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

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Moreover, losses are not indexed. Hence, they need to be discounted under loss carry forward to compute them in net present value terms. Under consolidation, losses are more valuable. A loss in one part of the company can be offset immediately against profits elsewhere as long as these are positive. In that case, losses can always be offset against these profits and without discounting. Therefore, the tax burden under loss consolidation is generally lower than under loss carry forward. To illustrate how much the corporate tax burden will fall under loss consolidation, consider the following example (this closely resembles what we assume in CORTAX). Suppose there are 100 firms. Among them, 80 make a profit of 1000 and 20 make a loss of 1000 (this corresponds to the loss probabilities and the loss size used in CORTAX). The total taxable base of profit making firms is therefore 80 000 if the losses cannot be offset and 60 000 if losses are offset immediately. Under loss consolidation, the tax base is thus 25% smaller. As the tax reduction applies only to multinational firms, we multiply this by the share of multinationals in the economy, which is approximately 60% in Europe. Consolidation would then reduce the corporate tax burden by 15%. 12 In the steady state equilibrium of CORTAX, the reduction in the tax base is smaller because losses can be carried forward from the past. In CORTAX, 80% of the previous-year losses (i.e. the probability of profit) can be offset against profits in the next year (the other 20% dry up because no profits are made). In our example, this equals a loss compensation of 16 000. Yet, these profits need to be discounted at, say 5% interest, which reduces its current value to 15200. Compared to immediate loss offset under consolidation of 20 000, the value of losses drops by 4 800. It implies a reduction of the corporate tax base by 4 800 / 64 800 = 7.5% when moving from loss carry forward to loss consolidation. Assuming a share of multinationals of 60% of all companies, the aggregate decline in the tax base in the steady state would be 4.5%. In the CORTAX simulations, loss consolidation indeed reduces corporate tax revenue in Europe by slightly less than 5%, which is about 0.2% of GDP. The reduction is higher for countries featuring high corporate tax rates and a large multinational sector. The incentive effects of loss consolidation on investment and employment are subtle. The box “Incentive effects of loss consolidation versus loss carry forward” explains this in more detail. 13 Despite the lower corporate tax burden due to consolidation, it shows that the cost of capital does not necessarily fall. Intuitively, marginal returns on investment can still be positive but taxed later or only partially under loss carry forward. Under loss consolidation such positive marginal 12 Fuest, Hemmelgarn and Ramb (2006) find a decline in the tax base of 20% using data on German multinationals. ORBIS suggests that the share of multinationals in Germany is 70%. It would imply a direct reduction of 17.5% in Germany. 13 Note that CORTAX does not capture three other potentially important effects of loss consolidation. First, higher after-tax profits may stimulate investment if firms are liquidity constrained. Empirical evidence supports the positive investment effect of net internal funds (see e.g. Hubbard, 1997). This argument seems most relevant, however, for small domestic firms and not for multinationals. Second, a more symmetric treatment of profits and losses under consolidation may reduce the risk of investment as the government better insures losses. This Domar-Musgrave effect may stimulate risk taking and raise returns to capital in the economy. Finally, loss consolidation can remove a barrier for multinational firms to locate in certain countries or to organise their affairs in the most efficient way. 48
eturns are taxed immediately and always and therefore taxed at a higher effective rate. We also see that that labour demand will be affected since wage costs may effectively decline. The economic effects of loss consolidation are therefore not a priori clear. Incentive effects of loss consolidation versus loss carry forward Assume a firm that produces output by combining labour and capital. Ex-ante, firms are equal. Ex-post, they may suffer from a random shock in the value of sales. In the good outcome, the revenue from sales equals Y g t . In the bad outcome, there is a lower value Y b t , such that profits are negative. Ex-post, a share of q firms obtain a good outcome and a share 1-q obtains a bad outcome. Assuming risk neutrality, firms consider the expected value of output when determining their demand for inputs. Under loss consolidation, we assume that all losses can be immediately offset against profits elsewhere in the multinational group. The expected aggregate corporate tax base is C g b (1) E( Π t ) = qYt + (1 − q) Yt − wLt −φI t where wL t denote labour costs, I t is investment and ø stands for an investment tax credit. Immediate loss offset does not distort the demand for capital and labour: 1−φτ g b ( (3) qYL + ( 1− q) YL = w 1−τ g b (2) qYK + 1− q) YK = r where subscripts denote marginal productivities, r is the return to equity and τ is the corporate tax rate. Expressions (2) and (3) suggest that firms set the expected marginal productivity of capital and labour equal to their respective prices. According to (2), the corporate tax raises the cost of capital as long as investment is not fully deductible, i.e. øY b L ). Whether or not loss carry forward raises capital costs depend on the corporate tax system: if only a small share of investments are deductible (i.e. if ø is small), the reduced taxation of production in bad outcomes Y b K implies a reduction in the cost of capital. L 49
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 and 22: Figure 2.4 Corporate tax revenue in
Page 23 and 24: countries (each point representing
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: shifting within the EU (see section
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
Page 75 and 76: Appendix B Country tables CCTB The
Page 77 and 78: Table B.2: CCTB-WG25 for all firms
Page 79 and 80: Table B.4: CCTB-WG20 for multinatio
Page 81 and 82: Table B.6: CCTB-EUav for multinatio
Page 83 and 84: Table B.8: CCTB-WG20 for multinatio
Page 85 and 86: Table B.10: CCTB-WG20 for multinati
Page 87 and 88: Table B.12: CCTB-WG25 for all firms
Page 91 and 92: Table B.16: CCTB-EUav for multinati
Page 95 and 96: Table B.20: CCTB-WG20, multinationa
Page 99 and 100:
Table B.24: CCTB-WG25 for all firms
Page 101 and 102:
Table B.26: CCTB-WG20 for multinati
Page 103 and 104:
Table B.28: CCTB-EUav for multinati
Page 105 and 106:
Table C.1: CCCTB-WG20 for all firms
Page 107 and 108:
Table C.3: CCCTB-EUav for all firms
Page 109 and 110:
Table C.5: CCCTB-WG25 for multinati
Page 111 and 112:
Page 113 and 114:
Page 115 and 116:
Table C.11: CCCTB-WG20 for all firm
Page 117 and 118:
Table C.13: CCCTB-EUav for all firm
Page 119 and 120:
Table C.15: CCCTB-WG25 for multinat
Page 121 and 122:
Page 123 and 124:
Page 125 and 126:
Table C.21: Decomposition CCCTB-WG2
Page 127 and 128:
Table C.23: Decomposition CCCTB-WG2
Page 129 and 130:
Page 131 and 132:
Page 133 and 134:
Page 135 and 136:
Page 137 and 138:
Table C.33: CCCTB-EUav for multinat
Page 139 and 140:
Page 141 and 142:
Page 143 and 144:
Table D.1: EUCIT-WG20 for all firms
Page 145 and 146:
Table D.3: EUCIT-EUav for all firms
Page 147 and 148:
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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