Reinventing the Dutch tax-benefit system; exploring the frontier of the equity-efficiency trade-off

European governments aim to raise labour supply, cut unemployment and, at the same time, maintain social cohesion. Yet, economists have stressed the trade-off between these objectives. This paper reviews the key policy insights from optimal tax theory to identify options for reform in the tax-benefit system that can potentially improve the equity-efficiency trade-off. Using a comprehensive applied general equilibrium model, we then explore whether reforms along these lines in the actual Dutch tax-benefit system will raise employment without sacrificing equality. The analysis reveals that selective tax relief for elastic secondary earners and low-skilled workers have this potential. A flat income tax structure possibly combined with a negative income tax worsens the equity-efficiency trade-off.

Taxation and foreign direct investment; a synthesis of empirical research

This paper reviews the empirical literature on the impact of company taxes on the allocation of foreign direct investment. We make the outcomes of 25 empirical studies comparable by computing the tax rate elasticity under a uniform definition. Read also the accompanying press release .The mean value of the tax rate elasticity in the literature is around 3.3, i.e. a 1%-point reduction in the host-country tax rate raises foreign direct investment in that country by 3.3%. There exists substantial variation across studies, however. By performing a meta analysis, the paper aims to explain this variation by the differences in characteristics of the underlying studies. Systematic differences between studies are found with respect to the type of foreign capital data used, and the type of tax rates adopted. We find no systematic differences in the responsiveness of investors from tax credit countries and tax exemption countries.

Corporate tax policy and incorporation in the EU.

In Europe, declining corporate tax rates have come along with rising tax-to-GDP ratios. This paper explores to what extent income shifting from the personal to the corporate tax base can explain these diverging developments. We exploit a panel of European data on legal form of business to analyze income shifting via incorporation. The results suggest that the effect is significant and large. It implies that the revenue effects of lower corporate tax rates possibly induced by tax competition - will partly show up in lower personal tax revenues rather than lower corporate tax revenues. Simulations suggest that between 12% and 21% of corporate tax revenue can be attributed to income shifting. Income shifting is found to have raised the corporate tax-to-GDP ratio by some 0.25%-points since the early 1990s.European Union; Corporate tax; Personal tax; Incorporation; Income shifting

Capital income taxation in Europe; trends and trade-offs

The EU capital market integrates. Portfolios become more international, cross border mergers are the order of the day, and never before has there been so much foreign direct investment. This links national tax systems. Residents pay foreign capital income tax, foreigners pay domestic capital income tax, and no member state can afford to overlook the danger of capital flight. What is the appropriate policy response? To do nothing? To coordinate tax systems at the European level? The data do not unequivocally support the tax-race-to-the-bottom hypothesis. On the one hand, member states decrease their statutory capital income tax rates. On the other, they broaden their capital income tax bases. Thus, fear for an economy-wide undertaxation of capital income -the main tenet of tax competition theory- is as yet ungrounded. Nevertheless, tax coordination may be beneficial. It resolves relative undertaxation of particular kinds of capital, forces convergence of capital income tax rates, and creates order in the costly European tax maze. Unfortunately, it simultaneously infringes upon the sovereignty of member states, and sidelines the disciplining force that tax competition exerts on government spending. This study assesses the most important proposals for capital income tax coordination against a background of the recent trends in capital income taxation and the trade offs between distinct policy objectives. It is a guide to the debate that is easy to read, yet firmly grounded in empirical evidence and economic theory.

Four futures of Europe

Europe is at a crossroads. The enlargement with ten new members forces the European Union to reform its decision making process and to reconsider its policies. At the same time, developments such as ageing force EU member states to reform their welfare states. Read also the accompanying press release .Where will this bring the European Union and its members states ten or twenty years from now? And how should policy makers deal with this uncertainty when deciding about policies with long-lasting consequences? This study develops four scenarios on the future of Europe. They serve as tools for analysing these questions. Moreover, the study elaborates on the policy agenda of international organisations and European governments in response to the various challenges during the next two decades.

An applied analysis of ACE and CBIT reform in the EU

We assess the quantitative impact of two reforms of the corporation tax that would eliminate the differential treatment of debt and equity. The two reforms are: the allowance for corporate equity (ACE), and the comprehensive business income tax (CBIT). We investigate the impact of these reforms on various decision margins, using an applied general equilibrium model for the EU calibrated with recent empirical elasticities. The results suggest that, if governments adjust statutory corporate tax rates to balance their budgets, profit shifting and discrete location render CBIT more attractive for most individual European countries. European coordination makes a joint ACE more, and a joint CBIT less, efficient. A combination of ACE and CBIT is always welfare improving.

Corporate tax policy and incorporation in the EU

In Europe, declining corporate tax rates have come along with rising tax-to-GDP ratios. This paper explores to what extent income shifting from the personal to the corporate tax base can explain these diverging developments. We exploit a panel of European data on legal form of business to analyze income shifting via incorporation. The results suggest that the effect is significant and large. It implies that the revenue effects of lower corporate tax rates ? possibly induced by tax competition ? will partly show up in lower personal tax revenues rather than lower corporate tax revenues. Simulations suggest that between 12% and 21% of corporate tax revenue can be attributed to income shifting. Income shifting is found to have raised the corporate tax-to-GDP ratio by some 0.25%-points since the early 1990s.

Enhanced Cooperation in an Asymmetric Model of Tax Competition

This paper analyzes enhanced cooperation agreements in corporate taxation in a three country tax competition model where countries differ in size. We characterize equilibrium tax rates and the optimal tax responses due to the formation of an enhanced cooperation agreement. Conditions for strategic complementarity or strategic substitutability of tax rates are crucial for the welfare effects of enhanced cooperation. Simulations show that enhanced cooperation is unlikely to be feasible for small countries. When enhanced cooperation is feasible, it may hamper global harmonization. Only when countries are of similar size is global harmonization a feasible outcome.tax coordination, asymmetry, enhanced cooperation agreements, strategic tax response

Alternative Systems of Business Tax in Europe: An applied analysis of ACE and CBIT Reforms

This paper explores the economic implications of an allowance for corporate equity (ACE), a comprehensive business income tax (CBIT) and a combination of the two in the EU. We illustrate the key trade-offs in designing ACE and CBIT in the presence of tax distortions at various decision margins of firms, such as its financial structure, investment, profit allocation and discrete location. Using an applied general equilibrium model for Europe, we quantitatively assess the effects of ACE, CBIT and combined reforms in EU countries. The results suggest that ACE is welfare improving as long as corporate tax rates are not used to cover the cost of base narrowing. CBIT typically reduces welfare by exacerbating marginal investment distortions. When governments adjust statutory corporate tax rates to balance their budget, however, CBIT reforms become more attractive while ACE reforms are welfare reducing in a number of countries. European coordination of reforms mitigates fiscal spillovers within the EU and renders ACE reforms more, and CBIT reforms less, attractive for welfare. A combination of ACE and CBIT reforms can be designed to be revenue neutral and welfare improving through smaller financial distortions.European Union, corporate taxation

Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian Tax

This paper extends the Mirrlees (1971) model of optimal income redistribution with optimal corrective taxes to internalize consumption externalities. It is demonstrated that the optimal second-best tax on an externality-generating good should not be corrected for the marginal cost of public funds. The reason is that the marginal cost of public funds equals unity in the optimal tax system, since marginal distortions of taxation are equal to marginal distributional gains. The Pigouvian tax needs to be modified, however, if polluting commodities or environmental quality are more complementary to leisure than non-polluting commodities are.marginal cost of public funds, optimal environmental taxation, optimal redistribution, externalities