1. Taxes on corporations

2. Introduction
Corporations owned by shareholders → ownership transferable by selling shares
Investors are responsible up to the amount invested
Revenues from these taxes is likely inferior to the EB they generate
In the U.S. Tax o corporations generated 14% of all tax revenues in 2009
Several aspects of corporate taxes are examined
Justifications
Structure of tax
Incidence and EB
Effects on behaviour
Taxation of multinational corporations
European experiences
Proposal for reforms

3. Why taxing corporations?
Legal justification: corporation is a legal entity, just like individual → must pay taxes
No economic meaning → only individual pay taxes
Why not taxing only the income of shareholders?
Separation between ownership and control (Jensen and Meckling, 1976)
Corporation is a separate entity, imperfect control by owners → it does not mean that it must be taxed
Limited responsibility is a benefit for owners → corporate taxes are a user fee that owners pay for this benefit
Taxes are not correlated to limits to responsibility
Y invested in corporation not taxed as personal Y
Corporation tax is a way to make individual pay for this tax shelter
There are more efficient ways to deal with this problem

4. Structure of the tax Mainly referred to U.S. corporate income tax
large majority of corporations in the world are American
U.S. system has inspired other legal systems (e.g. via OECD fiscal templates)
In the U.S. corporate income is taxed at 35% for income < 10 million (15% rate when tax base is less → rare)
Statutory tax gives little information about effective burden → many deductions

5. Taxing corporate incomes
Often corporate income taxation distinguishes between legal types of firms/corporations
Individual firms and noncorporate societies taxed via personal income tax
Corporations taxed via corporation income tax
System typical of most European countries (e.g. Italy)
Corporate income=revenues-costs-depreciations(and provisions)- passive interests

6. Tax base of a typical corporation tax
Liabilities
Revenues from sales
Changes in provisions
Increases in value of corporation wealth
Increases in values (e.g., changes in costs/cost structures)
Dividends from owned shares or passive interest on capital lent
Deductions
Operating and actual costs
Losses
Decreases in values
Passive interests paid on borrowed capital
Depreciations

7. Deductions
Employee compensations are deduced → principle that for tax purposes, income should be measured net of expenses incurred in earning it
Interest payments on borrowed capital → same principle
But: when corporations finance themselves by issuing stocks → dividends paid to stockholders NOT deductible (in the U.S.) → asymmetry
Depreciations of assets
Economic depreciation → certain inputs of production (e.g. computers, vans) wear out/become obsolete over time → a cost to the firm
Difficult to evaluate effective depreciation →tax code assigns a tax life to each type of asset → often a (quite imprecise) estimate of actual depreciation

8. Calculating value of depreciation allowances - 1

9. Calculating value of depreciation allowances - 2

10. Integration between personal taxation and corporate taxation
Important not only understanding corporation tax liability, but the total tax rate of income generated in the corporate sector → integration of the personal and corporate income taxation
Corporate earnings can be either retained or paid to stockholders as dividends → tax treatment of dividends at the core of integration between personal and corporate income taxation
3 possible ways for integration
Classic system
Full integration (partnership criterion)
Dividend relief

11. Classic system Tax burden rises with amount of distributed profits
All corporate earnings taxed through corporation tax
Personal Y tax only on distributed profits (dividends)
Non neutral system
Tax burden rises with amount of distributed profits
Double taxation of dividends
Why do firms distribute profits?
Signal solidity of the firm
Nobody really knows
USA still adopt classic system

12. Partnership criterion (aka full integration)
Corporation earnings (distributed or not) are - partly or fully - included in the tax base of the shareholder’s personal Y tax
Taxed with tax rates of personal Y tax
If corporation earnings are fully included in personal Y tax base → Corporation tax is de facto eliminated
Neutral
Administrative problems (e.g. how to tax corporation earnings of an individual who held the shares for less than 1 year?) → not unsurmountable
Advantages are the elimination of the huge EB involved in corporate taxation

13. Dividend relief
Source of problems of integration is double taxation of dividends
Double taxation can be eliminated in 2 alternative ways
Allow corporation to deduct dividends paid to stockholders just as it deducts interest payments to bondholders
Exclude dividends from taxation at the individual level
Less neutral than full integration but lower administrative costs
Corporation tax would still exist

14. International effective tax rates on corporate capital income
Djankov et al. (2008) estimate the effective MARTAX on corporate capital income in different countries
Such comparisons require assumptions about the choice of discount rate, expected rate of inflation etc.
Djankov et al. (2008) maintain that their estimates are robust
The effective burden of corporation taxes depends crucially on how investments are financed
Borrowing
Issuing stocks
Internal funds
More generally, the EB of corporate income tax depends on what type of tax it is

15. International comparisons (Djankov et al. 2008)
COUNTRY
Statutory rate
Effective rate
1 year
5 year
AUSTRALIA
30.0
21.96
23;03
CANADA
36.12
21.78
25.93
CHINA
33.00
15.75
CROATIA
20.06
6.04
11.90
France
35.43
14.06
14.42
HONG KONG
17.5
0.00
12.25
INDIA
36.59
20.28
24.29
INDONESIA
30.00
20.84
21.01
ITALY
37.25
23.82
JAPAN
42.05
28.66
31.64
SINGAPORE
20.00
10.25
13.17
SLOVENIA
25.00
14.38
15.76 UK
18.61
21.44
USA
35.20
18.19
31.99
VIETNAM
28.00
18.37
18.79

16. A tax on corporate capital?
Corporation not allowed to deduct the opportunity cost of dividends paid to shareholders
BUT: opportunity cost of K is included in tax base → corporation tax = tax on K used in corporate sector
2 main effects
→ Migration of capital from corporate sector until after tax rates of return are equalized throughout the economy
→ Partial tax shifting from capital return to labour return, depending on K intensity of production
By reducing K accumulation in the corporate sector → tax distorts K from most effective use → EB
Jorgenson and Yun (2001) estimate that EB of corporate taxation is high (about 24% of revenues collected, without tax interaction effects)

17. A tax on profits?
The tax on corporate income can be equivalent to a tax on profits because costs of production are deducted from gross corporate income → what remains are ‘profits’
As such, no EB → tax does not affect decisions on prices and production → no behavioural adjustments for the firm → no tax shifting
Wrong → economic profits require that opportunity costs of all inputs (including those supplied by owners) be included → tax on corporation does not allow deduction of K supplied by shareholders
Stiglitz (1973) shows that under perfect certainty about future net rates of return and costs of financing → corporation tax = profit tax
Heroic hypotheses

18. Effects of taxes on individual choices
Corporation tax may affect 3 margins (firm behaviour and decisions)
Size of investment in K
Type of K to purchase
Ways to finance investments
Most of these decisions are taken simultaneously by the firm

19. Size of the investment - 1
Do features of corporate income taxation (accelerated depreciation, I tax credit) stimulate I demand?
It depends on how corporations make I decisions
3 models
Accelerator model
Neoclassical model
Cash flow model
Accelerator model→ K is a fixed % of Y, depending on the fixed technology (Leontiev)
If Y grows, K grows, I do not dependent on P (only on output size), t (tax rate) is irrelevant

20. Size of the investment - 2

21. Size of the investment - 3
The idea is that a firm invests in a given K (e.g. a machinery) only if the before tax rate of return of the machinery exceeds C
Example: if r=10%, δ=2%, t=35% and τ=15% → C=21,7%
Jorgenson (1982) shows that I are very sensitive to C and taxes can affect C, as the formula indicates
Engen and Skinner (1996) estimate that the elasticity of I to C is between 0.25 and 1

22. Size of the investment - 4
Cash flow model → I depend on firm’s capacity to self finance them
There is no perfect K markets hypothesis, the firm must consider the borrowing costs
Cash flow model presupposes that costs of self financing are lower due to asymmetric information in the credit markets
If cash flow model is correct → lump sum tax on corporations would reduce I because reduces the cash flow, while this is not the case in the neoclassical model
Stein (2005) finds positive correlation between firms’ cash flow and I levels → identification problem: successful firms might have both high cash flow and I

23. Financial choices and taxation
Taxes affect 2 margins of firm financial choices
Dividend policy
Debt vs. equity finance

24. Dividend policy
Firm’s profits can be either
Distributed to shareholders
Retained by the company to finance future I
Without uncertainty about future I returns, without taxes and provided perfect K markets, the two ways are equivalent for stockholders
Either they have 1$ paid in dividends or the value of their stock increases by 1$
Since dividends are taxed immediately and K gains are not taxed until they are realized → distributing dividends should not be preferred
Instead, in the U.S. 60% of realized dividends are distributed. Why?
Signalling effect → firm wants to signal solidity since K markets are imperfect
Clientele effect → untaxed institutions (e.g. pension funds) face a tax rate =0 → certain firms attract these investors by paying high dividends
Chetty and Saez (2004) find that after the 2003 reduction of the top tax rate on dividends in the U.S. from 35% to 15%, dividends surged by 20% as well as the number of corporations that paid them (also to taxed individuals)
Estimated elasticity is -0.5

25. Debt vs. equity finance - 1
Firms have two ways of financing themselves
Debt → firm pays interests on borrowed capital then gives the capital back
Selling shares → pays dividends according to profits and shares
Tax system affects these financial choices because of
Definition of depreciation rates (already seen)
Tax treatment of passive interests and returns on risky capital assets

26. Debt vs. equity finance - 2
Modigliani-Miller theorem → barring taxes and uncertainty about returns on firms investments, the two ways are equivalent in a efficient markets world → the value of a firm is unaffected by how that firm is financed.
Tax treatment on debt and risky capital (shares) may alter this fundamental equivalence

27. Debt vs. equity finance - 3
With corporation tax (correlated to profits) firms prefer debt to shares
With debt financing and deduction of interest payments, no distortion
Net return for creditor = Gross return → neutrality
With own capital (selling shares) gross return is subject to taxation
Net return lower than market (gross, before tax) return
To guarantee equality (neutrality) firm must reach a higher gross return→ reduces investments
Gordon and Lee (2001) test the hypothesis that, if taxes affect debt- equity ratios → corporations with lower tax rates should use less debt (lower advantage of deducting interest from corporate taxable income)
Econometric evidence that this is the case

28. Taxation of multinational corporations
General rule: tax paid abroad cannot exceed tax paid under national tax law → tax paid abroad generates a tax credit
2 main complications
Subsidiary status: a foreign firm owned by a national one but incorporated abroad
Profits earned by a subsidiary are taxed only if repatriated to the parent company → incentives to create firms in ‘tax heavens’
Especially important now with internet companies, which do not need of large K and L investments
Income allocation: difficult to know what part of the total income of a multinational firm is produced in each country
Arm length principle → tax code treats domestic and foreign branches as separate enterprises selling goods to each other
Parent company distributes its income artificially to the various branches so to minimize total tax liability