The Peripatetic Nature of EU Corporate Tax Law

This article examines some aspects of the European Union’s corporate tax set-up which correspond to aspects of a country’s corporate tax regime. The overarching question is whether there is such a thing as EU corporate tax law. This article seeks to address this in the context of the following issues: the existence of a uniform tax base and tax rates;the existence of anti-abuse rules and a transfer pricing regime; and, finally, the existence of a common tax administration and its powers. The article questions whether the peripatetic development of EU corporate tax law is suitable for the EU or whether it undermines its long-term objectives. The potential impact of Brexit in the development of EU corporate tax law is also addressed.

The Incidence of the Corporate Income Tax on Wages: Evidence from Canadian Provinces

Tax rate changes are some of the most significant and far-reaching decisions a government can take. A good understanding of the odds of any such changes is essential for any business debating the timing and location of investments. This paper investigates the factors that affect the timing of statutory tax rate changes by Canadian provincial governments. The authors develop a simple theoretical model to explain the “stickiness” of tax rates — the factors that lead a province to decide against tinkering with the tax system — based on the presence of fixed costs of adjusting tax rates. The results indicate that if the current rate falls within a range of tax rates bracketing the optimal rate, then the government will not adjust its tax rate because the cost of the reform outweighs the potential benefits. To build up a body of evidence, this paper employs a multinomial logit model to examine the likelihood of changes to personal income tax (PIT), corporate income tax (CIT), and provincial sales tax (PST) rates by provincial governments over the period 1973-2010. Regression results indicate that provincial governments that start with higher tax rates are more likely to cut, and less likely to raise, their tax rates. A higher provincial budget deficit reduces the probability of a CIT rate cut and raises the probability of a PST rate increase. Party ideology seems to matter. Provinces with leftleaning governments are less likely to cut PIT and PST rates, and more likely to raise PIT rates compared to non-left-leaning governments. The authors also find that a federal PIT rate cut raises the probability of a provincial PIT rate increase, whereas a federal CIT rate cut raises the probability of a provincial CIT rate reduction.

Does reducing the corporate income tax accompanied by an increase in the consumption tax to meet the government's budget constraint improve welfare? To respond, we examine the welfare‐maximizing corporate income tax and consumption tax rates in an R&D‐based growth model under the constraint that the government's budget is balanced at each point of time. Further, we consider how welfare‐maximizing tax rates change as patent protection becomes stronger, as seen in many countries. The results show that as patent protection becomes stronger, the corporate income tax rate should be higher and the consumption tax rate should be lower. This implies that under stronger patent protection, recovering production at the expense of innovation by raising corporate income tax and reducing consumption tax improves welfare.

This article uses U.S. corporate tax return data to assess how government revenue would have changed if, over the period 1957–2013, corporations had been subject to a hypothetical corporate cash flow tax—that is, a tax allowing for the immediate deduction of investments in long‐lived assets like equipment and structures—rather than the corporate tax regime actually in effect. Holding taxpayer behavior fixed, the data indicate actual corporate tax revenue over the most recent period (1995–2013) differed little from that under the hypothetical cash flow tax. This result has three important implications. First, capital owners appear to bear a large fraction of the corporate tax today. This is because economic theory holds that corporate cash flow taxes are largely borne by capital owners and my result implies that the actual tax behaves in practice much like a cash flow tax. This theory is embodied in the Treasury's most recent model of corporate tax incidence. Applying the model to my results implies that only a small portion (2–10 percent) of the U.S. corporate tax was borne by labor in the years before the 2017 Act and thus capital providers are the primary beneficiaries of the Act's large corporate rate cut. Second, the results suggest that the United States could switch fully over to a cash flow tax, which is likely to be administratively simpler for both the government and corporations, at relatively low revenue cost. Third, the impact of fully switching to a cash flow tax on the operations of the real economy and its efficiency are likely to be fairly small. This is precisely because the corporate tax has already evolved to largely mimic a cash flow tax, and the article explores the reasons underlying this evolution using a novel dataset.

This article uses U.S. corporate tax return data to assess how government revenue would have changed if, over the period 1957–2013, corporations had been subject to a hypothetical corporate cash flow tax—that is, a tax allowing for the immediate deduction of investments in long‐lived assets like equipment and structures—rather than the corporate tax regime actually in effect. Holding taxpayer behavior fixed, the data indicate actual corporate tax revenue over the most recent period (1995–2013) differed little from that under the hypothetical cash flow tax. This result has three important implications. First, capital owners appear to bear a large fraction of the corporate tax today. This is because economic theory holds that corporate cash flow taxes are largely borne by capital owners and my result implies that the actual tax behaves in practice much like a cash flow tax. This theory is embodied in the Treasury's most recent model of corporate tax incidence. Applying the model to my results implies that only a small portion (2–10 percent) of the U.S. corporate tax was borne by labor in the years before the 2017 Act and thus capital providers are the primary beneficiaries of the Act's large corporate rate cut. Second, the results suggest that the United States could switch fully over to a cash flow tax, which is likely to be administratively simpler for both the government and corporations, at relatively low revenue cost. Third, the impact of fully switching to a cash flow tax on the operations of the real economy and its efficiency are likely to be fairly small. This is precisely because the corporate tax has already evolved to largely mimic a cash flow tax, and the article explores the reasons underlying this evolution using a novel dataset.

Canada is losing its edge in the competition for global capital. After a decade of remarkable progress in reducing the tax burden on business investment — moving from one of the least tax-competitive jurisdictions among its industrialized peers in 2000, to ranking in the middle of the pack by 2011 — Canada has slipped by largely standing still. As other countries in our peer group have continued to reform their business-tax regimes, they have surpassed Canada, which has slid from having the 19th-highest tax burden on investments by medium-sized and large corporations in 2012, to the 14th-highest among 34 OECD countries in 2014. Even more worrying is that Canada’s political currents are running the wrong way, with a few provinces having increased taxes on capital in recent years and a number of politicians today floating the possibility of even higher business taxes to help address budgetary strains. But the right approach to raising tax revenue and improving the economy is quite the opposite: lowering rates and broadening the tax base by making Canadian jurisdictions even more attractive to corporate investment. An important step towards that would be for federal and provincial governments to reduce targeted tax assistance and to level the tax field for all industries and sizes of businesses, ending the preferential treatment of favoured industries and small enterprises. In addition, those provinces that have yet to harmonize their sales tax with the federal GST should do so, or at least consider adopting a quasi-refund system that would relieve the provincial sales tax on capital inputs. Alberta, with no sales tax, could become more competitive by adopting an HST and using the proceeds to reduce personal and corporate taxes. Finally, Canada would do much better to mandate a uniform corporate tax rate, with an 11 per cent federal rate and a nine per cent average provincial rate. This would encourage capital investment and attract corporate profits to Canada, without a significant revenue cost to either the federal or provincial governments. †

The marginal cost of public funds measures the welfare loss a society incurs in raising an additional dollar of tax revenue. Tax increases distort economic decisions and erode tax bases because of tax avoidance and tax evasion by taxpayers. This Commentary uses econometric estimates of the effects of higher provincial tax rates on the provinces’ corporate income tax, personal income tax, and sales tax bases to calculate the marginal cost of public funds (MCF) for these taxes. The results indicate that the cost of increasing provincial tax revenues through a corporate tax rate increase is very high, and in some provinces, corporate tax rate reductions in 2006 would have increased the present value of the provincial government’s total tax revenues. The results also suggest that significant welfare gains would accrue from reducing provincial corporate income tax rates. As well, increasing provincial corporate and personal income tax rates can cause significant reductions in federal tax revenues because the federal and provincial governments levy taxes on the same tax bases. Finally, Canada’s system of the equalization grants might reduce the perceived MCF of recipient provinces.

We develop a model to investigate the relations among (1) corporate tax incidence, (2) tax capitalization, and (3) implicit corporate tax in a competitive equilibrium. The economic pretax return is independent of whether the incidence of the corporate tax is shifted from shareholders to non-shareholders, such as customers or workers. However, tax incidence does affect the pretax accounting return, because the denominator of the return measure reflects the historical cost of the firms' assets and is often measured using prior year book values. To the extent a tax rate change changes the fair values of corporate assets (i.e., tax capitalization), the corporate tax affects pretax economic returns but not pretax accounting returns. The implicit tax rate for corporations reflects differences in corporate tax rates but is independent of pretax accounting returns.

Corporate tax harmonisation in Europe: a guide to the debate

The U.S. federal government raises tax revenue almost exclusively through income taxes, both corporate and individual, whereas its trading partners and competitors rely for their national revenue on both income taxes and “destination based” value added taxes (VATs), which are not imposed on exports but are imposed on imports. As a result, U.S. corporations, which are subject to U.S. corporate income tax, may be at a serious trade disadvantage to competitor non-U.S. corporations with respect to both U.S. domestic sales and foreign sales, if the U.S. corporate income tax exceeds the foreign country’s income tax imposed on those competitors. The Biden administration has proposed raising the tax rate on U.S. corporate income from its current 21 percent to 25 percent and perhaps even more likely to 28 percent. The proposed rate increase faces substantial Republican opposition. The opposition to the proposed rate increase argues that such an increase will chase business offshore and put the U.S. at a competitive disadvantage in attracting business and selling products both in the U.S. and abroad that compete with foreign products. The problem, simply put, is that foreign countries rely on VATs and can afford to maintain lower corporate income tax rates than otherwise, but the U.S. does not have a supplemental source of revenue like a VAT. The issue of a competitive U.S. corporate income tax is not simply a current Biden/Republican tax rate disagreement about raising the U.S. corporate income tax. Rather, it is an issue about U.S. corporations having to compete with foreign corporations from countries that impose a lower income tax (and no VAT on exports) on those corporations than the U.S. imposes on its domestic corporations, and, further, that the U.S. cannot reciprocate by charging a lower income tax on its exports than on its domestic sales because of international treaty constraints. Thus, the issue reaches well beyond a proposed Biden administration corporate income tax increase, but rather to the structure of the U.S. business tax system of not having a VAT in some form as an integral part. This Article considers revenue raising alternatives to supplement the current business income taxes and recommends that a subtraction VAT should be added to the corporate income tax as, at the very least, a step in keeping the corporate income tax competitive with the U.S.’s trading partner countries, perhaps as the long-term solution but perhaps as a first step to the adoption of a credit VAT to supplement the corporate income tax. In doing the foregoing, the Article compares the two types of business-level consumption taxes, the credit method VAT and the subtraction method VAT, relating them back to the most basic consumption tax, the retail sales tax. The Article argues that the subtraction method VAT, although not adopted by any other country, should be the choice because it can be added to the corporate income tax as a supplemental tax and can most easily coexist and be coordinated with that tax. It thereby allows for the easiest transition and is likely to be most acceptable to the public, which is well used to the corporate income tax and, as many observers believe, would be unwilling to adopt a credit method VAT, seeing it as a refined retail sales tax, which is a consumption tax imposed on individuals. The Article then describes the proposed “Supplemental Subtraction VAT” that would supplement the tax on a corporation’s income and how it can be engrafted onto the existing corporate income tax to minimize the disruption to the current corporate income tax collection system. It then argues that the new supplemental subtraction VAT imposed on corporations, which would be destination-based, should be accepted as a VAT by the WTO and the U.S.’s trading partners for international tax and trade treaty purposes.

This paper examines whether corporate tax changes or corporate tax regime changes influence the capital structure of firms. We exploit the corporate tax changes in Canada (1981-2015) and the United Kingdom (1981-2015), and tax system changes in Australia (1981-1998) and Taiwan (1981-2009) to assess these effects on capital structure. By employing fixed effect models, we find that corporate tax changes do not have significant impact on the capital structure of firms within the established imputation systems of Canada and the United Kingdom, and for the classical tax system in Taiwan. However, corporate tax has a negative impact on debt (ie debt goes down) when the system moves from a classical to imputation tax system in Taiwan. Overall, our findings suggest that although changes in corporate taxes have no impact on capital structure, tax regime change does have an effect on capital structure when a regime shifts from classical to imputation. This has important implications, for government policy, financial distress, and aggregate investment.

The Incidence of the Corporate Income Tax on Wages: Evidence from Canadian Provinces

Corporate income tax (CIT) incidence is an important and contentious issue in tax policy discussions. Much of the focus in the recent literature and in policy discussions concerns the allocation of the burden of the CIT between owners of capital and labour. Since income from capital tends to be concentrated with wealthier individuals, if the burden of the CIT falls largely on capital it increases the tax system’s progressivity. On the other hand, if the tax is borne mostly by labour through lower wages, the CIT is less progressive. Despite the importance of this issue in policy discussions, empirical evidence is quite limited and the results are mixed; there is a particular dearth of empirical research on the incidence of corporate taxes in a Canadian setting. According to theoretical open economy general equilibrium models, the burden of the CIT may partly, and possibly largely, fall on labour. In these models, an increase in the CIT reduces the return to capital, causing capital to leave the jurisdiction, which lowers the marginal product of labour and ultimately wages. Thus, the CIT can have a negative indirect effect on wages through its impact on labour productivity by way of its impact on capital. However, the magnitude of this effect depends critically on several modelling assumptions and parameter values related to the size of the country, the degree of capital mobility, the nature of competition in the output market, etc. An emerging empirical literature investigates the effects of CIT on wages by way of this indirect transmission mechanism. Empirical studies in this vein include Hassett and Mathur (2006, 2015) for a cross-section of countries; Desai, Foley and Hines (2007) and Felix (2007, 2009) for the U.S. They all find evidence in support of the relevance of the indirect channel using national aggregate data. Other studies, such as Carroll (2009) and Felix (2009) for the U.S., examine corporate tax incidence at the subnational level, and find that a substantial amount of the burden of the CIT falls on workers. However, a recent study by Clausing (2013) using OECD data casts some doubt on the relevance of the indirect channel and the empirical results of some of the above studies. Another strand of research has focused on an alternative channel whereby the CIT affects wages directly. In these models, firms earn economic rents due to imperfect competition and/or other market frictions. Firms and workers bargain over these rents, allowing workers to earn a premium over the value of their marginal product. If firms earn economic rents and bargain with workers over their distribution, then an increase in the corporate tax can affect wages directly by lowering the rents available for distribution. Again, the theoretical results can be sensitive to various modelling assumptions and the emphasis has been on empirically identifying the so-called direct effect. Studies in this vein include Felix and Hines (2009) for the U.S., Dwenger et al., (2011) and Fuest et al., (2015) for Germany and Arulampalam et al., (2012) for a cross-section of European countries. They tend to find some empirical support for the direct transmission mechanism, though estimates of the size of the effect vary. In this paper, we undertake one of the few empirical investigations of the incidence of the CIT on wages using Canadian data. We focus on the indirect transmission mechanism of corporate taxes on wages. To this end, we estimate wage and capital/labour ratio equations simultaneously, using a panel of provincial data from 1981 to 2014. In our most preferred specification, we estimate that the elasticity of the real hourly wage rate with respect to the statutory CIT rate at the provincial level is -0.107; thus, a one per cent increase in the provincial corporate income tax rate is associated with a 0.107 per cent reduction in the real hourly wage rate. A common approach to assessing the impact of an increase in the CIT on wages is to calculate the impact on aggregate wages of raising one more dollar in corporate tax revenue. We use this approach to calculate the incidence of the CIT in Canada’s 10 provinces implied by our elasticity estimate. Under the commonly employed assumption that the CIT base is insensitive to changes in the tax rate, our estimates suggest that a $1 increase in corporate tax revenues due to an increase in the provincial statutory CIT rate reduces aggregate wages by from 95 Canadian cents in Newfoundland and Labrador to C$1.74 in New Brunswick. In an innovation to this approach, when we account for the fact that the CIT base shrinks in response to an increase in the tax rate, our estimates are significantly higher, ranging from C$1.52 for Alberta to C$3.85 for Prince Edward Island. Our results provide empirical support in a Canadian setting for the indirect transmission mechanism highlighted in the open economy general equilibrium models of corporate tax incidence and suggest that workers bear a significant part of the corporate income tax liability in the form of lower wages. The empirical results are robust to various sensitivity checks and are within the range of values obtained in previous similar studies. The remainder of the paper is organized as follows. In section 2, we provide a brief overview of the literature on the incidence of the CIT. In section 3, we specify the empirical model and discuss the data. The empirical results are presented and discussed in section 4. Section 5 concludes.

Who bears the burden, or incidence, of the corporate income tax (CIT)? This is an important, if not somewhat contentious, policy issue. In this paper we provide a discussion of the existing research on the question, viewing it through a Canadian policy lens. We also use some new results from a companion technical paper, which undertakes one of the few empirical investigations of the issue using Canadian data, to discuss the implications of increases in corporate taxes for wages in Canadian provinces. While it is clear that people, not corporate entities, ultimately bear the burden of corporate taxes, a key question is which people? The answer to this question has important implications for the equity, or fairness, of the tax system. Much of the recent focus in policy discussions concerns the allocation of the burden of the CIT between owners of capital and labour. Since income from capital tends to be concentrated with wealthier individuals, if the burden of the CIT falls mostly on the owners of capital, it increases the progressivity of the tax system. On the other hand, if the tax is borne mostly by labour through lower wages, the CIT is less progressive. Much of the research into the incidence of the CIT has employed theoretical simulation models. Early models of this type, which were based on a closed economy with fixed supplies of labour and capital, suggested that most of the burden of the CIT would be borne by the owners of capital throughout the economy, and not just the shareholders of firms in the corporate sector. Subsequent extensions of those models into a small open economy setting, where capital and goods are highly mobile between jurisdictions (countries, provinces), predict that most of the burden of the CIT will be borne by other inputs that are relatively inelastic in supply, such as labour. These small open economy models are particularly relevant for Canada. Viewing the results of these models through a Canadian lens, we conclude that there is good reason to expect that much of the burden of corporate taxes in Canada, particularly those levied by provincial governments, will fall on labour through lower wages. While useful, the predictions of these simulation models should be viewed with caution, largely because of the sensitivity of the results to the underlying assumptions. A nascent empirical literature has emerged that provides econometric-based estimates of the distribution of the burden of corporate taxes. While this research is relatively new, our reading is that the evidence is mounting that corporate taxes are indeed borne to a significant extent by labour through lower wages. However, there is very little empirical work done in an explicitly Canadian context. In a companion technical paper we employ Canadian data to examine the impact of provincial corporate taxes on wages. Our results suggest that, consistent with the predictions of the open economy simulation models, provincial corporate taxes adversely affect the capital/labour ratio, which lowers the productivity of labour which, in turn, lowers wages. Accounting for the shrinkage in the corporate tax base in response to an increase in the tax rate, we calculate that for every $1 in extra tax revenue generated by an increase in the provincial CIT rate, the associated long-run decrease in aggregate wages ranges from $1.52 for Alberta to $3.85 for Prince Edward Island. Applying our estimates to the recent 2 percentage point increase in the CIT rate in Alberta we calculate that labour earnings for an average two-earner household will decline by the equivalent of approximately $830 per year, which amounts to a $1.12 billion reduction in aggregate labour earnings for the province. By way of comparison, other research has estimated the impact of the recently imposed carbon tax in Alberta – the subject of considerable scrutiny – to be approximately $525 per household.