Abstract
ROBERT H. FLOYD *
ROBERT H. FLOYD *
A public enterprise may be any government-owned and/or controlled unit that produces and sells industrial, commercial, or financial goods and services to the public.1 However, public finance literature has generally focused on only two traditional types of public enterprises. First are industries that, owing usually to the inelasticity of demand, are operated as fiscal monopolies (by the government or its agent) to provide a source of government revenue, such as salt, alcohol, or tobacco monopolies. Second are firms or industries that cannot be operated both profitably and efficiently owing to the decreasing cost characteristic of the production function, such as public utilities in power, water, or some transportation systems. In this case, the government generally either undertakes the production and provision of the good or service in question or permits the emergence of a privately owned “natural monopoly” that it regulates. Since such activities, if operated efficiently, generate losses that must be financed from other sources, attention in the literature has generally been focused on the appropriate pricing policy and government subsidy to finance the deficit.2
However, public ownership of business in many countries is no longer confined to traditional fiscal or natural monopolies. For a variety of reasons, many nations have established or assumed ownership of various commercial, industrial, and financial enterprises that have often generated profits and financial resources for the government even after capital investment requirements have been taken into account. Government ownership of “nontraditional” enterprises can be quite extensive. In the Federal Republic of Germany, for example, government-owned enterprises in 1968 accounted for over two thirds of aluminum production, a third of iron ore mining, a fourth of coal production, a fifth of shipbuilding, and significant parts of the oil, natural gas, and engineering industries.3 In India, there are over 80 government-owned corporations, including steel mills, locomotive factories, and airplane factories.4 The Iranian Government owns a controlling interest in more than 41 commercial and industrial corporations, of which 24 earned profits in 1972 and only 3 received government grants, all for capital purposes.5
The substantial government participation in nontraditional enterprises in many countries calls into question the almost exclusive focus on fiscal and natural monopolies in the literature. Only recently has attention been brought to bear on the roles and effects of nontraditional public enterprises. Although there is no succinct definition of non-traditional public enterprises, perhaps their most distinguishing characteristic is a potential for both profitable and efficient operations in markets other than those usually dominated by fiscal monopolies.6 Thus, the usual reasons for public ownership do not obtain, and in many countries such enterprises would be privately owned.
While a wide variety of transactions and relationships between the government and nontraditional enterprises would doubtless be of interest, the role of taxes, especially income taxes, seems of particular interest in economies that are neither centrally planned nor purely free enterprise. Since decreasing cost industries could not generate profits if they followed marginal cost pricing, and since profits of fiscal monopolies are turned over to the government, the role of income taxation could not arise in these cases. However, the possibility that the price mechanism could allocate resources efficiently for nontraditional public enterprises and the profit-making potential of these enterprises raise the question of the appropriate method of transferring profits to the government. In particular, since equal amounts of revenue could be transferred to the government by means of either a profits tax or a dividend, one might reasonably ask what economic function would be accomplished by using a profits tax for nontraditional public enterprises instead of a dividend.
The purposes of this paper are to evaluate the taxation of profitable, nontraditional public enterprises’ income with respect to its effects on the efficiency of resource allocation and the equity of income distribution (See Section III.) and to identify other criteria that may be relevant to the evaluation.7 This entails (a) consideration of the applicability to public enterprises of the traditional goals and justifications for income taxation of private enterprises, as well as (b) delineation of additional factors and characteristics peculiar to public ownership that may alter the expected economic effects (See Section II.). However, it is useful to begin by reviewing income tax provisions in several countries (See Section I.). Conclusions are given in Section IV.
I. Survey of Common Practices
The following brief survey of the tax treatment of public enterprises’ income in various countries is largely confined to the legal liability, rather than actual practices.8 In general, public enterprises either are subject to the same tax on profits as are private enterprises, or are fully exempted. However, in some countries, they are subject to somewhat different taxation. In some cases, income from industrial or commercial activities of government departments or ministries is also subject to tax.9 When the tax is applied to public enterprises, their liability usually extends only to income from their industrial or commercial activities. Distinctions between the tax liabilities of public and private enterprises do not seem to be related to the type of income tax employed—that is, to whether the income tax is an integrated income tax or a corporate profits tax, or whether it is schedular or global.
1. COUNTRIES THAT DO NOT DISTINGUISH BETWEEN PUBLIC AND PRIVATE ENTERPRISES FOR INCOME TAX PURPOSES
Among industrial countries, the United Kingdom, France, the Federal Republic of Germany, and Spain generally subject public enterprises to the same income taxes as private companies. Among developing countries that follow this policy are Sri Lanka, India, the Syrian Arab Republic, the Philippines, and Tanzania. There are occasional minor differences, particularly in industrial countries, generally resulting from specific exemptions of income earned in certain activities.
State-owned public enterprises in the United Kingdom are subject to the national profits tax in accordance with the same rules applying to private enterprises, but enterprises owned by local authorities are exempt from the tax.10 The liability of state-owned enterprises arises under the general Income and Corporation Taxes Act, but in some cases it also has been made specific in the relevant nationalization acts.11
French public enterprises are subject to the corporation income tax, at the same rate as private corporations, on their profits from industrial or commercial activities.12 However, certain income, such as income from rental of real property, arising from nonindustrial or noncommercial activities is subject to tax at a reduced rate. Although the liability applies in general to enterprises owned by any level of government, there are certain exceptions. For example, gas, electric, water, and transportation utilities operated by local governments are exempt with respect to their provision of essential public services.13 All public enterprises engaged in scientific, educational, and welfare activities are exempt from tax, as is the income of public enterprises that is derived from building and financing low-cost rental housing. The exemptions extend only to the main activities of the enterprises and not to investment income.
Public enterprises in the Federal Republic of Germany, unless specifically exempted, are subject to the corporation income tax, at the same rates as private enterprises, on income from commercial or industrial activities.14 In addition, the tax liability applies to certain income of the Federal Republic and of the states and the cities, which are organized as corporations under German public law. The profits arising from distinguishable commercial and industrial activities, including the provision of traditional public utilities, carried on by such governmental entities are subject to tax even if the activity is not separately organized as a limited liability company. However, the profits of such entities that are derived from agricultural or forestry activities are exempt; and their income, such as tax revenues, from purely governmental operations is not taxed. However, the administration of property is not considered to be a commercial activitity, and income derived therefrom, such as profits on securities portfolios, is not taxed.
Spanish public enterprises are subject to the various schedular taxes that are levied on account of the general corporation income tax in respect of their industrial, commercial, or mining activities.15 Although there is no general differentiation between public and private enterprises, specific exemptions are granted to some public entities, for certain sources of income. For example, income derived from properties owned by the state and its institutions and departments, as well as the income of various public financial enterprises, is exempted from the Rural Land Tax.16 Similar exemptions are also granted for the Urban Land Tax.17 In addition, dividends from state-owned shares in the petroleum and tobacco monopolies and the earnings of local corporations are exempted from the Capital Yields Tax.18 All exemptions to the schedular taxes also constitute exemptions from the general tax on company profits.
In Sri Lanka, the tax rate for most resident companies, including those owned wholly or partly by the Government, is 60 per cent of taxable income plus 33 per cent of the aggregate amount of gross dividends, although smaller companies are taxed at lower rates.19 By declaration of the Minister of Finance, newly established companies to whose capital the Government has contributed, as well as some private companies, may be exempted from the income tax for a period of five years after their establishment.20
All Philippine corporations owned or controlled by the Government, unless explicitly exempted by law, are subject to the same taxes, including the corporation profits tax, as privately owned companies.21 However, government ownership of business in the Philippines is relatively limited, and some of the more important public enterprises are exempt from all taxes.22 Nevertheless, financial statements of public enterprises for which tax liabilities arise indicate that the practice is to make payments to the Government as a private corporation would.
In Tanzania and Syria, public and private enterprises, as well as individuals, are subject without differentiation to a tax on net income derived from commercial, industrial, and professional activities.23 In Tanzania, the available accounts of public enterprises for 1972 indicate that they are consistent taxpayers, with those in the mining, manufacturing, and financial sectors being the most important sources of tax revenue.24
2. COUNTRIES THAT DISTINGUISH BETWEEN PUBLIC AND PRIVATE ENTERPRISES FOR INCOME TAX PURPOSES
The sharpest distinctions between the taxation of private and public enterprises’ profits are made by the United States, Brazil, South Africa, and El Salvador, among others. These countries exempt public enterprises from the income tax, as did Colombia until its recent tax reform.25 Italy, Iran, Algeria, Bolivia, Australia, and New Zealand make less comprehensive distinctions.
Most operating public enterprises in Italy are owned by holding companies that are wholly state-owned, such as the Institute for Industrial Reconstruction (IRI). The actual operating companies, which may have private sector participation, are operated similarly to private enterprises, although there is budgetary supervision of the holding companies by the Ministry of State Participations.26 The reform of the Italian income tax system in 1974 specified that while all operating companies are subject to a 35 per cent income tax rate and privately owned holding companies to a 7.5 per cent rate, state-owned holding companies are taxed at a rate of 6.25 per cent.27
In Iran, government companies are subject to a progressive tax on their net income at rates ranging from 15 per cent to 60 per cent, but privately owned companies’ profits are generally taxed at lower rates. Furthermore, various tax incentives offered to private companies are not offered to government companies. For companies with mixed government and private ownership, the profits are apportioned in the same manner as the ownership and are taxed according to the relevant schedule for type of owner.28 In Iran, income tax revenues from government companies substantially exceed income tax revenues from private companies.
Government corporations in Algeria are subject to a lower tax rate (50 per cent) on industrial and commercial profits than are private individuals and companies (60 per cent). Furthermore, certain profits of public enterprises that are reinvested in the same year are taxed at only a 20 per cent rate. Government enterprises and agencies that are without financial autonomy and that provide low-cost housing are permanently exempt, and temporary exemptions may be granted to local government enterprises.29 In Bolivia, public enterprises are subject to a special tax on their net profits that is generally lower than the tax levied on private enterprises. However, Bolivian public enterprises are not granted the same tax incentives for reinvestment of profits as are private enterprises.30
Some Australian public enterprises are exempt from income taxes (e.g., government banks, railways, and the Australian Broadcasting Commission) while others (e.g., the national airlines) are not. Apparently, exemption is granted when public enterprises are not in competition with private enterprise on the theory that in the absence of competition, the tax would amount to only a bookkeeping entry.31 Similarly, public enterprises in New Zealand are subject to full income taxation only when they are in direct competition with private enterprises.32 Additionally, after provision for reserves, these enterprises transfer to the Treasury any remaining after-tax profits.
This brief survey indicates the lack of uniformity or pattern among countries that tax the earnings of public enterprises. Perhaps the most common, but far from universal, practice is simply to make no distinction between public and private ownership. Even this is deceptive; for example, both the Federal Republic of Germany and France would seem to fit this description, but the former taxes the net income of public utilities and the latter does not. Furthermore, the same legal liabilities may not be uniformly enforced on public and private enterprises, although few data are available to check actual administrative practices. The absence of uniformity probably indicates that public enterprises’ profits are often taxed (or not taxed) without regard for the type of public enterprise or for the economic effects that might be expected. With the growth of nontraditional public enterprises, further study of these effects is surely in order.
II. Rationale for Taxation of the Earnings of Publicly Owned Capital
1. OVERALL CONSIDERATIONS
The taxation of income derived from privately owned capital is usually justified by considerations of interpersonal equity and efficient use of resources. If one’s concept of vertical and horizontal equity is based on income, then capital income should be included in the national tax base with all other sources of income. From the point of view of efficient resource allocation, a tax on all sources of income is more likely to mitigate tax-induced distortions in productive uses of factors (i.e., the factor mix in production), as well as in the offering of factors for use (i.e., the labor-leisure choice). Essentially, the more general is the tax base, the less is the scope for tax-induced substitution and income effects.33 However, these principles are generally applied with reference to the income of privately owned capital, and their applicability in the case of income from publicly owned capital has seldom been considered.34 In addition, one needs to ascertain whether there are special characteristics of public enterprises that may be relevant to the equity and efficiency objectives, as well as to stabilization and, consequently, to determining whether to tax the profits of public enterprises.
In an economy where the ownership of capital is divided between the public and private sectors (an economy that is not completely centrally planned), the central question is whether differential taxation of the income of public enterprises vis-à-vis the income of private enterprises would lead to adverse effects on equity, efficiency, and stabilization.35 Analytically, by ascertaining the effects of taxing public enterprises’ profits, one, of course, also determines the converse effects of exempting them from tax.36
2. APPLICABILITY TO PUBLIC ENTERPRISES
The more general justifications for taxing the income from capital present a strong prima facie case for taxing public and private enterprises alike. There is no obvious reason why the taxation of public enterprises should not serve the same goals as taxation of private enterprises—that is, to promote equity in income distribution and efficiency in resource allocation. However, any tax’s actual effects on equity and efficiency will depend on the managerial response to the tax and may, therefore, differ between public and private enterprises if the behavioral patterns of their managers differ. Unless otherwise noted for the remainder of this paper, it is assumed that the managers of nontraditional public enterprises attempt to maximize profits, even though their efforts may be constrained by a variety of external decisions imposed by the government. Thus, they are assumed to behave in a rational economic manner, as managers of private enterprises do, insofar as external constraints do not limit such behavior. For example, managers of nontraditional public enterprises would neither give away their output nor pay more than necessary for their inputs.37
However, the relevance of the equity and efficiency goals, as well as the usual objective of macroeconomic stability, is affected by the extent of government ownership of productive capacity. A useful categorization is presented in the matrix in Table 1. Nine possible situations depict the extent of government ownership in an economy, an industry, and an individual firm. Cases 1, 4, and 7 represent no government ownership and are of no concern to this analysis. Case 3 is of little concern, since it depicts complete government ownership and represents the ideal, and probably nonexistent, centrally planned economy. Our interest, therefore, lies primarily with Cases 2, 5, 6, 8, and 9, which represent various situations of limited government ownership. However, since Case 2 can be representative of any of the other four cases, it will not be treated separately.38 Let us look at these cases from the points of view of the stabilization, equity, and efficiency objectives.
Nine Cases of Government Ownership of Productive Capacity
Nine Cases of Government Ownership of Productive Capacity
| Extent of Ownership | |||
|---|---|---|---|
| Organizational Level | None | Some | Complete |
| Economy | 1 | 2 | 3 |
| Industry | 4 | 5 | 6 |
| Firm | 7 | 8 | 9 |
Nine Cases of Government Ownership of Productive Capacity
| Extent of Ownership | |||
|---|---|---|---|
| Organizational Level | None | Some | Complete |
| Economy | 1 | 2 | 3 |
| Industry | 4 | 5 | 6 |
| Firm | 7 | 8 | 9 |
a. Stabilization
The macroeconomic or stabilization policy objective of taxation in the sense of capitalist economies is unimportant in the case of complete government ownership and planning of the economy (Case 3).39 If all productive capacity of the economy were government owned, taxes would be little more than one facet of overall government plans determining macroeconomic variables, such as price, income, and employment levels. Production levels, savings, and investment would be set in accordance with planned priorities and growth rates; the market price mechanism would not serve as the means of signaling the optimum allocation of resources; and taxation would not be a major instrument for equating planned savings and investment. Surpluses of enterprises would bear little resemblance to profits in a competitive world, and a profits tax would be little more than a mechanism to transfer to the budget savings generated by public enterprises in accordance with the economic plan.
If, however, public ownership were less than complete, the economy were not planned, and public enterprises were operated entirely on a competitive and profit-maximizing basis as if they were privately owned, the macroeconomic effects of a profits tax could be similar to one in a privately owned economy. In this case, the greater the proportion of productive facilities that were publicly owned, the greater would be the potential implications for stabilization policy of excluding public enterprises’ profits from taxation. However, none of the four matrix cases under consideration necessarily involve significant macroeconomic effects, although Case 2 could if government ownership were sufficiently important to the economy as a whole and if planning were not used. But, for Cases 5, 6, 8, and 9, where the extent of government ownership is limited, whether or not a tax were levied on the profits of public enterprises would be likely to have little impact on macroeconomic variables.
Nevertheless, for the remainder of the paper, a balanced budget analysis is employed, so that the stabilization impact of an equal yield dividend is considered, ceteris paribus, to substitute for the yield of an income tax on public enterprises. Any of several dividend policies could produce equal revenue for the government. The dividend could be stated as a percentage of profits, which would be identical to an income tax at the stated percentage. Alternatively, the dividend could be stated as a percentage of the value of an enterprise’s capital. However, since the percentage of capital’s value would have to vary in order to obtain an equal yield over the business cycle, and since the government’s primary concern is likely to be with its overall revenue, for the remainder of the paper it is assumed that, as an alternative to an income tax on public enterprises, a flexible dividend policy could be adopted to avoid stabilization effects, with payments negotiated between the government and individual public enterprises. In this regard, it should be noted that the equal yield requirement need hold only in the aggregate; there is no need to have equality between tax bills and dividend payments of individual public enterprises. In this case, even though there would be no stabilization effects, the exemption of public enterprises could, in some circumstances, give rise to inequities and inefficiencies in both individual enterprises and the economy as a whole. The question of profits taxation of public enterprises, therefore, may be viewed mainly as one of tax structure rather than tax levels.40
b. Equity
Tax equity is inherently a matter of interpersonal comparisons, not of interenterprise or intercorporate comparisons, and thus is affected only when real income distribution in the private sector is affected by differential income taxation of public enterprises. Private sector income distribution is likely to be affected directly only in Case 8 when there is partial private ownership of the taxed firm. For public enterprises that are fully owned by the government (Cases 6, 9, and perhaps 5), it makes little sense to speak of equity unless it is assumed that the tax is shifted, since the tax burden would otherwise fall solely on the public enterprise’s profits, and hence on the government, with private sector incomes remaining unaffected.41 When the tax is shifted, a thorough analysis of how equity is affected by differential taxation of public enterprises’ profits requires an assessment of both how the distribution of real income between income groups (vertical equity) and within any income group (horizontal equity) is affected. This requires a knowledge or presumption of the relative income position of capital owners vis-à-vis other income recipients, as well as of the consumption patterns of all income groups, that is beyond the scope of this study. Consequently, this analysis is restricted to a general statement of when equity may be affected, rather than a determination of actual effects.
In the short run, assuming that shifting of the tax through changes in prices or noncapital factor payments by public enterprises is independent of shifting by private enterprises, the tax on public enterprises’ profits would result in relatively heavy consumers of public sector outputs or recipients of noncapital factor payments from public enterprises being relatively worse off than they would have been in the absence of the tax.42 If the tax were shifted forward into product prices, it would be borne by consumers of the public enterprise’s output, and would be proportional, progressive, or regressive depending on the relative values of the income and price elasticities of demand for the output. Forward shifting may occur in all four cases, but it seems most likely in Case 6, when unutilized monopoly power may be available to the public enterprise. Short-run backward shifting to noncapital factor prices seems more likely in Case 6 than in other cases, since public enterprises are less likely to be price takers in factor markets.43
In the longer run, shifting through factor movements may occur if the tax does not apply uniformly to all business profits and if there is capital mobility between taxed and untaxed sectors. In this case, capital in the untaxed sector may be forced to share the burden of the tax as capital shifts from the taxed to the untaxed sector, thus lowering the net rate of return in the latter.44
c. Resource allocation
The strongest case for equal taxation of the profits of public and private enterprises may be based on the implications for efficient resource allocation. Any public use of resources involves an opportunity cost in terms of foregone resources for alternative private and public uses. Although the evaluation of opportunity costs may be somewhat arbitrary when resources are used to provide traditional public goods, it should be more precise, and consequently even more useful, when resources are employed by the public sector to provide goods and services that could be provided efficiently by the private sector.
Differences in taxation between public and private enterprises that result in differences between opportunity cost pricing of inputs and outputs may distort decisions on resource usage unless they are taken into account. For example, the exclusion of public enterprises from a profits tax may lead to a relative overstatement of the return to public investment; conversely, it may lead to an understatement of the opportunity cost of capital employed by public enterprises relative to capital employed by private enterprises, and, consequently, to an excessive allocation of capital to the public sector and to overly capital-intensive production. Furthermore, the use of a profits tax exclusion by public enterprises to keep output prices at artificially low levels could constitute a permanent barrier to entry of private firms that are subject to tax.
The efficiency arguments for equal taxation are valid in all four cases under consideration, since the production of maximum output with minimum input is desirable regardless of ownership and since, even if there is no direct competition between the output of the public and private sectors, there is always competition for resources or factors.45 The efficiency effects in the four matrix cases are discussed more fully in Section III.
3. ADDITIONAL CONSIDERATIONS
It is also useful to review some special characteristics associated with government ownership that could either strengthen the prima facie case for equal taxation or affect the achievement of the traditional goals of taxation and consequently suggest that public and private enterprises should be taxed differently. In this connection, the extent of government ownership also provides guidelines as to the relevant type of analysis of the economic effects of a profits tax on public enterprises. For example, Cases 8 and 9, where public ownership is limited to a few firms, lend themselves to partial equilibrium analysis, and Case 6 may require partial equilibrium analysis to the extent that all firms in the monopolized industry are under unitary management. However, to the extent that factors are mobile between industries or that substitutes or close rivals in consumption are available, general equilibrium effects may also be relevant to Case 6. Case 5 is best analyzed in a general equilibrium framework, since it represents a situation in which taxation may affect the interactions between private and public producers not only within the same industry but also in all other industries.
a. Nonmarket constraints
Nonmarket constraints on managerial behavior resulting from other government policies are potentially the most important special characteristic in determining the effects of income taxation of public enterprises. There is probably an almost endless variety of such constraints imposed in attempts to achieve various objectives, but the more important are likely to be government-imposed decisions on investment, prices, wages, employment, and perhaps output levels. Some constraints may be explicitly articulated, but other implicit constraints or pressures may also impinge on public enterprises. For example, in many cases, they may reflect nothing more formal than a conversation between the enterprise’s managing director and a cabinet minister.46
Some nonmarket constraints may be similar in some respects to taxes. For example, government-imposed output prices that are lower than those that would prevail in a free market may be similar in their effects on producers to an excise tax on the public firm’s or the industry’s output. Even if a public enterprise is technically free of direct constraints, it may be expected to purchase inputs from other inefficient public enterprises, thus possibly inflating its own costs. Furthermore, other government financial or budgetary transactions with public enterprises may substantially influence, even if they do not directly constrain, managerial behavior. For example, subsidized credit from the government may have effects opposite to that of a profits tax, and an operating subsidy may have effects opposite to those of an excise tax.47
In practice, nonmarket constraints are likely to vary between countries and even between enterprises within a given country. In the Federal Republic of Germany, public enterprises are supposedly operated as if they were privately owned,48 but in India, public enterprises have been subjected to extensive guidelines.49 The guidelines require that, when they are in competition with private domestic producers, public enterprises should allow market forces to determine prices and output. If only foreign competition exists, public enterprises are required to establish prices not greater than the landed costs of imports. Other provisions concerning pay and allowances and procedures were instituted to preclude the hiring of surplus labor. The Indian guidelines extend even to the standard of housing to be provided to employees and the use of certain building materials.
From a practical point of view, the existence and extent of non-market constraints is likely to be directly related to the relative political power of individual public enterprise managers and government ministers and perhaps even the stability of the government.50 For example, the scarce technical skills possessed by some managers of large public enterprises might enhance their power and effectively give them tenure through successive governments. However, from a theoretical viewpoint, to the extent that nonmarket constraints on public enterprises are to be used as an instrument for the achievement of social goals, the decision should, at least, be at the discretion of the government, which is presumably motivated by the public interest, rather than at the discretion of managers, who may be responsive to more limited special interests.
While the nature, and even the existence, of many nonmarket constraints may be difficult to ascertain, their likely economic significance is clear. To the extent that they effectively close ordinarily available avenues of adjustment, they impede the ability of managers of public enterprises to respond to market signals or to taxation in making their input and output decisions. Input and output prices may not reflect opportunity costs, and an inefficient use of resources may result.
b. Accounting procedures
Especially when there are nonmarket constraints or other external influences, the need for public enterprises to maintain economically meaningful accounts is crucial. For example, failure to account for subsidized government credit would understate capital costs, overstate profits, and exaggerate the return to capital invested in the enterprise. The opportunity cost of public versus private use of resources would thus be understated, possibly leading to a misallocation of resources. The effect of a tax applied to an exaggerated base of public enterprises’ profits would be similar to that of a higher effective tax rate on their real profits, but, so long as the tax was not confiscatory on their accounting profits, even the higher effective rate would not offset any tendency to misallocate resources resulting from improper accounting.
In this connection, the equal application to public enterprises of any profits tax may serve another useful function. Tax laws often specify the method of accounting to be used for the determination of taxable profits. To the extent that the law forces public enterprises to take into account deviations from opportunity costing and pricing, such as through proper allowances for depreciation, then the tendency to misallocate resources may be reduced. However, while some items may be rather easily ascertained and appropriate adjustments easily made, others may be more intractable. For example, the effects on revenues and costs of government-imposed prices and wages or of the costs of forced purchase policies may be almost unquantifiable. In these cases, the scope for improved accounting practices as a result of equal taxation is limited.51
c. Incentives to efficiency
The equal application of a profits tax to public and private enterprises has some advantages of a broader nature, especially when contrasted with the use of dividends for public enterprises. Either a tax or a dividend can transfer some portion of a public enterprise’s profits to the government while permitting the public firm to retain some profits for its own use. However, the tax has the advantage of providing both managers of enterprises and the government with a greater degree of certainty as to the distribution of profits. In contrast, dividends that are arbitrarily determined and subject to changing political considerations may easily impede efficient managerial practices.
The certainty of control over a portion of profits guaranteed by the use of a profits tax is likely to impart an incentive to managers of public enterprises to improve the efficiency and profitability of their operations and, at the same time, to provide them with increased flexibility in their investment planning and operations. Furthermore, a profits tax ensures that relatively more funds for investment will be available automatically to firms or industries that the market signals, through relatively higher profits, as desirable areas for investment.52 Indeed, the profits tax is even used frequently in centrally planned socialist economies with essentially complete government ownership to promote more efficient resource usage by providing employee and managerial incentives. When actual profits exceed planned profits, often only a part of the excess is taxed away, and the remainder is retained by the enterprise to provide for investment, employee welfare, or bonuses to workers and managers.
At the same time, the certainty provided by a tax can also be advantageous to the government. The tax automatically provides the government with funds for general purposes as well as for investment in areas of high public priority where market forces alone would not necessarily indicate the need for investment, such as in infrastructure projects with significant social benefits. In addition, a profits tax provides a strong built-in stabilizer, the effects of which would not necessarily be duplicated by an arbitrary dividend. Furthermore, the imposition of a profits tax does not preclude the use of dividends to transfer additional funds to the government as desired.53
d. Market structure
Another factor of particular importance in determining the expected effects of, and thus the rationale for, taxing nontraditional public enterprises’ profits is the market structure in which they operate. Market structure may have considerable importance for the incidence of a tax, the ability to shift the tax, and the efficient use of resources. For example, even though a public enterprise may face no domestic competition, foreign competition may prevent it from behaving as a profit-maximizing monopolist and suggest a different pattern of incidence for profits taxation. The potential importance of market structure seems so great that it is given more extensive treatment in the next section.
e. Firms with mixed ownership
A complication arises when a firm is only partly owned by the government (Case 5), and different tax rates are applied to the government’s share of profits, as, for example, in Iran.54 Suppose that the government owns a half interest in a firm, that profits of private interests are taxed at 25 per cent, and that profits of the government are taxed at 50 per cent (See Table 2.) The distribution of the after-tax profits is critical to the effects of the tax. For example, if total after-tax profits were distributed as equal dividends to the private owners and the government, then the effective tax rate on the government’s share would be 37.5 per cent, and a fourth of the government’s tax liability would have been shifted to the private sector. Similar results would obtain if profits were retained and an appropriate adjustment were not made to ownership shares. Thus, the distribution of after-tax profits, whether in the form of dividends or of accrued increments to capital, must be in accordance with the proportions implied by the different tax rates in order to avoid shifting from the owner taxed at the higher rate to the owner taxed at the lower rate.55 In the absence of such an adjustment, if private profits were taxed at the same rate as profits from alternative private investments while government profits were taxed at a higher rate, the effect of the tax differential would be to discourage private participation in joint ventures with the government.
Unequal Profits Taxation with Partial Government Ownership
(In per cent)
Unequal Profits Taxation with Partial Government Ownership
(In per cent)
| Private Ownership | Government Ownership | Total | |
|---|---|---|---|
| Pretax profits share | 50.0 | 50.0 | 100.0 |
| Tax | 12.5 | 25.0 | 37.5 |
| After-tax profits share | 37.5 | 25.0 | 62.5 |
Unequal Profits Taxation with Partial Government Ownership
(In per cent)
| Private Ownership | Government Ownership | Total | |
|---|---|---|---|
| Pretax profits share | 50.0 | 50.0 | 100.0 |
| Tax | 12.5 | 25.0 | 37.5 |
| After-tax profits share | 37.5 | 25.0 | 62.5 |
III. Analysis of Economic Effects
It is convenient to analyze the effects of profits taxation somewhat taxonomically in accordance with market structure and the analytical techniques suggested by the extent of ownership. As was noted earlier, Cases 8 and 9 generally lend themselves to partial equilibrium analysis, and Cases 5 and 6 may be analyzed in either a general or partial equilibrium framework, depending on circumstances.
1. MONOPOLIZED INDUSTRY
As it is in many respects the simplest case, consider first a fully monopolized industry, or a combination of Cases 6 and 9.56 If the public enterprise has no foreign competition and exhibits monopolistic behavior, and if there are neither monopoly nor monopsony elements in the markets for factors of production other than capital, at least the short-run effects of a profits tax are obvious. Since imposition of the tax would not affect the maximum profit solution for the industry, the tax would fall in the short run on monopoly profits and the normal returns to equity capital.57 Price and output decisions would not be affected, and the tax itself would have no direct effect on the equity of private income distribution or the efficiency of resource allocation. The sole effect of the tax would be to transfer automatically to the government a certain portion of the monopoly profits and the normal return to equity.
In the longer run, the effect of the tax is less clear. The application of the tax would not, in itself, lead to any improvement in resource allocation or income distribution. However, if the combined investment in the monopolized industry by the government and by the public enterprise were to exceed that which would have been undertaken by the public enterprise alone in the absence of the tax, the allocation of resources could be improved. But if the government were to leave investment decisions solely to the discretion of the public enterprise, the tax-induced reduction in the net rate of return or the lower retained earnings (depending on the dividend policy that was followed in the absence of the tax) might lead to lower growth of output by the monopoly than might otherwise have been undertaken, thus perhaps worsening the misallocation of resources resulting from monopolistic behavior. Perhaps most importantly, the exemption of public enterprises would constitute a substantial barrier to the possible entry of private firms into the industry in the longer run.
These results might be altered, however, if the industry were not characterized by monopolistic behavior. This might follow from a variety of factors including officially sanctioned competition between various firms within a fully government-owned industry, government-imposed output prices or wage levels, or foreign competition. In the first case, the industry would effectively no longer be monopolized and there would be no monopoly profits. The tax on profits then would become a tax on the return to the government’s equity capital. If the imposition of the tax were to induce the firms in the industry to collude and to adopt monopolistic pricing in order to restore their net profits to a pretax level, then the tax might, in the short run, be shifted forward to consumers or backward to noncapital factors, thus altering the distribution of private real income and leading to a misallocation of resources.58 To the extent that the tax induced monopolistic behavior where none had been practiced, it would also probably result in a longer-run misallocation of resources and in increased barriers to entry. The possibility that the tax would induce monopolistic behavior would probably be greater if it were imposed as a means of transferring more revenue to the government than would be available from pretax dividends.
Monopolistic pricing behavior may be mitigated by prices or wages imposed by the government, either arbitrarily or under various rules. Various possible situations may be illustrated by Figure 1. A monopolist’s maximum profit price is OA, at which a quantity OH is sold and a monopoly profit of ABDE is earned. A short-run competitive, efficient price is OC, at which price equals marginal cost. Any arbitrarily imposed price greater than OC would clear the market and result in some monopoly profit on which, along with the return to equity, a profits tax would fall. So long as the tax does not affect the arbitrarily imposed price, it will have neither equity nor efficiency effects, although the pricing decision has both effects. However, to the extent that wages or payments to other factors of production are not fixed or imposed by market conditions, backward shifting could occur. But if the price is administered and is set by a fixed markup over cost including the tax or if it is set to achieve a fixed net rate of return, then the price would increase with the imposition of the tax, and some of the tax burden would be shifted to consumers.
Even if the public enterprise has no domestic competition, it may, at least, face potential foreign competition. So long as the world price is less than the domestic monopoly price OA but more than the domestic monopoly’s marginal cost for the amount demanded in the taxing nation, the domestic monopoly will sell at the world price, earn a reduced monopoly profit, and satisfy all domestic demand. If the world price is less than the domestic monopoly’s marginal cost for the amount demanded, but more than its minimum average cost (i.e., a price between OC and OJ), a further reduced monopoly profit is earned, but foreign supply satisfies some domestic demand. In either case, the tax is borne by the short-run monopoly profits, by the return to equity, and perhaps by quasi-rents in the longer run. The tax cannot be shifted to consumers owing to the world-imposed price. Backward shifting to labor would be possible only if there were monopoly or monopsony power in labor markets, such as government-imposed wage levels or quasi-rents. However, in the long run there could be no quasi-rents, and the tax could only be shifted through factor flows to other monopolized industries in which higher monopoly profits could be earned.
Thus, the imposition of a profits tax on a publicly owned monopoly is not likely, in itself, to lead either to a deterioration or an improvement in resource allocation. Improvement would most likely result from preventing the exercise of monopoly power or, in the long run, from removing barriers to entry into the industry. While a profits tax might promote these objectives by denying the monopoly the retention of, and control over, its earnings, an appropriate dividend policy could achieve the same effect. Finally, a profits tax would have no effect on income distribution in the private sector unless it were shifted forward to consumers or backward to labor in the short run. In the long run, shifting could only affect monopoly profits in other industries.
Even though traditional considerations of efficiency and equity offer few bases for preferring an income tax over a dividend as a means of transferring the profits of a public monopoly to the government, there are certainly no grounds for exempting the monopoly from a general profits tax. Indeed, owing to its automatic and compulsory nature, the tax could circumvent any tendency by the enterprise to retain its profits and thereby to enhance its ability to pursue objectives that might be inconsistent with those of the government.
2. OLIGOPOLISTIC INDUSTRY
An oligopolistic industry in which the government owns either part or all of the few firms in the industry can represent a combination of Cases 5 and either Case 8 or Case 9. Oligopolistic behavior can be quite varied, and the effects of profits taxation will generally turn on the assumptions one makes about the interdependent behavior of the firms in the industry. One variant of oligopolistic behavior is that all firms in the industry collude so as to maximize joint profits. To the extent that firms, including those owned by the government, collude to maximize profits both before and after the imposition of a profits tax, the incidence of the tax would be essentially the same as in the case of monopoly.
However, joint maximization of profits is intuitively unappealing when at least one of the firms in the industry is owned or controlled by the government. Indeed, one motivation for establishing a public enterprise is often to introduce competition into oligopolistic industries. If the public enterprise is sufficiently large to achieve economies of scale and sufficiently efficient to be competitive with privately owned firms in terms of costs, it may take a leading role in the industry by promoting higher output and lower prices than would obtain in the joint profit maximization case.59
It has been shown that if the public enterprise attempts to maximize the industry output through its price and production policies, it can succeed in reducing prices and increasing output from the monopoly solutions, but cannot enforce competitive market results so long as the private firms continue to collude among themselves and retain more than a minor proportion of the industry’s capacity.60 Thus, with leadership by the government firm and continued collusion by private firms, a profits tax would fall in the short run on monopoly profits, quasi-rents, and returns to equity capital in private firms. For the government-owned firm, the incidence of the tax would depend on the leadership pricing and output policies. However, so long as the public enterprise follows objectives other than profit maximization, the application of the tax to its profits is not likely to affect the public enterprise’s behavior or its impact on the allocation of resources.61 Exemption of public firms from the tax might appear to enhance their ability to assume a leading role in the industry, but this would be mainly in the short run, since their efficiency and opportunity costs, not profits or taxes on them, ultimately determine the public enterprise’s ability to undertake a leading role.
If profits are an objective of the public enterprise, the decision as to whether or not to tax it may affect equity if the enterprise attempts to shift the tax. For example, suppose that the government, with the intention of increasing the industry’s output, purchases one of four, equal-sized, constant cost firms in an oligopolistic industry with no foreign competition. The government firm elects to sell an amount equal to its capacity output at an efficient price with the intention of forcing the remaining private firms to follow suit. Such a possibility is shown in Figure 2. Industry capacity is assumed to be OG. Prior to the government’s purchase, all four firms faced demand curve dd and jointly maximized profits by selling output OE at a price OC. However, when the government firm elects to sell FG (one fourth of maximum output) at a price OA, the three remaining firms face a residual demand curve d’d’ and jointly maximize profits by charging OB and selling OD.
Although the government firm has forced an increase in the industry’s output and a decrease in its price, thus increasing the efficiency of resource usage, it has earned only a normal return to equity capital and no additional profit. It could achieve exactly the same private producers’ price and ouput and a profit for itself by selling FG at a price above OA.62 In this case, the public enterprise is subject only to a constraint on its output. If it were earning less than the maximal profit possible under its output constraint, then it could shift some of any increased profits tax forward to consumers by simply raising its price. Thus, if, for example, some targeted amount of internally generated funds for investment were an objective of the public enterprise, then the tax could induce (or increase) oligopolistic behavior in the short run and forward shifting of the tax without any worsening of the efficiency of resource usage resulting from the output constraint. However, the same behavior could have occurred in the absence of the tax if only output, and not prices, were subject to a constraint. Consequently, imposition of the tax on the public firm could result in (a) the automatic transfer of some existing returns to equity and of monopoly profits, if any, to the government, or (b) forward shifting, or (c) both. However, profit-maximizing private firms could not shift the tax, and it would fall in the short run on their monopoly profits.
In the longer run, efficiency (and perhaps income distribution) could only be improved in the industry by a reduction of barriers to the entry of additional resources. There is no a priori reason to expect this to result from the exemption of the public enterprise from the tax. At best, it might be hoped that exemption might result in higher net profits that the public enterprise would use to invest in additional capacity, an outcome that could also be achieved through taxation and budgetary allocations. On the other hand, leadership behavior by the public enterprise and equal taxation of its profits might reduce barriers to entry into the industry by other private competitors.
Clearly, the effects of a profits tax on public enterprises in oligopolistic markets cannot be ascertained without additional knowledge of the price and output policies of these firms, the nonmarket constraints imposed on them, and the ways in which these would be altered by the tax. However, in general, the effects of the tax on the pricing and output decisions of the government firm, and, in turn, on the decisions of private firms, are more likely to be significant, the more important is the government firm’s market position in the industry, the more the firm participates in interdependent behavioral patterns with private firms, and the more important are considerations of profit to the government firm.
Although traditional considerations of equity and efficiency offer little reason for preferring a profits tax to a dividend for oligopolistic public enterprises, they similarly offer little reason to exclude such enterprises from a profits tax. The tax is not likely to have a significant long-run or short-run impact unless it favorably or adversely affects other public sector policies that would alter efficiency and income distribution. There is no obvious reason why the tax should do either. However, as is true for a monopoly, a reasonable case for taxing public enterprises can be made on the basis of the argument that the compulsory nature of a profits tax is more likely to ensure that any profits are automatically made available for public purposes, and that exemption of public enterprises could, under some circumstances, constitute a barrier to the entry of private enterprises.
3. BROAD COMPETITION BETWEEN PUBLIC AND PRIVATE ENTERPRISES
The analysis thus far has been largely confined to public enterprises within the context of a single firm or industry. However, in many countries, the scope of government ownership of business is so broad that public enterprises in a variety of industries face direct competition from private enterprises. Even when there is no direct competition, there may be strong indirect competition between near-substitutes. There are few data to enable one to assess the extent to which public and private enterprises compete in various countries, but the German (Federal Republic), Indian, and Iranian examples cited earlier indicate that competition exists. A United Nations survey, concerned primarily with developing countries, concluded that competition exists between private and public enterprises in at least some countries, including Uganda, Sudan, Greece, Chile, Spain, Israel, and Iran.63 In many cases, the competition resulted from the establishment of pioneer firms that, subsequent to the development of competing privately owned firms in the industry, the government was unable to sell to private interests.
Furthermore, even if there is no competition in product markets, there is always competition in the markets for factors of production. Although the overall proportion of government ownership may be a poor indicator of the extent of competition in product markets, it may be roughly indicative of the extent of competition between public and private enterprises for productive factors. One would be negligent, for example, to ignore tax-induced effects in factor markets in economies such as Mexico, where over a fifth of gross investment in 1962 was undertaken by public enterprises,64 or Argentina, where 27.8 per cent of total gross fixed investment in 1975 was made by public enterprises.65 The extent of public ownership varies greatly between countries and apparently is not related to the level of development; however, the sectoral and industrial pattern of government ownership within developed and semideveloped countries is similar.66
In a competitive industry, in which a public enterprise is only one of many producers, a profits tax could not be shifted in the short run and would fall on the return to equity capital. However, in the longer run, shifting of the profits tax may occur. An analysis of longer-run shifting under conditions of either direct or indirect competition between private and public enterprises in product markets can be conducted in the context of a Harberger-like neoclassical, competitive economy. In this framework, two factors of production, capital and labor, are fixed in total supply, but are fully employed in producing two goods, X and Y.67
The effects of differential taxation of public enterprises’ profits in this context depends crucially on the assumption that is made concerning the mobility of capital invested in public enterprises, or, more importantly, the responsiveness to the rate of return that the assumption represents. So long as the government’s investment decision is based on any considerations other than those affected by tax changes, capital invested in public enterprises in each industry may be assumed to be fixed exogenously. For example, the goverment may establish, solely for national prestige, an automobile plant. In such circumstances, regardless of whether there is direct or indirect competition in product markets, the imposition of a profits tax on the earnings of public enterprises affects only those earnings.68
There would be no difference in this case between the transfer of public enterprises’ profits to the government by means of a tax or by means of a dividend. Since the tax is imposed only on the return to an essentially “captive” factor of production that is not capable of shifting the tax by moving to untaxed uses, only that factor bears the tax.69 Similarly, the imposition of a tax on the earnings of all private capital results only in a decline in these earnings by the amount of the tax. Consequently, the exclusion of public enterprises from a tax on the earnings of capital will have no effect on factor allocation or on private income distribution. The sole effect of the exclusion would be that the net retained earnings of public enterprises would be higher, by the amount of the tax, than they would be if the tax were applied to these earnings.
It can also be shown that the basic result also would hold if one were to consider a tax on only private corporate earnings under which unincorporated capital’s earnings were not taxed. However, unlike the case of a general tax on the earnings of all capital, imposition of a tax on the profits of only private corporations does not leave public enterprise’s profits unaffected. For example, assume that X is the corporate sector output and Y is the noncorporate sector output and that private enterprises produce both goods X and Y while public enterprises produce only good X, In this case, the return to public capital unambiguously rises if Y production is more capital-intensive than private X production, which, in turn, is at least as capital-intensive as public X production; however, the effect is ambiguous if X is capital-intensive. Intuitively, since untaxed alternative uses are available, the tax induces private capital to shift from X to Y production. If Y is capital-intensive, relatively less capital is released from X production than is desired by Y producers at existing factor prices. Labor is hired away from public enterprises, offsetting, at least somewhat, the tendency for the return to private capital to fall and increasing the return to public capital employed in X production. However, these changes result solely from the imposition of a tax on the earnings of private corporate capital; they do not vary with the tax treatment of public enterprises’ earnings.
If it is assumed that capital invested in public enterprises is mobile and responsive to the rate of return, the results are different. However, even in the case of mobility, the exemption of all public enterprises from the profits tax will affect equity and resource allocation only when there are tax-induced factor shifts in the private sector. For example, a profits tax applying to all private enterprises would fall solely on their profits. Private capital could not escape the tax by shifting to untaxed uses, and relative product prices would not be affected. Consequently, if all public enterprises were exempt from the tax, there would be no incentive for public capital to shift employment. On the other hand, if the tax applied only to private corporations, private capital would be induced to shift to noncorporate uses, and the tax would be shifted, as the net rate of return to all private capital would fall.70 This would lead to a rise in the price of corporate goods relative to noncorporate goods and to an increase in the gross return to corporate capital. If public enterprises were exempt from the tax and their capital were mobile, there would be a tendency to shift resources to production of corporate goods, which would offset, at least somewhat, the tax-induced shifts in the private sector and their consequent effects on equity and efficiency. Exemption of public enterprises could, under these circumstances, result in relatively more concentrated government ownership in taxed industries than in untaxed industries.71
In summary, it is obviously not sufficient to argue that, “if there is … competition, it is obvious that the two types of enterprise, ought to be placed on an equal footing, in respect of taxation as in every other respect, unless discriminatory treatment is deliberately intended.”72 This statement is strictly true only when public enterprises are responsive to alternative rates of return and are able to shift resources to uses yielding higher returns. However, if the level of investment by public enterprises in particular industries or uses can be considered fixed or exogenously determined, then the profits of public enterprises are effectively a residual; under these circumstances, it is of no significance to efficient resource allocation or to the distribution of income in the private sector of the economy whether or not public enterprises are taxed.73 Furthermore, the conclusion holds irrespective of the existence of nonmarket constraints on public enterprises in markets other than the one in which the tax is levied.
However, the conclusion that only under certain circumstances would the exemption of public enterprises from the profits tax affect income distribution in the private sector is restricted to the Harberger “fixed resource endowment” context. In a longer-run growth context, for example, public enterprises’ investment decisions would also certainly be influenced by their own net rates of return if the enterprises were allowed to retain a substantial part of their profits for net investment. The exclusion of its earnings from taxation could result in higher investment expenditures by a public enterprise than might be justified on the basis of opportunity costs. This suggests that, if the government does not retain control over public enterprise investment in the long run, the profits of these enterprises could be taxed in the same manner as those of private enterprises, simply to preclude the possibility of unproductive investment. Furthermore, equal taxation would avoid the possible development of a barrier to entry.
IV. Summary and Conclusions
The variation between countries in the legal liability of public enterprises for profits taxes probably indicates a general lack of consideration of relevant economic factors. Even when public enterprises are legally liable for the same taxes as are private enterprises, the uniformity can be misleading, for a variety of reasons. For example, liabilities may not be enforced on public enterprises generally; exemptions may be granted to specific public enterprises; and failure to take into account other financial transactions, both explicit and implicit, between the government and public enterprises may result in wide differences in the tax base between public and private enterprises. Thus, extralegal, as well as legal, considerations may lead to effective differential taxation of public enterprises.
Given the existing and generally growing importance of nontraditional public enterprises, this paper has attempted to isolate both the rationale for and the expected economic effects of taxing their profits. These enterprises do not reflect the characteristics that have traditionally led governments to assume ownership. Rather they often operate in industries in which the price mechanism could operate effectively as a market signal. Consequently, both profitable and efficient operations should be feasible for nontraditional public enterprises. This suggests that the objectives of taxing nontraditional public enterprises should be essentially the same as those for taxing private enterprise. That is, taxes should be designed not only to raise government revenues but also to promote efficient resource usage, an equitable distribution of the tax burden (and, hence, of disposable incomes), and a stable and growing economy. However, even though the goals of taxation should not differ for public enterprises, special characteristics of public ownership, such as the existence of other government policies and social objectives, may significantly alter the effects of taxation of public enterprises.
Simple analyses of the effects of profits taxes imposed on public enterprises under monopolistic conditions indicate that, so long as public enterprises maximize profits, the tax will have no effect on resource allocation or income distribution. However, if profits are not maximized but the public enterprise operates with some positive profit objective, then the tax may be shifted, with various possible implications for resource allocation and income distribution. For economies in which the scope of government ownership is broad and involves substantial competition with private firms in various industries, the effects of taxing public enterprises’ profits depend upon the importance of the profit motive to public enterprises. If public enterprises’ behavioral responses were similar to those of competitive firms—as might be indicated, for example, by these enterprises channeling their investment into areas with high rates of return—then there would be a strong suggestion that public enterprises should be taxed in the same manner as private enterprises in order to prevent tax-induced distortions in the allocation of resources. However, if investment, pricing, and output policies of public enterprises were not affected by rates of return, then it would be of no importance to efficiency or equity whether or not they were taxed. The government might just as well have received the revenue via dividends.
The study does not provide conclusive results on the economic effects of a tax on public enterprises’ profits, since much depends on managerial behavioral patterns. Nevertheless, some tenuous observations may be drawn. First, the potential for short-run shifting of a tax on public enterprises’ profits and the consequent effects on the economy are greatest when market imperfections or nonmarket constraints have prevented the attainment of maximum profits. In this case, the tax could constitute an additional distortion in the economy and might or might not have undesirable effects. In general, however, nonmarket constraints on public enterprises appear just as likely to insulate the economy from any short-run effects of taxes on public enterprises as to provide new channels for transmission of such effects. In the longer run, when factors are mobile and when the extent of government ownership is sufficient to affect factor allocation, application of a profits tax will have no effect on the economy if investment in public enterprises is unresponsive to rates of return, but exemption of these enterprises from the tax may distort resource allocation and alter private income distribution if their investment is responsive to rates of return.
In summary, the greater are government or other nonmarket constraints on public enterprises in the taxed market, the more limited will be the effects of the tax. But the less important are such constraints, and the more important are market incentives, the greater will be the effects on the economy of exempting public enterprises from the tax. Consequently, while imposition of the profits tax under many circumstances might have neither bad nor good implications, the exemption of public enterprises from this tax could have either no effects or only bad effects. The stronger case, therefore, rests with taxing public and private enterprises alike. However, even this observation should be tempered by the obvious need to consider more thoroughly the objectives of nontraditional public enterprises and the behavioral responses of their managers to taxation. Both would be fruitful fields for further study.
Mr. Floyd, Senior Economist in the Tax Policy Division of the Fiscal Affairs Department, received his doctorate from Rice University. Before joining the Fund, he worked for the Federal Reserve System.
A more rigid definition of public enterprises seems both elusive and undesirable in view of the variety of legal and organizational forms encountered in various countries. However, to distinguish them more clearly from governmental and quasi-governmental bodies, such as school districts and charitable organizations, it is perhaps useful to require that the revenues of public enterprises should be more or less related to their output and that at least some day-to-day operational autonomy should be in the hands of the managers of the enterprise rather than the ministerial authorities. Such a definition obviously leaves possible borderline cases that would have to be classified by individual characteristics. For example, a marketing board whose price and procurement policies are strictly imposed by the government has fewer characteristics of a public enterprise than a marketing board that is permitted to influence such policies on the basis of market forces.
For example, see Richard A. Musgrave and Peggy B. Musgrave, Public Finance in Theory and Practice (New York, 1973), pp. 679-83.
Henry J. Gumpel, Taxation in the Federal Republic of Germany (Chicago, Second Edition, 1969).
India, Ministry of Finance, Budget for 1969-70, Vol. II, “Public Sector Enterprises—A Memorandum,” pp. 362-69.
Iran, Plan and Budget Organization, The Budget of the Imperial Government of Iran, 1351 (1972/73) (Tehran, 1972).
Many aspects of “nontraditional” public enterprises, although not the role of income taxation, are considered in William G. Shepherd and Associates, Public Enterprise: Economic Analysis of Theory and Practice (Lexington, Massachusetts 1976).
The stabilization effects of taxes on public enterprises’ income are only briefly examined, since they are mainly a function of tax levels rather than tax structure and since the revenue from such taxes could presumably be duplicated by an equal yield dividend.
The survey has been compiled from a variety of source material. Consequently, detailed information was obtained for some countries but only sketchy generalities were obtained for others. Furthermore, the survey is confined primarily to income taxation. Information on other forms of taxes is generally not specified in tax legislation, which apparently indicates that public enterprises are usually not legally exempt from other taxes such as sales taxes or tariffs.
Governmental entities, such as cities or states, are often organized in a corporate form but are never subject to income or profits taxes on revenue related to their purely governmental activities (i.e., tax revenues).
See Terence C. Daintith, “The United Kingdom,” Chapter 5 in Public and Private Enterprise in Mixed Economies, ed. by Wolfgang G. Friedmann (Columbia University Press, 1974), pp. 268-74. Also see the Income and Corporation Taxes Act, 1970. State-owned enterprises are subject to local taxes, or rates, based on the notional annual rent obtainable from their properties, or, where notional rentals are not ascertainable, on special statutory formulas.
See, for example, Transport Act 1968, S. 52 (5).
General Tax Code, Articles 206-1 and 1654.
General Tax Code, Article 207-1, 6.
Henry J. Gumpel, Taxation in the Federal Republic of Germany (cited in footnote 3), pp. 238-39 and 246. Specific exemptions may be found in the Corporation Income Tax Law, Section 4 (1), Nos. 1-3. The exemptions mainly apply to government entities, such as the Federal railways, the state lotteries, and the Bundesbank.
General Tax on the Income of Companies and Other Legal Entities, Decree 3359, December 1967. The schedular taxes include the agricultural land, urban land, earned income, and capital yields taxes and the tax on income derived from commerce and industry.
Rural Land Tax, Decree 2230, July 1966. Among the exempted institutions are the Spanish National Telephone Company, Banco de España, Banco de Crédito Local de España, Banco de Crédito Agrícola, Banco de Crédito Industrial, and Banco Hiptecario de España.
Urban Land Tax, Decree 1251, May 1966.
Capital Yields Tax, Decree 3357, December 1967.
Inland Revenue (Amendment) Act No. 18 of 1965, Section 53 (4).
Inland Revenue Act No. 4 of 1963, Sections 28 (1) and (m) exclude from the wealth tax those corporations established under the government-sponsored Corporations Act and the State Industrial Corporations Act No. 49 of 1957 (which include most major public industrial enterprises), the Central Bank, the Ceylon State Plantations Corporation, the Ceylon State Mortgage Bank, Air Ceylon, and various research and marketing boards.
Republic Act No. 104 of June 2, 1947.
Republic Acts Nos. 358 and 1345 of June 1949 and June 1955, respectively, exempt the National Power Corporation and the National Marketing Corporation. The National Power Corporation was not exempted from payment of real property taxes by Act No. 358.
Tanzania, Law No. 33 of 1973, Income Tax Act; and Syrian Arab Republic, Order of Law No. 112 of 1958 and Decree 928 of April 1968.
Tanzania, Ministry of Economic Affairs and Developing Planning, Accounts of the Parastatals 1966-1972 (Dar es Salaam, 1973). Parastatal enterprises include companies in which the Government owns at least 50 per cent of the issued share capital. There are over 100 such enterprises engaged in extensive and diversified commercial, industrial, financial, and other activities in Tanzania.
In Brazil, public enterprises are effectively exempted, since the proportion of profits attributable to the share participations of federal, state, and municipal governments in any enterprise is excluded from the determination of profits for tax purposes. See Decree No. 58400 of May 12, 1966, Articles 211 and 245.
Some of the more traditional public enterprises, such as the state fiscal monopolies, are included directly in the national budget. In addition, some public entities that control and distribute credit, such as the Bank of Italy and various development funds, are not a part of the state budget but do come under the supervisory review of various central government authorities.
Foreign Tax Law Association, Italian Income Tax Service (Ormond Beach, Florida, 1975), p. 313. In addition, public enterprises benefit from reductions in, or exemptions from, various indirect taxes.
Direct Taxation Act of March 1967, Articles 80 and 134.
Algerian Code of Direct Taxes and Taxes Assimilated thereto (Impôts sur les bénéfices industriels et commerciaux) and Loi de Finances, 1975.
Decree 8959 of October 25, 1968; Decree 8986 of November 7, 1969; and Decree 11154 of January 1975. See also Malcolm Gillis and Charles E. McLure, Jr., “Tax Policy and Public Enterprises” in Report of the Bolivian Tax Reform Commission, forthcoming.
G. Sawer, “The Public Corporation in Australia,” in The Public Corporation: A Comparative Symposium, ed. by Wolfgang G. Friedmann, University of Toronto, School of Law, Comparative Law Series, Vol. I (Toronto, 1954), p. 34.
L. C. Webb, “The Public Corporation in New Zealand,” in The Public Corporation: A Comparative Symposium, op. cit., pp. 295-96.
For a detailed discussion of taxes on capital income see Richard A. Musgrave, The Theory of Public Finance (New York, 1959), especially pp. 246-49, 260-72, 378-79.
A notable exception is Richard A. Musgrave, Fiscal Systems (Yale University Press, 1969), especially pp. 13-16 and 40-62.
In Fiscal Systems (cited in footnote 34), Musgrave considers only the polar cases of complete public or complete private ownership.
Although the analysis is largely restricted to the likely response of public enterprises, the possibility of interreactions in the responses of publicly and privately owned competitors is also considered when appropriate.
This assumption is not necessarily inconsistent with other behavioral assumptions that could be made about public enterprises’ managers, such as output maximization or the generation of a targeted amount of internal funds. For example, output maximization could affect profits in the same way as a government requirement to operate at plant capacity. A targeted level of internal funds may have a similar effect on profits to government-imposed prices or output levels. Of course, an assumption of optimal behavior of any sort by managers of public enterprises suggests that the important, but separate, problem of incentives to managerial behavior is only considered insofar as incentives may be affected by taxation.
Even the four remaining cases are not necessarily mutually exclusive. For example, Case 5 (a mixed industry) can be representative of either Case 8 (a mixed enterprise) or Case 9. Case 6 (either a fiscal monopoly or a nationalized industry) necessarily represents Case 9, but Case 9 is not necessarily representative of Case 6. If all firms in an industry are government-owned and are managed in accordance with the government’s established industry-wide policies, the industry is monopolized and may be analyzed as if it were a single firm; and Case 6 merges with Case 9. However, if individual nationalized firms within an industry compete among themselves, Case 6 is not the same as Case 9 and could instead be representative of a competitive industry.
See Richard A. Musgrave, Fiscal Systems (cited in footnote 34), pp. 30-32.
This ignores both the built-in stabilizer aspect of a profits tax and the possible implications for investment and growth, which are discussed in Section II.3.c.
A lengthy debate over whether and how the corporate income tax is shifted has produced considerable controversy but few conclusions. The assertion of short-run shifting was first made rigorously in Marian Krzyzaniak and Richard A. Musgrave, The Shifting of the Corporation Income Tax: An Empirical Study of Its Short-Run Effect on the Rate of Return (Johns Hopkins Press, 1963). A number of other studies of the U.S. corporation income tax have found that the tax is not shifted in the short run. For example, see Robert J. Gordon, “The Incidence of the Corporation Income Tax in U.S. Manufacturing, 1925-62,” American Economic Review, Vol. 57 (September 1967), pp. 731-58. An evaluation of four applications of the Krzyzaniak/Musgrave model to other countries is found in Jeffrey Davis, “The Krzyzaniak and Musgrave Model—Some Further Comments,” Kyklos, Vol. 26 (No. 2, 1973), pp. 387-94. Long-run shifting and incidence of the tax was first analyzed in Arnold C. Harberger, “The Incidence of the Corporation Income Tax,” Journal of Political Economy, Vol. 70 (June 1962), pp. 215-40.
It is not uncommon in developing countries for nontraditional public enterprises to charge different (often lower) prices for outputs or pay different (often higher) wages to noncapital factors than their privately owned competitors, often because of government-imposed constraints. This, of course, necessitates the use of some type of rationing mechanism. For example, rationing may take the form of long lines and empty shelves in government shops.
It is perhaps noteworthy that in Cases 5, 8, and 9, shifting by either public or private enterprises may lead to shifting by the other, and consequently to a substantially different pattern of real income distribution than would probably have emerged if the tax had not been applied to public enterprises. This, of course, attributes a profit-maximizing motive to managers of public enterprises and also assumes an interdependence of behavior that is most likely to be found in oligopolistic market structures.
The possibilities for tax-induced changes in prices and factor payments under various assumptions concerning market structure are considered in greater detail in Section III, although primarily with regard to their effects on efficient resource allocation. Section III.3 analyzes more fully the importance of the assumption concerning capital mobility.
It appears that Albert H. Hanson oversimplified when he concluded that taxation of public enterprise is necessary for “an equal footing” only when it is in direct competition with private enterprise. See Albert H. Hanson, Organization and Administration of Public Enterprises (United Nations, Economic and Social Council, 1966), p. 168.
For a more detailed discussion, see Albert H. Hanson, Organization and Administration of Public Enterprises (cited in footnote 45), pp. 28-51.
While such “expenditure side” policies are clearly important to the overall net effect of government policies, they are not considered in detail in this study.
Colin Jones, “Western Europe’s Public Sector Changes Focus,” European Community, No. 85 (September 1965), p. 9.
India, Ministry of Finance, Budget for 1969-70 (cited in footnote 4), pp. 362-69.
Shepherd depicts the relationship between the government and a public enterprise as a bilateral monopoly in which each side possesses certain advantages that enhance its ability to control the enterprise. See William G. Shepherd, “Objectives, Types, and Accountability,” Chapter 3 in William G. Shepherd and Associates, Public Enterprise: Economic Analysis of Theory and Practice (cited in footnote 6), pp. 44-45.
This discussion raises, without answering conclusively, the interesting question as to what the appropriate income tax base is for public enterprises. There are at least four elements that could be taken into account in determining profits and tax liabilities: (1) the operational activities of the enterprise (including depreciation, capital gains, and requited transactions with the government); (2) unrequited transactions with the government, such as operational subsidies (but excluding dividend payments out of net profits); (3) the quantified financial impact of government-imposed nonmarket constraints; and (4) the quantified impact of externalities, or social costs and benefits, in addition to or not related to element (3). Clearly, for evaluation of investment decisions, all four elements should be taken into account in order to avoid inefficient resource allocation. Furthermore, insofar as differential profits taxation could affect either equity or efficiency, then the tax base should include the same elements for public and private enterprises. Consequently, at a minimum, any of the above elements that would differentially affect the profits of public and private enterprises should be taken into account in determining the tax base.
This ignores the case of a firm or industry earning economic rents, in which additional investment may not be desirable. Furthermore, in the case of monopoly, there may be a need for more variable, but not for more fixed, inputs.
At least two considerations suggest that a profits tax alone may not be a sufficient policy instrument for the government. First, the overall development strategy of a country may indicate that some development projects have higher priority than some profitable public enterprises’ planned investments. In such cases, selective dividends from the lower-priority public enterprises could be used to ensure the desired allocation of investment. Second, public enterprises exploiting scarce natural resources may earn an economic rent in addition to a normal return to capital. In this case, the government may wish to confiscate the economic rent for public purposes by use of dividends or a production tax, in addition to the profits tax.
These observations are applicable for partly owned firms in any market structure.
Alternatively, the problem posed by different tax rates does not arise if the rates apply only to dividend distributions, which does not appear to be the case in Iran.
It is assumed that the monopolist attempts to maximize profits even when subject to externally imposed constraints. If there is more than one firm in the industry, it is necessary to assume that all firms are under centralized control and that the industry as a whole operates as a profit-maximizing monopolist and is thus a price maker.
Quasi-rents accruing in the short run to factors temporarily in limited supply, such as capital or specialized managerial talents, may in the longer run be forced to absorb some part of the tax.
In this case, the results are quite similar to the analysis of oligopolistic market structures.
See the discussion of the purposes of Italian public enterprises in Giuseppino Treves, “Public and Private Enterprise in Italy” in Public and Private Enterprise in Mixed Economies (cited in footnote 10), pp. 47-50. See also John B. Sheahan, “Public Enterprise in Developing Countries,” Chapter 9 in William G. Shepherd and Associates, Public Enterprise: Economic Analysis of Theory and Practice (cited in footnote 6), p. 212. Pricing guidelines to Indian public enterprises in semimonopolistic or oligopolistic industries also indicate the government’s intention that these firms should operate as industry leaders.
See William C. Merrill and Norman Schneider, “Government Firms in Oligopoly Industries: A Short-Run Analysis,” Quarterly Journal of Economics, Vol. 80 (August 1966), pp. 400-412. The analysis assumes that all firms have the same cost curves and size of plant, so that compensation of lower-profit firms does not arise.
The price, wage, output, and investment decisions of the public enterprise obviously have important implications for both the allocation of resources and the equity of private income distribution. However, in this situation, they should be regarded as independent of the profits tax.
The profit would be less than its quarter share of jointly maximized profits. Furthermore, there exists a maximum price for the government firm, such as OH, under this policy. At the price OH, the three private firms could satisfy all industry demand by producing their capacity OF, thus forcing the government firm to either lower its price or drop out of the market.
Albert H. Hanson, Organization and Administration of Public Enterprises (cited in footnote 45), pp. 8-9.
Clark W. Reynolds, The Mexican Economy (Yale University Press, 1970), pp. 270 and 284-85.
Consejo Empresario Argentine Las Empresas Publicas en la Economia Argentina (Buenos Aires, December 1976), p. 44.
Frederic L. Pryor, “Public Ownership: Some Quantitative Dimensions,” Chapter 1 in William G. Shepherd and Associates, Public Enterprise: Economic Analysis of Theory and Practice (cited in footnote 6), pp. 3-22.
The following discussion is intuitively obvious, but it can be substantiated by modifying the standard Harberger model to include public ownership of some capital and some public production of at least one good. The basic model on which this discussion is founded can be found in Arnold C. Harberger. “The Incidence of the Corporation Income Tax,” (cited in footnote 41), pp. 215-40. The uses to which the model and its subsequent variations have been put may be found in Charles E. McLure, Jr., “General Equilibrium Incidence Analysis: The Harberger Model After Ten Years,” Journal of Public Economics, Vol. 4 (February 1975), pp. 125-61. Since factors of production are both mobile and fixed in supply, the context of the Harberger model is neither strictly short run nor long run, but rather somewhere in between. Thus, while it can depict the effects of taxes on factor allocation, the model can be used only to infer their long-run effects on such variables as the growth rates of capital and labor.
Direct competition may be depicted by having public enterprises produce some of good X and having private enterprises produce the rest of good X and all of good Y. Indirect competition would have all X produced by public enterprises and all Y produced by private enterprises.
It can be argued that, especially in developing countries, employees of public enterprises are paid more than the value of their marginal product; consequently, they have no incentive to move to private sector employment. In this case, which is not depicted by the Harberger model, it is conceivable that some of the burden of a profits tax on public enterprises could be shifted to their labor force without inducing labor to shift to private sector employment.
This is essentially the original Harberger result.
If a profits tax were imposed on all private, but only some public, enterprises, the results would be essentially reversed. The exemption would result in a shift of public enterprises’ resources to production in their untaxed uses, which would, in turn, induce an opposite shift by private enterprises. Government ownership would be relatively more concentrated in the untaxed uses.
Albert H. Hanson, Organization and Administration of Public Enterprises (cited in footnote 45), p. 168.
By the same reasoning, the exemption of the output of public enterprises from a general sales tax or value-added tax when there was competition in product markets would alter relative prices, patterns of resource allocation, and private income distribution. The return to private capital would be lower, but the wages of labor in public enterprises, the return to public capital, and the output of public enterprises would be higher as a result of the exemption. Although no indication of legal codifications of such exemptions have been found, they may, in fact, occur in numerous ways, such as simple failure to pay tax proceeds to the Treasury or by the government’s allowing tax proceeds to be employed for plant expansion.
