Reduction In Corporate Tax Rate Research Articles

Survey of recent developments

Summary The economy continues along the general trajectory described in recent Surveys. Growth is picking up, led by consumption but restrained by investment. Inflation has fallen well below Bank Indonesia's current target rate. Most interest rates have followed suit, including key lending rates. Bank lending has been expanding at around 20% p.a. for the past year or so, and international portfolio investors are again interested in Indonesia. But a scare in the mutual funds industry and scandals at two state banks remind that trouble still simmers just below the surface in the financial sector. Fiscal policy continues its conservative stance. The government is likely to have achieved its 2003 deficit target, and the budget for 2004 envisages further narrowing of the deficit. Still, the deadline for achieving a modest budgetary surplus has slipped two years, to 2006. Draft amendments to the income tax law foreshadow a probable reduction in corporate tax rates, increases in personal rates, and removal of certain key exemptions. Proposed administrative changes would give tax officials significantly greater powers of investigation and prosecution; observers foresee increased scope for extortion by unscrupulous officials. Monetary policy has become increasingly expansionary, given the central bank's desire to support economic recovery and its success in driving inflation down. This is reflected in quite rapid base money growth and sharp falls in policy interest rates, notwithstanding some efforts by Bank Indonesia to slow their decline. Trade policy has been dominated by increasing signs of resurgent protectionism, including a shift away from a transparent tariff regime to rent-generating systems of licensing. On the political front, opinion polls in advance of the national elections suggest a considerable shift in the parliament, away from PDI-P in favour of Golkar. The size of this shift will be critical in determining the choice of candidates for the subsequent presidential elections. At present, Megawati Sukarnoputri remains the front-runner, but almost any combination of major parties could still form a coalition and make a credible run at the presidency. With elections looming, little further progress can be expected on the economic policy front in 2004. In these circumstances, the focus for progress shifts to a politically independent Bank Indonesia. With strong policies in its areas of responsi-bility—inflation, monetary policy and financial sector development—further progress is achievable even during an election year. This would lay a solid foundation for robust economic recovery, hopefully policy driven by the next administration.

Corporate Tax Policy, Foreign Firm Ownership and Thin Capitalization

This paper analyzes the implications of foreign firm ownership and international profit shifting through thin capitalization for corporate tax policy. We consider a model of interjurisdictional tax competition where the corporate tax serves as a backstop to the personal income tax, interest on debt is deductible from the corporate tax base and multinational firms may shift profit across countries through thin capitalization. We show that the problem of thin capitalization induces countries to reduce their corporate tax rates below the personal income tax rate and to broaden their tax bases. Moreover, foreign firm ownership leads to a reduction in corporate tax rates. We also show that there is scope for welfare enhancing tax coordination in our model. In the presence of both foreign firm ownership and thin capitalization, countries gain from a coordinated increase in corporate tax rates or from a coordinated broadening of the tax base.

What Kind of Tax Reform Do We Really Need?

>. The Treasury's well-leaked September options paper set forth several proposals affecting corporations, among them an extension of the investment tax credit to include bricks and mortar, a small reduction in the basic corporate tax rate, relief from the double taxation of corporate dividends and elimination of the infamous lunch as a tax deductible expense. The most novel proposal is the reduction in the double taxation of dividends. Under most approaches to the of corporate and shareholders' income taxation, shareholders would gain. In addition to the corporation's dividend, each would receive, for some portion of the actual U.S. taxes paid by the corporation, a tax credit of the same dollar amount per share. The shareholder could use this credit to reduce his federal tax liability, dollar for dollar, on wages and salary as well as on dividend income. Unfortunately, partial integration has several drawbacks. To begin with, the importance of the tax credit depends on the investor's marginal income tax bracket: A per-share credit of a given amount will offset a larger portion of the lower tax bracket investor's tax. Then too, net of the credit, the low bracket investor's tax will be an even smaller fraction of the higher bracket investor's than it is now-a result that hardly seems compatible with the President's avowed intention of creating a fairer tax code. Furthermore, the tax credit will have no value at all to investors who do not pay U.S. income taxes. Corporations that pay low effective U.S. income taxes, such as financial institutions holding taxexempt municipals and multinational corporations paying the bulk of their taxes to foreign governments, would be at a disadvantage in competing for capital against corporations bearing the same overall tax rate, but paying a higher proportion of their total tax bill to the U.S. government. The simple way to benefit corporate capital investment is to cut the basic 48 per cent tax rate. Coupled with some trimming in personal income tax rates, such a cut could speed up the pace of economic activity, eventually generating higher revenues that would largely offset the Treasury's initial revenue loss. A reduction in the corporate tax rate would also reduce the value of business tax preferences and expense deductions including three-martini lunches. o