Explicit, implicit and total taxes in the corporate sector: evidence for the Netherlands

Abstract

This paper provides empirical evidence on the existence of implicit taxes in the corporate sector. With this finding, it provides support for the offsetting nature of explicit versus implicit taxes. Governments continuously provide tax preferences (tax incentives) to firms to induce these firms to alter their investment, production and financing decisions to reallocate resources towards outcomes that the government prefers. Tax preferences lead to lower explicit tax rates for firms that make use of these preferences. However (see Scholes and Wolfson (1992) and Wilkie (1992)), economic theory suggests that in equilibrium all firms must earn the same after-tax return (e.g. ROE). Hence high (low) implicit taxes (tax preference induced adjustments of pre-tax returns) can be expected for firms with low (high) explicit taxes. This paper uses financial statements of 123 listed firms for six years (1991-1996) to provide empirical evidence on the existence of implicit taxes in the corporate sector in the Netherlands. The paper finds that the inverse relation between implicit and explicit taxes exists, but is not a strong as expected, suggesting market frictions that prevent the equalisation of after-tax returns.