Appendix I. Incorporating special Provisions into Effective Tax Rates
Appendix II. Derivation of the Ultimate Impact of a Tax Shock
Equation (7) can be rewritten as follows:
Then difference and consider a shock to the U.S. rate (the fixed effect drops out by differencing; the differenced error term is omitted for brevity):
Solve for the sum in (20) using (19):
(22) into (20):
Divide by Y and define
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The authors are grateful for significant inputs by Michael Keen and collaboration on this topic by Nigel Chalk, Ruud de Mooij, Christophe Waerzeggers, and Victoria Perry. Helpful comments were provided by D. Benedek, U. Boewer, J. Eugster, E. Fernandez, J.-M. Fournier, C. Hillier, A. Giustiniani, Z. Manatta, H. Poirson, N. Sheridan, and FAD seminar and workshop participants.
See also Clausing, Kleinbard, and Matheson (2016) for an analysis of reform options for the United States and their likely spillovers. The reform adopted in 2017 shares some features with the options considered in that paper, but also has major differences.
For example, the BEAT (see following section) goes beyond all BEPS actions.
Section 199 of the Internal Revenue Code allowed a deduction of up to 9 percent of income from production activities including manufacturing, natural resource extraction, farming, construction, architecture, engineering, and the production of software, recordings and films.
Qualifying dividends and long-term capital gains were taxed at rates of up to 20 percent, but other gains were taxed at rates of up to 39.6 percent.
Though these earnings were undistributed, many were held in US banks and/or US$ denominated securities. See U.S. Senate (2011).
For a discussion of these practices, see Kleinbard (2011). Though check-the-box remains a feature of the US tax code, the shift to territoriality should greatly reduce its use, since foreign earnings are now exempt.
In 2018 this was scheduled to fall to 40 percent in the absence of the reform.
Specifically, the written-down value of the subsidiary’s non-real estate depreciable tangible business assets calculated using straight-line depreciation method (s.168(g)) is used. This is therefore not affected by accelerated depreciation or expensing and is independent of the foreign country’s depreciation rules.
The GILTI liability (expressed as a ratio to corporate pre-tax income) is calculated for each industry as the maximum of zero and [(Foreign net income + foreign income tax – 0.1*PP&E)*0.105 – 0.8*foreign income tax]/(foreign income + foreign income tax).
New restrictions on the use of loss carry overs are also likely to raise effective tax rates, especially for cyclical businesses.
Another approach to defining effective tax rates is to estimate them from economic aggregates, such as by dividing tax payments by profits. This approach is backward looking, because the tax payments are a function of past investment decisions and the resulting distribution of asset and funding sources. Even after a tax reform, figures will be affected by such past decisions, and importantly, by losses carried forward. Such measures are therefore less suitable for assessing firms’ incentives for new investments. For a discussion of different tax measures, see for example, OECD (2001), Nicodeme (2001), or Sørensen (2004).
Equity here refers to both retained earnings or new equity. As personal income taxes are not included, this makes no difference. If personal taxes were included, new equity would typically be at a disadvantage, because of the additional taxation of dividends.
The differences among tax rates under different scenarios are more interesting than the precise values, which depend strongly on the assumptions.
Strictly speaking, this is true only if investment takes place at the end of a period, but the expense can be claimed for the full year. Without this assumption, the tax rate would be low, but not zero.
Prior to the reform, the U.S. thin capitalization rule, Section 163(j), was less restrictive: Net interest expense exceeding 50 percent of adjusted taxable income (plus any excess limit carryover from previous years) was disallowed, unless the corporation met the safe harbor debt-to-equity ratio cap of 1.5. Disallowed interest expense or excess limit could be carried forward for up to three years.
The large absolute value for such EMTRs is explained by the fact the denominator (profits) is very small as these are marginal projects.
Most of the literature, and this section, focuses on statutory tax rates. A few papers, e.g., Overesch and Rincke (2011) also consider effective tax rates, but results are harder to interpret (given the multitude of effective tax rates depending on assumptions) and weaker.
Becker and Riedel (2012) find that cuts in foreign tax rates may sometimes even support domestic investment, for example, because of common inputs.
The semi-elasticity of 1.5 is a consensus-estimate from the literature, projected to the year 2015.
See also Gibbons and Overman (2012) for a critique of commonly used empirical identification strategies in this literature. They suggest using exogenous changes in tax rates to estimate fiscal reactions, but as those are hard to find for CIT, no paper we are aware of has employed such an approach.
Altshuler and Goodspeed (2015) argue that the United States is a leader in such tax competition in the sense that other countries react to the United States, but not vice versa. The fact that the United States is a late mover in lowering tax rates may not contradict this, because if acting as a Stackelberg leader—i.e., taking into account the rates cuts that will follow in other countries-it should cut less than in a Nash equilibrium.
We include a full set of time-specific and country-specific fixed effects as well as country-specific GDP, inflation, unemployment and population size variables.
This definition follows the theoretical model of Huizinga and Laeven (2008), assuming that all country operations are similarly profitable.
In the United States national law has the same status as treaties, hence a newer national law can override a treaty. In case this leads to a breach of treaty, the law would still apply, but the other party could terminate the treaty.
A new data base on tax policy measures, described in Amaglobeli and others (2018) could be used to study such detailed reforms.
Personal level tax rates are not taken into account in the calculations in the paper, but they are included here in the derivation to allow their potential inclusion by any researcher interested in their analysis.
A question arises about the timing of this depreciation. Equation (18) assumes that in the first year the 10 percent return applies to the full asset, in the second year to (1–6) and so on. One could also require the depreciation be already taken in the first year in line with the treatment of standard depreciation. In that case, the second fraction in Equation (18) would need to be multiplied by (1–6) in the numerator.