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For the measurement of the tax burden on highly skilled manpower, we cannot return to a well-established methodology. Existing analyses focus on average production workers, such as OECD (2002), or do not consider the tax burden on employees as an issue for the firm, such as the Euromod project (Sutherland, 2001). Concerning highly skilled employees, this is unsatisfactory since these employees generally receive sophisticated compensation packages and are highly mobile.5 To account for the former, an approach has been developed which allows to consider several components of the remuneration package, the family status, and varying levels of compensation.6 This concept parallels established methodologies for the quantification of company tax burdens by calculating the effective average tax rate (EATR) as an indicator of the tax burden. Mobility implies that employers compete for highly qualified employees and therefore have to compensate them for taxes on labour income and tax-like social security contributions. As a consequence, we compare the tax burden of different regions for a given disposable income after taxes which the employee can obtain at all locations.
For regional and national policy makers, the results of our study can be interesting since taxation is deemed to be an important location factor. For company taxation, this has been well established empirically. Thus, Büttner and Ruf (2004) show that location decisions of German multinationals are strongly affected by differentials in statutory as well as effective average tax rates. This is in line with De Mooij and Ederveen (2003) who conclude from a survey of empirical research that aggregate flows of foreign direct investment are strongly affected by taxation. Although less well documented empirically, the tax burden on mobile employees is likely to be an important location factor for firms, too. Our study contributes to assess the attractiveness of different locations from a tax perspective by comparing effective tax burdens inter-regionally and internationally. In particular, the joint consideration on taxes on both capital and skilled labour allows evaluating the strengths and weaknesses of locations more comprehensively than would be possible by an isolated look at corporate tax rates.
An effective tax rate is always the result of each particular case. To identify the general context and to find out the most relevant tax provisions in different economic constellations - the so-called tax drivers - the study examines the effect of important tax provisions on effective tax burdens. Thus, an additional benefit of our research consists of improving the understanding of the link between specific legal provisions and the ensuing tax burden.
In the remainder of the paper, we first present the estimates on company taxation (Section 2) and on the taxation of highly skilled employees (Section 3) separately. In these sections, we give a brief account of the models we use and our major results. In Section 4, we combine these findings so as to allow for a general discussion of tax policy strategies pursued by the countries studied. Section 5 offers some concluding remarks.
2 Company Taxation
2.1 The Model The Devereux/Griffith model considers an incremental, hypothetical corporate investment.
The investment we assume consists of five different types of assets (intangibles, industrial Winkelmann (2002) and Winkelmann et al. (2001) provide evidence on the extent of international mobility of highly skilled employees.
A formal description is provided in Elschner and Schwager (2004).
buildings, machinery, financial assets, and inventories). We take three different sources of finance into account: retained earnings, new equity, and debt. The hypothetical investment takes place in the beginning of a period and generates a return in its end. Thus, we suppose a one-period perturbation of the capital stock. We measure the cash flows connected with this investment and compute various measures of effective tax rates. Fig. 1 describes the structure of the model.
Fig. 1: Structure of the model
Before the background of a neoclassical economic framework, the model considers several important economic parameters: the unique market interest rate, the rate of inflation, geometrically declining economic depreciation of intangibles, industrial buildings and machinery, and the pre-tax rate of return on the investment. In order to isolate the effects of taxation from other economic effects, these economic parameters are exogenous, except for the calculation of the pre-tax rate of return of a marginal investment. This means that their values are supposed to be equal for all investments regardless of their location. Consequently, real interest rates and also nominal interest rates are equal across all the locations and regardless of the level of profitability of an investment. In the base case, we assume a corporation in the manufacturing sector which undertakes a particular mix of investments and uses a particular combination of sources of finance. Table 1 presents the assumptions of the calculations.
The study focuses on the effective tax burden at the corporate level, which is especially relevant for the choice of location of international corporations.7 Therefore, we include taxes on corporate income and capital. The effective tax rates computed for each region comprise taxes levied at the national, the state and the municipal level. The calculations consider the statutory tax rates of these taxes as well as the interaction of different kinds of taxes and the most important rules determining the tax base, e.g. differences in depreciation allowances and inventory valuation.
We express the headline results by the EATR, which indicates the effective tax burden on a very profitable investment. It is defined as the difference between the pre-tax and the post tax rates of return of an investment, divided by the pre-tax rate of return. This measure also represents the IBC Taxation Index for companies.
The results indicate that there is considerable dispersion of the EATRs between the countries and regions considered (see Table 2). The EATRs range from 13.8% in the Swiss canton Zug to 37.3% as the maximum tax burden in Germany. Whereas Ireland and Switzerland display comparatively low effective tax burdens, locations in France, Germany, and the United States show the highest EATRs. This finding suggests that the attractiveness of particular locations from a tax perspective differs dramatically, with Switzerland and Ireland as especially attractive countries.
In 2003, the effective tax burden in the selected new member states of the EU is in comparison rather low. Only a few Swiss cantons and Ireland show lower tax burdens in terms of the EATR than found for Hungary, Slovenia, and Slovakia. Given amendments and alterations in the tax systems, we additionally calculate effective tax burdens of companies for the accession countries based on the tax rules effective in 2004. Except for the Czech Republic, these changes in the tax systems significantly decrease the effective tax burden in these five accession countries, further improving their attractiveness.
We express a second set of results by the EMTR. In contrast to EATRs, EMTRs indicate the effective tax burden on an investment that is marginal in economic sense, i.e. an investment that earns a net present value of zero. Such an investment limits the profitable investment opportunities of a company. The lower the EMTR at the corporate level, the larger is the theoretically optimal level of investment. Also, a firm that faces a lower EMTR on its investment is deemed to have a competitive advantage over its competitors who face greater EMTRs.
The dispersion of effective marginal tax rates between the assessed regions is even greater than the dispersion of effective average tax rates. It ranges from -11% in Slovenia in the case where some special investment incentives fully apply up to 36.2% in Isère, France (see Table 2). The negative EMTR in the Slovenian incentive case means that the cost of capital is below the real interest rate, implying that investment in fact is subsidised in Slovenia. These results suggest that the optimal level of investment and the competitiveness of companies located in The non-consideration of taxes at the shareholder level is adequate in case managers do not know the tax position of their marginal shareholder. However, domestic shareholder taxation does not affect corporate investment decisions of multinationals under substantial international capital mobility. For a discussion of these issues see European Commission (2002), p. 142 f., or Spengel (2003), pp. 81–85. The effective tax rates at the combined levels of the corporation and the shareholder are reported in Lammersen and Schwager (2004 and 2005).
different regions also differ dramatically from a tax perspective. There is also a strong impact of targeted measures like investment tax credits or dual income taxes. Therefore, Austrian or Slovenian companies that can take full advantage of such measures display very low EMTRs.
On the other side, there is a disadvantage for companies which have to pay substantial nonprofit taxes. Non-profit taxes weigh especially heavily on investments with a low rate of return. France, e. g., imposes a comparatively strong non-profit tax in form of the taxe professionnelle. Consequently, the attractiveness of France as expressed by the EMTR is even lower than the one expressed by the EATR.
Statutory profit tax rates are found to be very important tax drivers for profitable investments.
However, tax burdens always depend on the individual characteristics of each investment, thus special rules regarding the tax base or property taxes may be very relevant in particular cases. French corporations carry an extra tax burden in form of the taxe professionnelle, whereas Italian corporations take advantage of a comparatively favourable definition of the corporate tax base. Although the combined statutory profit tax rate in Italy (38.25%) is significantly higher than the one in France (35.43%), effective tax burdens are lower in Italy than in France.
Sensitivity analyses reveal some interesting mechanics of the impact of taxation on effective tax burdens. E.g., the impact of French non-profit taxes heavily depends on the relative importance of fixed assets in the investment mix. French regions significantly improve their position compared with German regions when corporations are considered which hardly rely on buildings and machinery, as it is the case e.g. in the service sector. However, although some notable changes in the rankings occur, these changes are not strong enough to fundamentally challenge the main conclusions from the base case. With respect to EMTRs, the impact of the economic assumptions on the ranking is stronger than with respect to EATRs. Particular tax rules, e.g. the generosity of depreciation allowances, play a more prominent role, and the particular features of each individual investment become more important in determining the most tax efficient location. The weight of the statutory profit tax rate compared with the weight of various tax drivers increases along an increasing pre-tax rate of return.
3 Taxation of Highly Skilled Manpower
3.1 The Model In our approach, we evaluate the tax burden on a highly skilled employee for a given disposable income after taxes. To achieve this, we perform two steps. At first, we conduct the tax assessment of a typical qualified employee’s income before taxes (the total remuneration). If the resulting income after taxes falls short of (exceeds) the required disposable income, in a second step we repeat the assessment for a higher (lower) total remuneration. We then iterate until the total remuneration necessary to obtain the predetermined disposable income is found.
The effective average tax rate then is equal to the difference between total remuneration and disposable income (the tax wedge) divided by the total remuneration.