Modelling Behavioural Responses to Profit Taxation: The Case of the UK Corporation Tax

Abstract

This paper examines behavioural responses by companies to changes in profit taxation in their home country. It argues that as well as distinguishing real from shifting responses for profits, it is important to separate the responses of gross profits from those for deductions (such as claims for past or current losses) where these are endogenously related to gross profits declared at home. This occurs in the UK and many other corporate tax regimes. This endogenous response can be expected to differ over the business cycle and, using a microsimulation model of the UK corporate tax regime, it is shown that this can be important for empirical estimates of firms’ overall behavioural responses especially, but not exclusively, during cyclical downturns. It is shown also that endogenous responses of deductions to real or shifting responses for gross profits can be expected to be asymmetrical between periods of above- and below-trend growth.