The Impact of Taxation on the Location of Capital, Firms and Profit:

a survey of empirical evidence

Michael P. Devereux

University of Warwick

Plan of talk

• Introduction to ETPF Research Programme

• Setting the scene for Phase 1 research:– Previous economic research on the impact of

taxes on flows of capital, firms and profit

ETPF Aims and Objectives

1. Undertake high quality economics research on taxation and international business, with European researchers

2. Publicise research results

3. Stimulate research activity – especially empirical - in this area

ETPF: Initial 3 phases of research

1. Positive Economics How do real and financial international flows

respond to taxes?

2. Welfare Economics How does inward investment affect welfare of

domestic residents ? Do governments compete with each other?

3. Tax Design What would be the effects of alternative forms

of taxation?

Phase 1: Capital flows and investment

1. Taxes and the size of the foreign-owned capital stock: which tax rates matter?

– Michael Devereux, Ben Lockwood

2. The impact of non-profit taxes on foreign direct investment: evidence from German multinationals

– Thiess Buettner, Georg Wamser

Phase 1: Financial policy and the location of profits

3. Capital structure and international debt shifting in Europe

– Harry Huizinga, Luc Laeven, Gaetan Nicodeme

4. Profit shifting the EU: evidence from Germany

– Alfons Weichenrieder

Phase 1: Other Projects

5. A survey of existing evidence of the impact of taxes on flows of capital, firms and profits

– Michael Devereux, Giorgia Maffini

6. Corporate income taxes in the EU: an economic assessment of the role of the ECJ

– Stephen Bond, Malcolm Gammie, Socrates Mokkas

Phase 2: Corporation tax and labour

1. Do higher corporate taxes affect the demand for labour, and hence unemployment?

– Ruud De Mooij, University of Rotterdam

2. How far are corporation taxes passed on in lower wages?

– Michael Devereux and Giorgia Maffini, University of Warwick

Phase 2: Corporation tax revenue and tax competition

3. Is there evidence of competition over non-profit taxes paid by business?

– Michael Pfaffermayr, University of Innsbruck

4. Why have corporation tax revenues remained so high, when tax rates have fallen so far?

– Clemens Fuest, University of Köln

Tax Rates v Tax Revenues

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

aver

age

stat

utor

y ra

te

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

aver

age

corp

orat

ion

tax

as %

of G

DP

average statutory rate

average revenue as % of GDP

Phase 2: CCCTB Proposal

5. Can a common consolidated corporate tax base reduce variation in effective tax rates across EU?

– Michael Devereux, University of Warwick

Survey of previous Phase 1-type empirical work

• Very little research before 1990

• Most research uses US data– and sponsored by NBER or ITPF

Big issues for empirical research on effects of taxes on behaviour

1. What should be examined?– what is important for policy?

2. What level of data is available?– aggregate data; consolidated data on companies; data

on affiliates

3. What are the appropriate measures of taxation?– marginal or average; forward-looking or backward-

looking

What should be examined (1)?

1. Total Capital StockWhat capital flows are important?

• Foreign direct investment (FDI)?– Financial flows only; and include acquisitions

• Foreign portfolio investment (FPI)?

What should be examined (2)?

2. Multinationals

Do multinationals generate economic benefits?– higher productivity, higher wages, positive

effects on domestic firms?

If so, then their activities should be studied:– Where do they locate?– How much do they invest?– How much tax do they pay?

Data on capital flows,profit and finance

• Aggregate FDI• Bureau of Economic Analysis / US Treasury

– Data on foreign affiliates of US multinationals by country / industry

– tax return data (US Treasury);

• Consolidated financial accounts– Geographic segment of Compustat / Datastream

Microeconomic data

• Unconsolidated data on affiliates, with ownership – Individual-level BEA data (US)– Bundesbank (Germany)– Amadeus (Europe)

• Permits more detailed analysis of individual decisions

Which effective tax rate ?

1 LOCATION CHOICES – Firms choose option with highest post-tax profit

– tax measured by an effective AVERAGE tax rate

2 LEVEL OF INVESTMENT – Firms invest up to marginal project which breaks even

– tax measured by an effective MARGINAL tax rate

3. LOCATION OF PROFIT– Firms can reduce tax liabilities by locating profit in low

tax jurisdictions

– tax measured by STATUTORY tax rate (and possibly withholding taxes)

Measuring effective tax rates

Forward-looking• Based on hypothetical investment project• Can measure AVERAGE and MARGINAL• Only broad tax parameters typically used

Backward-looking• Based on data on tax payments and profit• Using firm level or aggregate data• Depend on past and current decisions

Non-profit taxes ?

Largely ignored in previous literature

• For good reasons? – if sales taxes passed on to consumers– if income taxes borne by labour– then they should not affect location and

investment decisions

• Measurement

EMTR EATR Average Tax Rate

Other

Time series and panel FDI

Slemrod (1990) Hartman (1984) Boskin, Gale (1987) Newlon (1987) Young (1888) Murthy (1989)

Jun (1994)Billington

(1999)

Bilateral FDI Devereux, Freeman (95)

Buettner (2002)Gorter, Parikh (2003)Bénassy Quéré et al

(2005)

Bénassy Quéré et al (2005)

Bellak, Leibrecht (2005)

Buettner (2002)Gorter, Parikh (2003)Bénassy Quéré et al

(2005)

Wei (2000)

Aggregate assets of US multinationals

Grubert, Mutti (1991)Hines, Rice (1994)Swenson (1994)Mutti, Grubert (2004)

Wheeler, Mody (1992)

Hines (1996)

Individual data on multinationals

Devereux, Griffith (98)

Kemsley (1998)Stöwhase (2002)

Individual data on affiliates

Cummins, Hubbard (95)

Buettner, Ruf (2006)

Altshuler et al (2001)Grubert, Mutti (2000)Altshuler, Hubbard

(2003)

Desai et al (2004b)

Broad results on location of capital

• Taxes do have some effect– But estimates vary considerably; cannot

summarise all results into a single elasticity

• For future research:– Need to distinguish more carefully impact of

different elements of tax on different types of decision

– Need to compare across countries

Today’s papers

Examine:

1. Impact of corporation tax on aggregate investment in host countries by US multinationals

• Differentiate impact of effective average tax rate (for location choice) and effective marginal tax rate (for investment)

2. Role of non-profit taxes on location and investment decisions of German multinationals

Data: Aggregate value-added

Aggregate data on affiliates

Firm-level Affiliate level

Profitability Bartelsman, Beetsma (2003)

Jenkins, Wright (1975)

Grubert, Mutti (1991)Hines, Rice (1994)

Klassen et al (1993)Harris (1993)Harris et al (1993)Collins et al (1998)Demirgüc-Kunt,

Huizinga (2001)

Grubert et al (1993)Huizinga, Laeven (2005)

Repatriation policy

Kopits (1972) Kopits (1976) Mutti (1981)Hines, Hubbard (1990)Altshuler, Newlon (1993)Altshuler et al (1995)Altshuler, Mintz (1995)Grubert (1998)Desai et al (2001)Altshuler, Grubert (2004)Desai et al (2006b)

Debt Collins, Shackelford (1992)

Froot, Hines (1995)Altshuler, Mintz

(1995)

Desai et al (2004a)

Other Desai, Hines (1999) Stöwhase (2002) Grubert, Slemrod (1998)Desai et al (2006a)Clausing (2001)

Observed prices

Bernard and Weiner (1990)Swenson (2001b)Clausing (2003)

Broad results on financial policy and location of profit

• Again, taxes have some effect– On rate of profit and financial behaviour– But, again, estimates vary considerably

• For future research– Broadly, research has been more careful in

developing specific hypotheses and tests– But limited by available data: opportunity has

arisen to examine impact of tax in different settings, across countries

Today’s papers

Examine

1. whether rates of profit in German parents and subsidiaries are correlated with tax rates in other countries

2. the extent to which host country tax rates affect the use of debt in European affiliates of multinationals