Differential Taxation and Firms' Financial Leverage: Evidence from the Introduction of a Flat Tax on Interest Income

Tax competition for the mobile factor capital has led to a trend in many countries to levy lower taxes on interest income, often introducing differential taxation between interest and business income. In this study, we analyze the effect of such differential taxation on the debt ratio of firms. We exploit a 2009 tax reform in Germany as a quasi-experiment, which introduced a flat final withholding tax and opened a gap of 18 percentage points between the tax rate on income from unincorporated businesses and the new lower tax rate on interest income. We apply a regression adjusted semi-parametric difference-in-difference matching strategy based on firm level panel data. In addition, we implement a more structural approach with a tax rate differential, taking into account its endogeneity by using instrumental variables. The results indicate that firms increase their leverage when the tax rate on interest income decreases, albeit to a small degree.Income taxation, capital taxation, financial structure, leverage, matching

Do multinational firms invest more? On the impact of internal debt financing and transfer pricing on capital accumulation.

This study analyses whether multinational companies (MNCs) that are able to reduce their tax burden on capital by shifting profits to low tax jurisdictions invest more than domestic firms. To study the relationship, I exploit a massive corporate tax rate cut of 10%-points in Germany 2008 as a quasi-natural experiment. This reform reduced substantially the incentive of MNC to engage in profit shifting. Using a difference in differences matching strategy (DiD), the results suggest that MNCs decreased their fraction of internal borrowing and their capital stock compared to purely domestic firms. Taking the evidence together, the findings suggest that if MNCs shift profits abroad, their capital accumulation is less depressed by the national tax rate and, therefore, benefits less from a tax rate reduction. The DiD results are confirmed by a more structural approach, which exploits variation in the tax incentive to shift profits to the headquarters for identification. Further, the results suggest that only internal debt financing but not transfer pricing fosters capital accumulation

Differential taxation and firms’ financial leverage - Evidence from the introduction of a flat tax on interest income

Tax competition for the mobile factor capital has led to a trend in many countries to levy lower taxes on interest income, often introducing differential taxation between interest and business income. In this study, we analyze the effect of such differential taxation on the debt ratio of firms. We exploit a 2009 tax reform in Germany as a quasi-experiment, which introduced a flat final withholding tax and opened a gap of 18 percentage points between the tax rate on income from unincorporated businesses and the new lower tax rate on interest income. We apply a regression adjusted semi- parametric difference-in-difference matching strategy based on firm level panel data. In addition, we implement a more structural approach with a tax rate differential, taking into account its endogeneity by using instrumental variables. The results indicate that firms increase their leverage when the tax rate on interest income decreases, albeit to a small degree

How cost-effective is public R&D in stimulating firm innovation?

This paper assesses the impact of public R&D on firm R&D using patent application data on the county and firm level in Germany. We address the endogeneity of public R&D by employing an instrumental variable estimator that uses lagged institutional funding for research institutes and universities as excluded instruments. We find that one additional public patent application generates 3.5 firm patent applications in the median county, but also that the relationship turns negative for high levels of public R&D. We estimate the public costs per firm patent to be between 0.8 and 1.5 million EURO

Gemeindefinanzreform gescheitert: warum sich die Kommunen querlegen

Die jüngsten Bemühungen zur Reform der Gemeindefinanzierung sind gescheitert. Die von der Bundesregierung vorgeschlagene kommunale Zuschlagsteuer auf Einkommen- und Körperschaftsteuer wird von den Kommunen abgelehnt. Die Gewerbesteuer bleibt erhalten. Ein Blick auf die kommunale Einnahmeseite verrät die Gründe. Im geltenden Recht sorgt nur der Einkommensteueranteil der Gemeinden für eine gleichmäßige Verteilung der kommunalen Steuereinnahmen. Mit der Einführung einer kommunalen Zuschlagsteuer auf die örtlich festgesetzte Einkommensteuer würde die bestehende Ungleichverteilung weiter verstärkt. Das gilt auch für die von der Bundesregierung vorgeschlagene Erhöhung des Umsatzsteueranteils der Gemeinden. Wesentliche Mängel des bestehenden Systems - ungleichmäßige Verteilung und Volatilität der Gewerbesteuereinnahmen - würden durch den Reformvorschlag der Bundesregierung wohl nicht wesentlich entschärft werden. Es gibt aber Möglichkeiten, die Eigenverantwortlichkeit der Gemeinden (fiskalische Äquivalenz) und eine angemessene kommunale Finanzausstattung gleichermaßen zu stärken. Vorgeschlagen wird eine aufkommensneutrale kommunale Umsatzsteuerzuweisung pro Einwohner, die die erhöhte Ungleichverteilung bei einer Zuschlagsteuer ausgleicht, stabile Einnahmen generiert und die richtigen wirtschaftlichen Anreize setzt.Gemeindefinanzreform, Zuschlagsteuer, Fiskalföderalismus

Large and influential: firm size and governments' corporate tax rate choice?

Theory suggests that large firms are more likely to engage in lobbying behaviour and have better bargaining positions against their host governments than smaller entities. Conditional on jurisdiction size, public policy choices are thus predicted to depend on the shape of a jurisdiction's firm size distribution, with more business-friendly policies being enacted if economic activity is concentrated in a small number of entities. We empirically assess this prediction studying local business tax choices of German municipalities. Exploiting rich and quasi-experimental variation in localities' firm size structures, we find evidence for an inverse relationship between the concentration of economic activity and communities' business tax choices. The effect is statistically significant and quantitatively relevant, suggesting that the rising importance of large businesses may trigger shifts towards a more business-friendly design of (tax) policies

Public Good Provision, Commuting and Local Employment

This paper assesses the differential impact of the local availability of grammar schools on local employment depending on the openness of a jurisdiction, measured by commuting costs. Commuting costs matter as they influence workers' reservation wage. While the reservation wage depends on public good provision in jurisdictions with high commuting costs, it does not so in jurisdictions with low commuting costs as workers' outside option is to commute and not to move away. We test these predictions using local grammar school closures in East Germany after 2000. In line with the predictions we find that school closures reduced employment only in jurisdictions with high commuting costs. Reassuringly, house prices responded, however, similar in both types of jurisdictions which rules out that differences in preferences are driving our results

Local fiscal policies and their impact on the number and spatial distribution of new firms

We examine the effect of local business taxation and local public good and service (PIGS) provision on the number and spatial distribution of new firms. The analysis draws on panel data for the universe of firm foundations in German municipalities, matched to municipalities' local business tax rates and the level and structure of their local PIGS provision. Methodologically, we estimate fixed effects poisson models coupled with a control function approach. The results suggest that local business taxation (PIGS provision) has a strong negative (positive) impact on the number of new firms in the policy-changing jurisdiction. Local business taxes are, moreover, found to exert beggar-thy-neighbor externalities on neigboring jurisdictions: tax reductions strongly lower the number of neighbors' firm foundations, implying that the aggregate number of new firms remains unchanged; while PIGS provision, on average, exerts no significant impact on the number of firms in adjacent jurisdictions, negative effects emerge for subsets of PIGS and firms

Evidence from individual firm-bank relationships in Germany

What began as a financial crisis in the United States in 2007–2008 quickly evolved into a massive crisis of the global real economy. We investigate the importance of the bank lending and firm borrowing channel in the international transmission of bank distress to the real economy—in particular, to real investment and labor employment by nonfinancial firms. We analyze whether and to what extent firms are able to compensate for the shortage in loan supply by switching banks and by using other types of financing. The analysis is based on a unique matched data set for Germany that contains firm-level financial statements for the 2004–2010 period together with the financial statements of each firm’s relationship bank(s). We use instrumental variable estimations in first differences to eliminate firm- and bankspecific effects. The first stage results show that banks that suffered losses due to proprietary trading activities at the onset of the financial crisis reduced their lending more strongly than non-affected banks. In the second stage, we find that firms whose relationship banks reduce credit supply downsize their real investment and labor employment significantly. This effect is larger for firms that are unable to provide much collateral. We document that firms partially offset reduced credit supply by establishing new bank relationships, using internal funds, and issuing new equity

Tax and occupancy of business properties : theory and evidence from UK business rates

We study the impact of commercial property taxation on vacancy rates and rents in the UK, using a new data-set, and exploiting exogenous variations in property tax rates from reliefs in the UK system: small business rate relief (SBRR), retail relief and empty property relief. We estimate that the retail relief reduces vacancies by 85%, and SBRR relief by up to 49%, while empty property exemption increases them by up to 89%. The effect of retail relief on clusters of urban properties (the "High St") is no different to its overall effect. SBRR increases (decreases) the likelihood that a property is occupied by a small (large) business. We also use data on asking prices for rental properties to study the effect of reliefs on rental rates. Rental rates move in the opposite direction to vacancy rates, except in the case of empty property relief. All these findings are consistent with a novel model of directed search in the commercial property market, also presented in the paper