Location, investment and regional policy: the contribution of the average effective tax rate theory

For decades, most industrialised countries have implemented some forms of fiscal and financial incentives to stimulate fixed capital formation. Tax cuts and capital grants are of great use in regional policy. Since these instruments mobilise huge amounts of public resources the issue of their efficiency is of particular interest for policymakers. The impact of taxation on investment income was traditionally apprehended through models measuring the effective tax rate on marginal investments. However recent literature, especially Devereux and Griffith (2002), showed the interest of resorting to an alternative tax measure – the effective average tax rate (EATR) - when firms face discrete investment choices that are expected to generate positive economic rent before tax. This effective average tax rate is defined by the difference between the net present value of the rent of the investment before and after taxes scaled by the net present value of the pre-tax income stream. In this sense, the effective average tax rate developed by Devereux and Griffith (2002) seems to be particularly relevant to shed a new light on the relative effectiveness of tax cuts and capital subsidy grants. In this paper we intend to compare the costs for public authorities to lower the corporate tax rate or to grant a capital subsidy. These public costs are directly affected by the variation of the after-tax revenue earned by the shareholder. The extent to which each policy must be implemented depends on the channel chosen by the government to stimulate investment. We pay attention to two of these channels: a reduction of the capital cost and a lowering of the EATR. Finally, in order to illustrate the relevance of our approach, we developed a numerical example for the Belgian case. JEL Classification: H25, H32 and R58

Location, investment and regional policy: the contribution of the average effective tax rate theory

For decades, most industrialised countries have implemented some forms of fiscal and financial incentives to stimulate fixed capital formation. Tax cuts and capital grants are of great use in regional policy. Since these instruments mobilise huge amounts of public resources the issue of their efficiency is of particular interest for policymakers. The impact of taxation on investment income was traditionally apprehended through models measuring the effective tax rate on marginal investments. However recent literature, especially Devereux and Griffith (2002), showed the interest of resorting to an alternative tax measure – the effective average tax rate (EATR) - when firms face discrete investment choices that are expected to generate positive economic rent before tax. This effective average tax rate is defined by the difference between the net present value of the rent of the investment before and after taxes scaled by the net present value of the pre-tax income stream. In this sense, the effective average tax rate developed by Devereux and Griffith (2002) seems to be particularly relevant to shed a new light on the relative effectiveness of tax cuts and capital subsidy grants. In this paper we intend to compare the costs for public authorities to lower the corporate tax rate or to grant a capital subsidy. These public costs are directly affected by the variation of the after-tax revenue earned by the shareholder. The extent to which each policy must be implemented depends on the channel chosen by the government to stimulate investment. We pay attention to two of these channels: a reduction of the capital cost and a lowering of the EATR. Finally, in order to illustrate the relevance of our approach, we developed a numerical example for the Belgian case. JEL Classification: H25, H32 and R5

Regional policy between efficacy and cohesion

The European experience of convergence reveals that the catching up of some peripheral countries takes place by an increase of their regional disparities. In a way there is a tension between growth and social cohesion. That is particularly worrying for the socio-economic balance of the European Union when one expects that the enlargement to the Central and Eastern European countries will introduce more heterogeneity in space. Is public intervention able to reduce this tension and to seek at once more efficacy and more cohesion, i.e. equity? The aim of this article is to model public intervention in its two dimensions. The first is a search for efficacy through expected increased returns, i.e. productivity gains resulting from agglomeration forces. The second is a search for some collective gains that arise from a preservation of social cohesion by limiting disparities. Tax rates, fiscal incentives and capital grants are not the only public determinants of firm's location choice. Public expenditures and economic infrastructures also play an important role on location behaviours. Regions compete by offering fiscal incentives and by supplying public goods in order to attract mobile capital. Our approach rests on several recent contributions. Models of effective taxation, in particular the seminal work of King and Fullerton (1984), have proved to be an appropriate framework to assess the impact of fiscal and financial incentives on firm's investment decisions. In addition, two inspiring studies provide us with an elegant way to take into account both agglomeration economies, which stimulate collective efficacy [Garcia-Milà and McGuire (2002)] and the reduction of interregional disparities [Garcia-Milà and McGuire (2004)]. The key factor in this analysis is the solidarity level between regions. The approach could make the trade-off between efficiency and equity more explicit. These theoretical and methodological contributions are then subject of an application to the Belgian economy and its regions, at the heart of the European issues