Appendix A. Effective Average Tax Rate
The effective tax rates were calculated according to the methodology developed by Devereux and Griffith (2003). The effective average tax rate, or EATR is defined as:
The rent of a project can be modeled as a perturbation in the value of the firm, defined as
Devereux and Griffith use this framework to analyze the tax consequences of a one period perturbation in the capital stock, financed by retained earnings, debt or new equity. This investment is modeled as an increase in capital stock by 1, yielding a real financial return of ρ, and being subject to real economic depreciation of δ The tax system provides an investment allowance of φ and taxes profits at rate τ. For convenience, the above equation is solved for retained earnings first, yielding a level of rent RRE. The cases of finance by new equity and debt are then dealt with by additional financial effects for new equity FNE and debt FD, which are calculated as:
This paper extends the Devereux and Griffith (2003) framework to allow the calculation of effective tax rates under limited deductibility of interest. This is achieved by changing the financial effect of debt finance to
The following specific assumptions were made to allow the calculation of tax rates: Economic depreciation (δ): 12.25 percent
Writing down allowances (φ): 20 percent per year declining-balance for four years, then 10 percent per year straight line until fully written down.
Local tax rate: 22.5 percent (i.e. “Hebesatz” of 450 percent).
Inflation (π): 2 percent.
Real interest rate (r): 5 percent (including risk premium).
Baldwin, Richard and Paul Krugman (2003) Agglomeration, Integration and Tax Harmonisation, European Economic Review 48, pp. 1 –23.
Becker, Johannes, Clemens Fuest and Thomas Hemmelgarn (2006) Corporate Tax Reform and Foreign Direct Investment – Evidence from Firm-Level Data, CESifo Working Paper 1722.
Bloom, Nicholas and John Van Reenen (2006) Measuring and Explaining Management Practices Across Firms and Countries, NBER Working Paper W12216.
Boadway, Robin and Neil Bruce (1984) A General Proposition on the Design of a Neutral Business Tax, Journal of Public Economics 58, pp. 57 –91.
Brueckner (2003) Strategic Interaction among Governments: an Overview of Empirical Studies, International Regional Science Review 26 (2), pp. 175 –188.
Buettner, Thiess (2001) Local Business Taxation and Competition for Capital: the Choice of the Tax Rate, Regional Science and Urban Economics 31, pp. 215 –245.
CEPS (2005) Achieving a Common Consolidated Corporate Tax Base in the EU, Report of a CEPS Task Force, Brussels: Centre for European Policy Studies.
Devereux, Michael P. and Rachel Griffith (2003) Evaluating Tax Policy for Location Decisions, International Tax and Public Finance 10, pp. 107 –126.
Devereux, Michael P., Rachel Griffith and Alexander Klemm (2002) Corporate Income Tax Reforms and International Tax Competition, Economic Policy 17 (35), pp. 451 –495.
European Commission (2001) Towards an Internal Market Without Tax Obstacles. A Strategy for Providing Companies with a Consolidated Corporate Tax Base for their EU-Wide Activities, Communication COM (2001) 582.
European Commission (2006) Implementing the Community Lisbon Programme: Progress to Date and Next Steps Towards a Common Consolidated Corporate Tax Base, (CCCTB) Report COM (2006) 157.
Haufler and Schjelderup (2000) Corporate Tax Systems and Cross Country Profits Shifting, Oxford Economic Papers 52, pp. 306 –325.
Keen, Michael and Alejandro Simone (2004) Does International Tax Competition Harm Developing Countries More Than Developed?, Tax Notes International, pp. 1317 –1325.
Klemm, Alexander (2001) Economic Review of Formulary Methods in EU Corporate Tax Reform, in: CEPS, EU Corporate Tax Reform, Report of a CEPS Task Force, Centre for European Policy Studies, Brussels, pp. 30 –54.
US Department of Treasury (1992) Integration of the Individual and Corporate Tax Systems: Taxing Business Income Once, Washington DC: US Government Printing Office.
Weiner, Joann (2002) Formulary Apportionment and the Future of Company Taxation in the European Union, CESifo Forum 1/2002, pp. 10 –20.
Prepared by Alexander Klemm (FAD) and Stephan Danninger (EUR).
On July 12, 2006, the Ministry of Finance published a list of cornerstones (Eckpunkte) of a business tax reform, available at the Ministry of Finance’s website: http://www.bundesfinanzministerium.de/. A revised proposal was announced by a working group in November 2, 2007 and its details are discussed in Appendix A. For an analysis of the 2000 reform see Keen (2002).
The exceptions being Malta, Norway, Slovenia, Spain and Sweden. Source: Updates from Devereux et al. (2002) (from http://www.ifs.org.uk/data/internationaltaxdata.zip) and KPMG Corporate Tax Rate Survey (various years).
The unexpected revenue losses were the result of the abolition of the previous split rate system, in which tax rates on distributions were lower than on retentions, and companies were allowed to reclaim the difference between both rates when they distributed previously retained profits. The reform introduced a uniform rate (below both previous rates), but still permitted firms to reclaim the tax differential when paying out previously retained profits. This created an incentive for firms to make distributions out of retained earnings to benefit from the tax rebate, while new profits could be retained without being subject to a higher tax rate. This accelerated pay out of retentions led to (temporary) negative overall tax payments.
Formally, the law provides for a statutory rate (Steuermesszahl) of 5 percent, which is augmented by a municipal multiplier (Hebesatz) between 200 and 490 percent.
This is calculated as
To be reduced, as already legislated, to €750 (€1,500 for couples) from 2007.
Reassuringly though, attempts to incorporate more tax rules, such as in the European Tax Analyzer model do not change rankings obtained by effective tax rates much. See Spengel and Wiegard (2005).
Headquarters located in countries that provide a credit for foreign taxes face additional tax charges on profits originating in countries whose taxes are lower than in the residence country. In practice such residence taxes can often be avoided, for example by mixing profits from low and high tax foreign jurisdictions.
Because a large economy loses more revenue from lowering the tax rate on its existing capital stock, while gaining little new capital in proportion to the existing capital (Bucovetsky, 1991).
This applies to advanced economies (Devereux, Griffith and Klemm, 2002). For developing countries there is some evidence that tax-to-GDP ratios have fallen somewhat as tax rates were reduced (Keen and Simone, 2004).
For a theoretical treatment of the incentives to broaden tax bases and cut tax rates to attract reported profits see Haufler and Schjelderup (2000).
There is a small empirical literature on how countries react to tax changes in other countries, surveyed in Brueckner (2003). At least for some taxes, there appears to be a behavioral response by tax authorities, rather than a common trend in tax policy. It is not possible though to distinguish between tax mimicking and a reaction based on resource flows.
For instance, a lower tax rate may generate profits in addition to those that would not be shifted anymore.
The following provides one example for each case: tax competition will be harmful if it reduces the taxing capacity of a welfare-maximizing government; it is irrelevant if there are other taxes that can be raised at the same cost instead; and it can be beneficial if governments are over-taxing for political economy reasons.
The banking sector would be exempted from changes in interest deductibility.
The 12.5 pp cut in the federal tax rate leads to a reduction in the cost of the solidarity surcharge and also reduces the deductibility benefit of the local tax; in net terms, the composite tax rate drops by 10 pp.
Or liable only to a very limited extent if double taxation treaty provides for a withholding tax.
Even though more taxes will be included, tax rates can decrease, because the required rate of return for shareholders is reduced by the taxation of interest.
Indeed, it is worth noting that the EMTR under debt-finance is negative under the current tax legislation. This outcome results from combining interest deductibility and investment allowances. The former already would ensure that normal profits would not be taxed, as they would just cover the interest paid. Additionally allowing firms to deduct depreciation allowances implies that the tax system is subsidizing some investment (assuming the firm has taxable profits to apply the deductions). It would be sufficient to have some expectation of future profits, as tax losses can be carried forward, although they will be less valuable because of lost interest.
This measure was approved by the cabinet on October 25, 2006.
Recent empirical evidence suggests that poor management practices are prevalent among family-owned firms which pass management to their eldest son (Bloom and Van Reenen, 2006).
The apportioned tax base could then be taxed in each country at the national tax rate. This would remove intra-EU profit shifting opportunities, but not necessarily tax competition, as companies could still move the factors of the apportionment formula to benefit from low tax rates. For an overview of the issues see inter alia Klemm (2001) or Weiner (2002). The policy was established in European Commission (2001) and its progress reviewed in European Commission (2006).
According to OECD Revenue Statistics (2006), taxes on immoveable property raised 0.4 percent of GDP in Germany, compared to 0.9 percent for the OECD average, 0.8 percent for the EU15 average and 2.8 percent in the United States in 2004.
Currently moveable investment goods can be depreciated at double rates using the declining balance method, until this leads to lower depreciation than the straight-line rate.