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.
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.