Economic theory indicates that in an open economy, shareholders do not bear the burden of corporation tax. Higher taxes require higher pre-tax rates of return so that shareholders can earn the same rate of profit after tax as they can in other countries. Instead the tax burden must be passed on to the workforce and consumers.
This paper is one of the first studies to test this theory. It does so using data from company financial accounts. The results strongly support the theory. In the short run, a £10 increase in the corporation tax liability results in a fall in wage payments of just over £5. In the long run, wage payments will fall by even more than £10. Not only is the tax wholly borne by labour, but in addition the cost of economic distortions created by the tax are also borne by labour.
The paper uses data on 23,000 companies, based in 10 countries, using data between 1993 and 2003. It uses sophisticated econometric techniques to analyse the relationship between wage rates and tax liabilities, allowing for many other factors, including measures of productivity, personal income taxes and employment protection legislation.
2 Common Consolidated Corporate Tax Base: large countries revenue would rise under the EU’s proposals
The European Commission is currently pursuing a proposal to introduce a “common consolidated corporate tax base” (CCCTB). The proposal is that a company operating in more than one country within the EU could declare only its EU-wide profit. That profit would be allocated to individual member states on the basis of a simple formula. Each member state would tax its allocation at its own tax rate. The details of the proposal are subject to ongoing discussions in Brussels.
This research paper analyses the likely impact of introducing these proposals on corporation tax revenues. It takes existing measures of taxable income for individual companies, and calculates how losses could be offset across countries within multinational groups, and also how alternative allocation formulas would affect the overall distribution of corporation tax liabilities.
If companies can choose whether to participate, they will generally only do so if they pay lower taxes: which implies that overall tax revenues will fall. Overall, EU tax revenues would fall by around 1%. But there will be gainers and losers amongst the EU member states. The UK would gain – irrespective of the allocation method used.
If companies are obliged to participate then EU-wide corporation tax revenues would rise by 8%. But again, the UK would do better than average. Depending on the allocation method used, UK corporation tax revenues could increase by over 20%.
A study by three Dutch economists examines the effect of corporation tax, income tax and VAT on the labour market in the EU. They build a computer model of the economies of the 17 largest EU countries which investigates in detail the impact of these taxes.
The central estimate of the effect of corporation tax is that a fall in corporation tax rates of around 8 percentage points – equivalent to reducing revenues by half of a percent of GDP – would increase employment by half a percentage point. Taking account of labour supply changes as well, the unemployment rate would fall by around a quarter of a percentage point. There is some variation in this effect between EU countries. The current UK unemployment rate is around 5.5% - such a tax change would imply a fall to around 5.25%.
But the effects of corporation tax are lower than the effects of income tax and VAT. On average in the EU, an equivalent fall in income tax would reduce unemployment by around 0.43 percentage points, and an equivalent fall in VAT would reduce unemployment by around 0.37 percentage points.
It is commonly believed that globalisation introduces tax competition as countries reduce tax rates to attract inward investment. This is supported by evidence of falling corporation at rates in the EU and elsewhere. But it is contradicted by evidence from the same countries of high corporation tax revenues. One reason for this apparently contradictory evidence may be that globalisation also leads to increased profit, which in turn generates higher corporation tax revenues, offsetting the cuts in tax rates.
This project tests directly whether globalisation leads to higher or lower tax revenues. Using data from Germany, it finds that tax revenues are higher in jurisdictions which are more globalised – measured by having more foreign direct investment and more trade. Specifically, it finds that a 10 percentage point increase in an index of a country’s globalisation raises corporation tax revenue by 4.4%.
5 Tax competition in income tax as well as corporation tax
The academic evidence for competition between countries in setting corporation tax rates is well established. But until now, there have been no studies considering whether there is competition in other taxes. The project tests the hypothesis that there is also competition in attracting unincorporated businesses through income tax rates.
Based on data from OECD countries over the last 10 years, the project finds substantial evidence of tax competition in both income tax rates and corporation tax rates.
Further, it finds that these taxes are substitutes for each other. If corporation tax rates in other countries fall, a country will respond by reducing its corporation tax rate and raising its income tax rate. If income tax rates in other countries fall, a country will respond by reducing its income tax rate and raising its corporation tax rate.