What are the effects of taxes on business behaviour?
A core research area of the Centre is the investigation of how taxes on business – broadly defined – can affect the behaviour of business. Projects typically use detailed theoretical and/or empirical modelling, with empirical projects typically based on the analysis of detailed microeconomic data. Two important themes in the research are the exploration of differences between businesses in their response to taxation, and of the role of uncertainty in long term investment decisions – uncertainty in the economic environment, and also in policy.
Two main areas of business behaviour are investigated: the location and scale of investment, and financing patterns and legal and organisational form. Both draw on more basic research on the measurement of effective tax rates.
Each of these areas of research contains several individual projects.
1. Measurements of effective tax rates
A key data requirement for much of the Centre’s research is basic information about the structure of taxes in different countries and over time. We collect such data, and we also develop a number of measures of effective tax rates for use in empirical work.
We have integrated well-known measures of effective tax rates with company level data. Such measures can provide a useful source of cross-section variation in effective tax rates across companies, which can be used in empirical research. They can also be used to evaluate the effects of tax reform more directly.
Individual projects
2. The location and scale of investment
Research projects on the location and scale of investment include analysis of: the impact of tax on the location of headquarter companies, the extent of foreign direct investment between countries, the quantity and location of cross-border acquisitions, the impact of various forms of taxation in a risky environment, and the effects of different elements of taxation including formula apportionment.
Individual projects
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The effects of taxation on cross-border investment through acquisitions
Wiji Arulampalam, Michael Devereux
This project uses data from the ORBIS and ZEPHYR datasets to identify a large number of cross-border acquisitions by multinational companies in 2005-8. We estimate the determinants of whether a company undertakes an acquisition in a new country, and which country is chosen (conditional on the countries in which the company is already operating). We test various assumptions about the role of tax in such decisions. |
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Corporate tax effects on affiliate investment – Evidence from European multinationals
Johannes Becker, Nadine Riedel
Several recent papers show that increases in the capital stock at one multinational affiliate tend to raise the capital stock at other locations, rather than to reduce it. In this paper, we theoretically and empirically explore the consequences of these findings for national corporate tax policy. Our main hypothesis is that domestic corporate taxation not only reduces domestic capital investment but also lowers capital stocks at foreign affiliates within a multinational group. The paper identifies several channels through which domestic taxation may exert such a cross-border effect on foreign capital. Using micro data on European multinational firms, we confirm the hypothesis showing that a ten percentage point increase in corporate tax rates is associated with a 5.5 percent decrease in the affiliate’s capital stock. From a welfare point of view, this cross-border tax effect on capital investment gives rise to a negative fiscal externality of corporate taxation which is empirically shown to compensate a substantial fraction of the well-known positive profit shifting externality. |
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Corporate tax effects on the quality and quantity of FDI
Johannes Becker, Clemens Fuest & Nadine Riedel
This project measures the relative importance of quality and quantity effects of corporate taxation on foreign direct investment. Taxes reduce the equilibrium stock of foreign capital in a given country (quantity effect) and decrease the extent to which investment contributes to the corporate tax base (quality effect). We build a model with heterogeneous investment projects in order to analyse the interdependent effects of taxes on investment quantity and quality. The model predictions are tested using data from a large sample of European multinationals. We find that the quality effect accounts for up to seventy per cent of the total effect of taxes on the size of the tax base. An important implication is that governments should not so much care about the size of inbound FDI flows but more about its specific characteristics. |
Cross-border tax effects on employment
Johannes Becker, Nadine Riedel |
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ECJ tax case law and effect on neutrality
Clemens Fuest, Rita de la Feria
The aim of this project is to assess through an interdisciplinary analysis whether ECJ case law on direct taxation leads to a level playing field, an increase in neutrality, and a decrease in distortions to competition. |
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The role of the corporation income tax as an automatic stabilizer
Clemens Fuest, with Thiess Buettner
This paper analyses the effectiveness of the corporate income tax as an automatic stabilizer. It employs a unique firm-level dataset of German manufacturers combining financial statements with firm-specific information about credit market restrictions. The results show that approximately 20 per cent of all firms report both positive taxable income and capital market restrictions. Taking account of the income tax rates and the size differences of the firms, we find that demand stabilization through the corporate income tax amounts to about 8 per cent of an initial shock to gross revenues. This stabilization effect varies over the business cycle and tends to increase during cyclical downturns. |
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The impact of taxation on the location of capital, firms and profit: a survey of empirical evidence
Michael Devereux
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Taxes and the size of the foreign-owned capital stock: which tax rates matter?
Michael Devereux, Ben Lockwood
This paper analyses the impact of effective average and marginal tax rates on the size of the capital stock owned by foreign affiliates of US multinational companies. We use data on 19 OECD countries, 1983-1998. A simple two-stage model of location choice, and investment conditional on location, identifies the role of each form of effective tax rate. The empirical results indicate a large and significant role for the effective average tax rate, but not for the effective marginal tax rate. As shown in the theoretical model, this is consistent with the discrete location choice playing a more important role in determining the size of the foreign-owned capital stock. |
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Taxing risky investment
Michael Devereux
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Taxes in the EU new member states and the location of capital and profit
Michael P Devereux
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Corporate taxation and multinational activity
Simon Loretz, with Peter Egger, Hannes Winner, Michael Pfaffermayr
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Bilateral effective tax rates and FDI
Simon Loretz, with Peter Egger, Hannes Winner, Michael Pfaffermayr
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Assessing the location pattern of German manufacturing and service industries: a distance based approach
Nadine Riedel, with Hyun-Ju Koh
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The downside of Formula Apportionment: Evidence on Factor Demand Distortions
Nadine Riedel
Forthcoming, International Tax and Public Finance
This paper investigates the impact of corporate taxes on the input factor choice of multi-jurisdictional entities (MJEs) under a formula apportionment (FA) regime. Our testing ground is the German local business tax that applies FA regulations with income apportionment according to the relative payroll share. Using unique data on the population of German firms, we find that MJEs distort their employment and payroll costs in favor of low-tax locations. On average, a 1-percentage-point-increase in the tax rate differential between an affiliate and foreign group members lowers the affiliate’s payroll to capital ratio by 1.9%. This implies that corporate taxation under FA causes a sizable externality on foreign jurisdictions’ welfare and corporate tax rates are inefficiently low. The analysis thus casts doubt on the European Commission’s plan to mitigate tax competition behavior in the EU by introducing FA. |
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The lock-in and capitalization effects of capital gains taxes: evidence from cross-border M&As
Johannes Voget
Capital gains taxes can affect asset supply and demand and thus asset prices. Agents with unrealized capital gains generally stand to gain from delaying the sale of their assets so as to reduce the present value of capital gains taxes. This reduction in asset supply is commonly referred to as the lock-in effect and it tends to increase asset prices. Conversely, prospective asset buyers may reduce their demand in the face of likely future taxation of capital gains. This reduction in demand is called the capitalization effect and it reduces asset prices. Identification of the lock-in and capitalization effects on asset prices has proven difficult. One reason for this is that capital gains tax rate changes are not so frequent in individual countries. A second reason is that a capital tax rate change would simultaneously affect asset prices through changes in demand and supply. Our international sample of M&As allows us to estimate separate lock-in and capitalization effects on acquisition premiums because the capital gains tax rate of acquiring shareholders can differ substantially from the capital gains tax rate of target shareholders. |
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Headquarter relocations and international taxation
Johannes Voget
This paper examines the extent of international headquarter relocations worldwide. Within a decade, about 6 percent of all multinationals relocate their headquarter to another country. Furthermore, the paper presents empirical evidence on the role of tax in relocation decisions. It considers a sample of 140 multinationals that relocated their headquarters over the last decade and compares them to a control group of 2083 multinationals that have not done so. It is found that the additional tax due in the home country upon repatriation of foreign profits has a positive effect on the probability of relocation. The empirical results suggest that an increase in the repatriation tax by 10 percentage points would result in a 2.3 percentage points increase in the number of relocating multinationals. Furthermore, the introduction of controlled foreign corporation legislation also seems to have a positive effect on the number of relocations. |
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Impact of international taxation on mergers and acquisition
Johannes Voget, with Harry Huizinga
forthcoming, Journal of Finance
The paper analyzes the impact of international tax regimes on the volume and direction of mergers and acquisitions between the United States, countries of the European Economic Area and Japan. First, tax regimes have an impact on the direction of mergers: Most countries either supply foreign tax credits or they exempt foreign income from taxation. Furthermore, capital income tax rates vary across countries. In mergers, these differences determine which firm becomes the bidder and which firm becomes the target as the involved firms minimize the additional tax burden. Second, the difference in tax regimes influences the relative share of mergers between countries: Acquiring firms from countries with exemption systems are over-represented when the target firm is located in a low tax country. Furthermore, mergers between countries with large differences in tax rates occur more frequently than predicted by standard gravity models, due to profit shifting incentives. These results imply that international discrepancies in foreign income taxation distort flows of foreign direct investment. Furthermore, countries may compete for tax base and corporate headquarters through their design of foreign income taxation. |
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Corporate tax elasticities: a reader’s guide to empirical findings
Ruud A. de Mooij, with Sjef Ederveen
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Optimal Climate Change Policies When Governments Cannot Commit
David Ulph, with Alistair Ulph
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3. Financing patterns, and legal and organisational form
Research projects in the area of financing patterns and legal and organisational form include analysis of: the extent of profit shifting between countries by multinational companies, the role of dividend taxes on share prices, the impact of taxation on the use of alternative forms of finance, the use of VAT in financial services.
Individual projects
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The effects of dividend taxation on equity prices
Stephen Bond, Michael Devereux, with Alex Klemm
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Opting for opting in? An evaluation of the Commission’s proposals for reforming VAT for financial services
Rita de la Feria, Ben Lockwood
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Options for taxing financial supplies in Value Added Tax: EU VAT and Australian GST models compared
Rita de la Feria, Michael Walpole
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When do dealings in shares fall within the scope of VAT?
Rita de la Feria
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Transfer-pricing and measured productivity of multinational firms
Giorgia Maffini, Socrates Mokkas
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Assessing indirect evidence of profit shifting
Socrates Mokkas
This paper looks into indirect evidence of profit shifting. The models presented by the literature show the effects of corporate tax rates on profits levels. This paper is different in that it models the effects of taxes on profit rates. If profit shifting is important, then post-tax profitability will be unambiguously negatively associated with the host country tax rate. The model’s prediction for pre-tax profitability is ambiguous, but if profit shifting is not too costly it should be negatively associated with the tax rate as well. The paper uses a sample of multinational subsidiaries resident in 18 countries and shows that profit shifting is significant and important. |
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Corporate Taxes and the Location of Intangible Assets within Multinational Firms
Nadine Riedel, with Matthias Dischinger
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Strategic Consolidation under Formula Apportionment
Nadine Riedel, with Thiess Buettner and Marco Runkel
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The Profitability Gap between Headquarters and Subsidiaries: Evidence and Implications
Nadine Riedel, with Matthias Dischinger
Using a large panel of European firms, this paper provides evidence that operations at multinational headquarters are significantly more profitable than operations at their foreign subsidiaries. The effect turns out to be robust and quantitatively large. We explain it to reflect agency and information costs faced by the central management at the parent firm if value—driving assets and functions are managed by a geographically distant subsidiary. In line with falling communication and travel costs over the last decade, the profitability gap is shown to decline over time. The results have various economic implications. They e.g. rationalize merger and acquisition policies that aim at creating national champions. |
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Corporate Taxation and the Choice of Patent Location in Multinational Firms
Nadine Riedel, Tom Karkinsky
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Corporate Taxation and Multinational Profit Shifting: A New Empirical Approach
Nadine Riedel, with Dhammika Dharmapala
A rising number of empirical studies investigate whether multinational firms shift paper profits from high-tax to low-tax affiliates. The identification strategies commonly rely on establishing a causal effect of corporate tax rate changes on affiliate profitability. Although the derived results are in line with profit shifting behavior, it is not possible to discriminate the shifting hypothesis against other potential explanations. The aim of this paper is to propose an alternative approach to test for multinational profit shifting. We identify shifting activities through earnings shocks at the headquarters firm and their propagation across multinational subsidiaries. Our results provide evidence in favor of shifting behavior as affiliates in high-tax countries are shown to be unaffected by earnings shocks at the parent level while the profitability of affiliates in low-tax countries positively depends on headquarters earnings. |
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Vodafone Essar dispute
Geoffrey Loomer
Forthcoming, National Law School of India
Abstract to follow |