation or tax-exempt status of (some) nonresident companies; liberalization of inward foreign investment; reduced corporate taxes on companies with a foreign holding; holdings in foreign corporations granted new exemptions (Germany 1993); lower tax rates extended to EU companies where previously only applied to resident companies (Greece 2000); foreign company entry made easier (Korea 1994).

  $+$1:

  Tax incentives to foreign investors or foreign companies were reduced or withdrawn; benefits to dual resident companies denied; certain tax rules extended to nonresident companies; definition of a resident corporation was expanded; taxes on income derived from subsidiaries in tax privileged countries were imposed; limited deduction of expenses of branch offices of nonresident companies; final withholding on nonresident corporations increased; deduction for expenses between resident and non-EC companies was disallowed (Italy 1991/2).

• Policies that target evasion or avoidance by companies

  $-$1:

  Increased efforts to combat evasion or avoidance, unless specifically directed at the individual level only, including provisions addressing international profit shifting, provisions to curtail the underground economy and a temporary tax amnesty to encourage the repatriation of capital illegally held abroad.

• Investment credits or other tax incentives to promote investment

  $-$1:

  Investment allowance/premium/deduction was introduced, increased or extended; exclusion of certain investments from taxation; tax holiday for investment projects or capital investments; incentives to promote investment; safe harbor leasing rules for investment credits.

  $+$1:

  Investment premium or deduction was abolished, reduced or restricted; companies were no longer allowed to allocate profits to a tax-free investment reserve.

• Accelerated depreciation or other depreciation allowances

  $-$1:

  Increased depreciation rates; depreciation period shortened; accelerated write-off of capital expenditures; threshold for depreciation was increased; special depreciation allowances granted; free depreciation scheme introduced.

  $+$1:

  Use of accelerated depreciation was reduced or abolished; depreciation rates were reduced; depreciation period was extended.

• Other tax rates that may affect the corporate tax base

  $-$1:

  Additional tax on business: Exceptional company profits or extraordinary business income (Hungary 1998; Portugal 1987); excess accumulated income (Korea 1994); municipal business tax on capital (Luxembourg 1998); assets tax (Mexico 1995); special temporary corporation tax (Japan 1994); branch profits tax (Australia, 1987); enterprise tax (Japan 1997); company formation tax (Hungary 1998). Capital taxes: Property transfer tax (Austria 1987); transfer of capital (Spain 1980); income from the increase in invested capital (Italy 1998). Development land tax (UK 1985). Specific business types: Shipping (Portugal 1991); foreign technology licensors (Korea 1988).

  $+$1:

  Additional tax on corporations: Surtax on corporations or surcharge on corporate income tax (France 1995, 1997; Germany 1991; Turkey 1995); large corporation tax on capital (Canada 1989, 1990); flat tax on tax-reserves of companies (Greece 1998); special temporary corporation tax (Japan 1991); special corporate rate on exempt entities (Spain 1987); branch profits tax (US 1986). Specific business types: Large banks, investment funds or financial institutions (Austria 1981; Denmark 1989; France 1981; Korea 1982); life insurance companies (Australia 1988; Germany 1993; Sweden 1986); oil companies or oil windfall profits tax (France 1980, 1981, 2000; Norway 1980; US 1986); manufacturing profits tax on computer software and data processing firms (Ireland 1984); telecommunications (Turkey 1999). Capital taxes: Immovable property (Belgium 1994, Germany 1982; Spain 1991); movable capital (Portugal 1980, 1983). Surcharge on the employment fund (Luxembourg 1991, 1994).

• Loss carry forward

  $-$1:

  Loss carry forward was extended or expanded; limits for carry-forward loss amounts were removed.

  $+$1:

  Ability to carry forward losses was suspended or restricted.

• Loss carry back

  $-$1:

  Loss carry back was introduced.

  $+$1:

  Ability to carry-back losses was restricted.

• Thin capitalization rules

  $+$1:

  Thin capitalization rules were introduced or strengthened (widened); adjustments were made to thin capitalization rules (assumed to be positive); debt-to-equity ratio was reduced.

• Controlled foreign company legislation

  $-$1:

  CFC legislation was introduced or redefined.

• Other changes to the corporate tax base

  $-$1:

  Eased tax burden of companies generally (Netherlands, 1983); new deduction or exemption permitted: Losses from disposal of fixed assets (Czech Republic 1995); investment abroad (France 1988); payroll (France 1998); cost of issuing new shares (Germany 1984); new employees (Ireland 1982); bonuses to directors (Portugal 1999); undistributed profits that are wholly reinvested (Greece 1988); repatriated earnings (Ireland 1988); income from overseas services if not taxed in the source country (Australia 1980); corporate income tax incentives in the form of a credit (Hungary 2002); participation exemption under the corporate income tax was extended (Luxembourg 1988); level of income below which a proportion tax reduction is allowed was raised (Finland 1984).

  $+$1:

  Measures to or emphasis on broadening the tax base, without mention of specific provisions (Hungary 1994; Japan 1998; Mexico 1987; US 1982; Turkey 1981); taxable base for lower rate was increased (Korea 1989); previous tax incentives restricted or abolished (Poland 1992); credits reformulated resulting in a sharp decrease in benefits (Spain 1988); certain provisions replaced, expected to keep total tax burden unchanged (Sweden 1989); loss of some deduction (Australia 1985; Netherlands 1989); allowances restricted (Hungary 1991); expenses were no longer recognized as business-related costs (Hungary 1993); inventory deduction abolished (Netherlands, 1986); extension of employment deduction for small and medium-sized businesses; reduction of certain tax expenditures (Belgium 1984); certain tax exemptions to promote growth of SME (Belgium 1998); deductions for corporate entertainment restricted (Japan 1994); investment deduction for employee profit sharing schemes eliminated (France 1985); maximum amount allowed to be credited to bad debt reserve was reduced (Japan 1982); full carry-over of tax benefits from international or contractual agreements (Portugal 1989); capital allowances phased out (UK 1984); corporate AMT extended (US 1986).

Appendix 2: Additional replication of previous work

In this Appendix, we conduct a replication exercise of Devereux (2007), as we did for Clausing (2007) in Sect. 4.3, using a similar baseline specification. We begin with the simple linear regression given by:

$$\begin{aligned} R_{it}=\beta _{0}+\beta _{1}\tau _{it}+\beta _{2}\tau _{it}^{2}+\varGamma X{}_{it}+\mu _{t}+\varepsilon _{it}, \end{aligned}$$

(4)

where $R_{it}$ is the ratio of corporate tax revenues to GDP, $\tau _{it}$ is the top statutory corporate tax rate, $X{}_{it}$ are control variables, $\mu _{t}$ are year fixed effects, and i denotes country and t denotes year. We use specifications that appear in columns (7) and (9) in Table 1 of Devereux (2007), which correspond to the most generous set of controls. The potential for income shifting is accounted for in two ways: specifications either include the GDP-weighted average of corporate tax rates in other OECD countries or include the top personal tax rate of the home country. Both sets of regressions include a measure of the corporate tax base, the present discounted value of tax depreciable allowances per dollar of investment in plant and machinery (PDV of allowances), interacted with all included tax variables.

Table 12 Replications of Devereux (2007)

Table 12 presents results from our replication exercise. Panel A presents results including the GDP-weighted average of other countries’ corporate tax rates in the regression as the “alternative” tax rate, and Panel B presents results including the top personal tax rate as the “alternative” tax rate. Standard errors are clustered at the country level. An important difference between these replications and the replications of Clausing (2007) is that these regressions now only include 20 OECD countries, as opposed to 30, due to the availability of data on the PDV of allowances.

Results from estimating these specifications via OLS appear in column (1) of Table 12. The results are qualitatively consistent with Devereux (2007). There is evidence of a nonlinear relationship between corporate tax rates and corporate tax revenues, which is highly statistically significant when controlling for the personal tax rate.³¹ The estimated revenue-maximizing corporate tax rate evaluated at the mean of the PDV of allowances for the estimation sample (0.773) is 32 %. As found in the original study, the “alternative” tax rate variable plays a significant role in neither specification.

Next, we account for unobserved time-invariant heterogeneity by including country-specific fixed effects (FE) and by estimating equation in first-differences (FD). Results from the FE and FD specifications are presented in columns (2) and (3) of Table 12, respectively. In all of these specifications, the relationship between corporate tax rates and corporate tax revenues becomes attenuated, and none of the corporate tax rate variables are statistically significant at the 5 % level. Some of these specifications oddly imply a convex relationship between corporate tax rates and corporate tax revenues. The implied revenue-maximizing rates from these specifications cover a surprisingly large range, from $-$18 % to over 100 %. These results are consistent with the explanation put forth in both Clausing (2007) and Devereux (2007) for not controlling for time-invariant unobserved heterogeneity: that insufficient within-country variation remains to identify corporate tax rate effects.