The economic effects of EU-reforms in corporate income tax systems

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2.2.2.6 Losses We use ORBIS to obtain information about the average loss probability and the aggregate ratio of loss/profit in the EU. The average loss probability is around 0.2; the aggregate ratio of loss/profit equals ¼. As the ratio of loss/profit probabilities 0.2/0.8 matches the aggregate loss/profit ratio, the average loss in a loss-making firm is assumed to be equal to the average profit in a profit making firm. These assumptions are adopted in the calibration of CORTAX. In the baseline of CORTAX, we assume that loss carry forward applies in all countries of the EU. 2.2.3 Key elasticities An important part of the calibration of CORTAX involves parameters that determine the key elasticities in the model. This section discusses how we choose these parameters and how elasticities compare to empirical evidence. 2.2.3.1 Labour-supply distortions Taxes on income and consumption distort labour supply incentives. These effects are determined by the substitution elasticities in the utility function of households, together with preference parameters. For all countries, the intratemporal elasticity of substitution between consumption and leisure is set at 1.0; the intertemporal elasticity of substitution is set at 0.5. The preference parameters for leisure are chosen so as to replicate data on the average hours per worker in EU countries. Based on these parameters, we find that on average across the EU, the uncompensated elasticity of labour supply is 0.19. This corresponds to the consensus in the empirical literature (see e.g. Evers et al., 2008). 2.2.3.2 Financial distortions In CORTAX, the convexity of the financial distress cost determines the impact of corporate taxation on a firms’ financial policy. A number of studies aim to identify this impact. Graham (2004) reviews earlier studies using time series data and concludes that most report small tax effects. More recent studies using cross-section variation between companies typically report larger effects. For instance, Gordon and Lee (2001) find that a 1%-point reduction in the corporate tax rate reduces the debt/asset ratio at the margin by 0.36%-point. Another strand of this literature has explored the impact of taxation on the financial policies of multinationals, thereby using cross-country variation in tax rates. Altshuler and Grubert (2003) report a semielasticity of − 0.4. Desai et al. (2003) arrive at a semi-elasticity of − 0.25. In CORTAX, we set the parameters in the financial distress cost function so as to obtain a semi-elasticity of the debt share with respect to the corporate tax rate between 0.2 and 0.4. The mean value is 0.27. As the financial distress cost is a convex function of the debt share, the semi-elasticity falls in the corporate tax rate. Figure 2.5 shows this by presenting the elasticity of the debt share for all EU 22
countries (each point representing a country) and relating it to the corporate tax rate in these countries. Figure 2.5 Reduced-form elasticities of the debt share with respect to the corporate tax rate in CORTAX 0.5 Tax elasticity of the debt share 0.4 0.3 0.2 0.1 0 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Corporate tax rate 2.2.3.3 Investment distortions To determine the size of corporate tax distortions on investment, we need to quantify two effects: (i) the impact of the corporate tax on the cost of capital and (ii) the impact of the cost of capital on investment. The effect of corporate taxes on the user cost of capital depends on the initial corporate tax system, as explained in the box on “The cost of capital and the EMTR”. The second effect depends on the substitution elasticity between labour and capital. The US Joint Committee on Taxation (1997) reports a range of estimated elasticities in the literature between 0.2 and 1.0. Chirinko (2002) reviews recent empirical literature and points at the wide range of estimates from less than 0.3 using aggregate investment data, 0.25-0.5 using firm-level panel data, to 0.4-0.9 with cointegration estimates on capital and its user cost. Most general equilibrium models adopt values between 0.5 and 1.0. We use a value of 0.7 in the baseline simulations. This corresponds with an elasticity of investment to the user cost of − 0.9. Direct estimates on the elasticity of investment with respect to the cost of capital are consistent with this (Hassett and Hubbard, 2002). To summarise the investment distortions induced by corporate taxes, we compute tax-rate elasticities of investment in CORTAX. They are depicted in Figure 2.6. On average, the taxelasticity is − 0.3, i.e. a 1%-point higher corporate tax rate reduces investment by 0.3%. It ranges from zero in Estonia to −0.6 in Spain (with a high EMTR). Investment thus becomes more responsive to tax if the EMTR in a country is larger. 23
Page 1 and 2: The economic effects of EU-reforms
Page 3 and 4: Contents 1 Introduction 5 2 The COR
Page 5 and 6: 1 Introduction This report analyses
Page 7 and 8: Household optimization yields expre
Page 9 and 10: In today’s corporate tax regimes
Page 11 and 12: Yet, not all forms of profit shifti
Page 13 and 14: companies which report total assets
Page 15 and 16: 2.2.2.1 Corporate tax rates Figure
Page 17 and 18: Table 2.3 Summary information about
Page 19 and 20: 2.2 shows the average debt share pe
Page 21: Figure 2.4 Corporate tax revenue in
Page 25 and 26: Figure 2.7 Reduced-form elasticitie
Page 27 and 28: Figure 2.9 Reduced-form elasticity
Page 29 and 30: 2.3 Interpretation of results CORTA
Page 31 and 32: structured discussion about both th
Page 33 and 34: There is a variety of combinations
Page 35 and 36: Table 3.2 shows the economic effect
Page 37 and 38: of the fixed factor is smaller. Acc
Page 39 and 40: Table 3.4 Economic effects for the
Page 41 and 42: Table 3.5 Economic effects for the
Page 43 and 44: shows the impact of the CCTB-WG20 r
Page 45 and 46: 4.1.2 A scenario without profit shi
Page 47 and 48: shifting within the EU (see section
Page 49 and 50: eturns are taxed immediately and al
Page 51 and 52: other hand, loss consolidation caus
Page 53 and 54: Figure 4.2 Welfare effects of selec
Page 55 and 56: asic version of CORTAX. Note, howev
Page 57 and 58: 5 European corporate income tax Thi
Page 59 and 60: 6 Conclusions We have analysed the
Page 61 and 62: Devereux, M.P. and S. Loretz, 2008a
Page 63 and 64: Appendix A Modelling firm behaviour
Page 65 and 66: c b ∂cb + dbt = r − rb + τRb (
Page 67 and 68: capital requires that the marginal
Page 69 and 70: − b Π t −1 = Yt −1 − wLt
Page 71 and 72: Substituting into the dividend equa
Page 73 and 74:
Appendix A2 Country tables baseline
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Appendix B Country tables CCTB The
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Table B.2: CCTB-WG25 for all firms
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Table B.4: CCTB-WG20 for multinatio
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Table B.6: CCTB-EUav for multinatio
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Table B.8: CCTB-WG20 for multinatio
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Table B.10: CCTB-WG20 for multinati
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Table B.16: CCTB-EUav for multinati
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Table B.20: CCTB-WG20, multinationa
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Table B.28: CCTB-EUav for multinati
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Table C.1: CCCTB-WG20 for all firms
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Table C.3: CCCTB-EUav for all firms
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Table C.5: CCCTB-WG25 for multinati
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Table C.11: CCCTB-WG20 for all firm
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Table C.13: CCCTB-EUav for all firm
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Table C.15: CCCTB-WG25 for multinat
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Table C.21: Decomposition CCCTB-WG2
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Table C.23: Decomposition CCCTB-WG2
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Table C.33: CCCTB-EUav for multinat
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Table D.1: EUCIT-WG20 for all firms
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Table D.3: EUCIT-EUav for all firms
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Table D.5: EUCIT-WG25 for all firms
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The economic effects of EU-reforms in corporate income tax systems

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