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International Tax and Public Finance

Erschienen in:

01.08.2013

A partial race to the bottom: corporate tax developments in emerging and developing economies

verfasst von: S. M. Ali Abbas, Alexander Klemm

Erschienen in: International Tax and Public Finance | Ausgabe 4/2013

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Abstract

This paper assembles a new dataset on corporate income tax regimes in 50 emerging and developing economies over 1996–2007 and analyzes their impact on corporate tax revenues and domestic and foreign investment. It computes effective tax rates to take account of special regimes, such as tax holidays, temporarily reduced rates and increased investment allowances. There is evidence of a partial race to the bottom: countries have been under pressure to lower tax rates in order to lure and boost investment. In the case of standard tax systems (i.e. tax rules applying under normal circumstances), the effective tax rate reductions have not been larger than those witnessed in advanced economies, and revenues have held up well over the sample period. However, a race to the bottom is evident among special regimes, most notably in the case of Africa, creating effectively a parallel tax system where rates have fallen to almost zero. Regression analysis reveals higher tax rates adversely affect domestic investment and FDI, but do raise revenues in the short run.

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The literature is summarized in Wilson (1999), and more recently Fuest et al. (2005). Most early tax competition models are based on the idea that globalization increases the elasticity of capital with respect to taxation. This increases the marginal cost of raising public funds and therefore reduces welfare. However, when other taxes are available, such as taxes on less mobile factors, or if governments raise taxes for reasons other than welfare maximization, then tax competition can be less harmful or even beneficial in some models.

This is possibly because the earliest work in the area was undertaken by institutions that focus on advanced economies—see, for example, OECD (1991) and European Commission (1992).

We use the term “developing and emerging” country loosely and include as many economies of growing importance as we could cover with our data. Some of them are indeed advanced economies under the WEO classification, e.g., Israel.

Many more papers exist that focus on one or a few countries or at best a region, but without a wide panel it is hard to draw general lessons from country experiences.

For an overview see Shah (1995), OECD (2001), Zee et al. (2002), and Klemm (2010).

The country’s ranking on the two measures may not be the same. For instance, a country with a high statutory rate and generous allowances will have a high EATR, because the investment allowance will make up for a small share of profits, but a low EMTR, because the generous allowance may cover most or all of the tax liability, reducing the relevance of the statutory tax rate.

See Klemm (2012) for details on how to adapt effective tax rates for such tax structures. See also Mintz (1990) for an earlier suggestion of an EMTR taking account of tax holidays.

Unlike the EMTR of Chen and Mintz (2008), our estimates do not attempt to incorporate other business taxes, such as asset-based taxes and sales taxes on capital inputs.

As it is possible that the largest economies follow different trends, we have also looked at Brazil, India and China. Among these, only India implemented major reforms to the standard tax system, cutting the statutory tax rate significantly and regularly from 46 % in 1996 to 34 % in 2007, while making the tax base narrower through more generous depreciation allowances for plant and machinery.

To generate the regional average for a given year, the most generous regime was identified for each country within the region in that year, and a simple average taken of the corresponding effective tax rates across countries.

Again we looked separately at Brazil, China, and India and found that India cut its tax holiday from 10 to 5 years, while the most generous regime in China remained unchanged. Brazil does not use tax holidays falling under our definition of broad applicability.

Temporary (one-year) reversals of 1 percentage point were not deemed to interrupt an episode. Thus if country i reduced its EATR from 20 percent in 2000 to 17 percent in 2001, then raised it 18 percent in 2002, but resumed the downward reduction till say, 2004, to a level of 15 percent, the episode was recorded as a 5 percentage point reduction starting in 2000 and ending in 2004.

Turkey, Mexico and Estonia are excluded because of the very large changes in their EMTRs: Turkey (3 yrs, starting 2003, +330 percentage points); Mexico (3 yrs, starting 1996, +250 percentage points); Turkey (1 yr, starting 1998, −300 percentage points); and Estonia (1 yr, starting 1998, −130 percent). Inclusions of these episodes would skew the reported averages.

Clausing (2007) additionally splits the ratio of profits over GDP into the product of the ratio of profits to value added and value added to GDP, but we do not have data on corporate value added.

We systematically use standard errors that are robust to heteroskedasticity and within-group serial correlation. Hausman tests reject the random effect in favor of the fixed effect model for most regressions, and we use fixed effect estimators throughout for consistency.

We are interested in the ratio of the tax base to profits. This ratio is greater than 1 if the tax base is broad, i.e., if deductions are smaller than true economic costs. This ratio can therefore be proxied by the ratio of the PDVs of true economic deprecation to statutory depreciation, which is equally exceeds 1 if the tax base is broad.

Like Clausing (2007), we cannot directly control for changes in the tax base that result from behavioral changes, as we do not have the required data.

Klemm and Van Parys (2012) consider the related issue of the impact on tax incentives on investment in African, Latin American and Caribbean countries. They find that FDI is responsive to the tax rate and some tax incentives, while total private investment is not.

This is also in line with Klemm and Van Parys (2012) who find no impact of tax incentives on investment.

See Keen (2002), Janeba and Smart (2003), and Gugl and Zodrow (2006).

Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87, 11–143. CrossRef

Bucovetsky, S. (1991). Asymmetric tax competition. Journal of Urban Economics, 30, 167–181. CrossRef

Chen, D., & Mintz, J. (2008). Taxing business investments: a new ranking of effective tax rates on capital. Washington: World Bank.

Clausing, K. (2007). Corporate tax revenues in OECD countries. International Tax and Public Finance, 14, 115–133. CrossRef

De Mooij, R. A., & Ederveen, S. (2003). Taxation and foreign direct investment: a synthesis of empirical research. International Tax and Public Finance, 10(6), 673–693. CrossRef

De Mooij, R. A., & Ederveen, S. (2008). Corporate tax elasticities: a reader’s guide to empirical findings. Oxford Review of Economic Policy, 24(4), 680–697. CrossRef

Devereux, M., & Griffith, R. (2003). Evaluating tax policy for location decisions. International Tax and Public Finance, 10, 107–126. CrossRef

Devereux, M. P., Griffith, R., & Klemm, A. (2002). Corporate income tax reforms and international tax competition. Economic Policy, 17(35), 451–495. CrossRef

European Commission, (1992). Report of the independent experts on company taxation. Luxembourg: Office for Official Publications of the European Communities.

Fuest, C., Huber, B., & Mintz, J. (2005). Capital mobility and tax competition. Foundations and Trends in Microeconomics, 1(1), 1–62. CrossRef

Gugl, E., & Zodrow, G. (2006). International tax competition and tax incentives in developing countries. In J. Alm, J. Martinez-Vazquez, & M. Rider (Eds.), The challenge of tax reform in a global economy (pp. 167–191). Berlin: Springer.

Hines, J. R. (1999). Lessons from behavioral responses to international taxation. National Tax Journal, 52(2), 305–322.

Janeba, E., & Smart, M. (2003). Is targeted tax competition less harmful than its remedies? International Tax and Public Finance, 10, 259–280. CrossRef

Keen, M. (2002). Preferential regimes can make tax competition less harmful. National Tax Journal, 54(2), 757–762.

Keen, M., & Mansour, M. (2010). Revenue mobilization in sub-Saharan Africa: challenges from globalization II—corporate taxation. Development Policy Review, 28(5), 573–596. CrossRef

Keen, M., & Simone, A. (2004). Is tax competition harming developing countries more than developed? Tax Notes International, Special Issue 28, 1317–1325.

Klemm, A. (2010). Causes, benefits, and risks of business tax incentives. International Tax and Public Finance, 17(3), 315–336. CrossRef

Klemm, A. (2012). Effective average tax rates for permanent investment. Journal of Economic and Social Measurement, 37(3), 253–264.

Klemm, A., & Van Parys, S. (2012). Empirical evidence on the effects of tax incentives. International Tax and Public Finance, 19(3), 393–423. CrossRef

Mintz, J. (1990). Corporate tax holidays and investment. World Bank Economic Review, 4(1), 81–102. CrossRef

Nickell, S. (1981). Biases in dynamic models with fixed effects. Econometrica, 49(6), 1417–1426. CrossRef

OECD (1991). Taxing profits in a global economy: domestic and international issues. Paris: OECD.

OECD (2001). Corporate tax incentives for foreign direct investment. OECD tax policy study, No. 4. CrossRef

Shah, A. (Ed.) (1995). Fiscal incentives for investment and innovation. Oxford: Oxford University Press.

Wilson, J. (1999). Theories of tax competition. National Tax Journal, 52(2), 269–304.

Zee, H., Stotsky, J., & Ley, E. (2002). Tax incentives for business investment: a primer for policy makers in developing countries. World Development, 30(9), 1497–1516. CrossRef

Titel: A partial race to the bottom: corporate tax developments in emerging and developing economies
verfasst von: S. M. Ali Abbas
Alexander Klemm
Publikationsdatum: 01.08.2013
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 4/2013
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-013-9286-8

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