Download Corporate Taxation, Business Investment and Economic Growth

Corporate Taxation, Business
Investment and Economic Growth
Steve Bond
(University of Oxford)
21 October 2014
Questions
• Do corporate taxes raise the cost of capital?
• Does a higher cost of capital reduce investment?
• Does lower investment reduce GDP per capita?
Answers
• Do corporate taxes raise the cost of capital?
– Yes …, though by less than they used to
• Does a higher cost of capital reduce investment?
– Yes …, we will look briefly at some evidence
• Does lower investment reduce GDP per capita?
– Yes …, less capital per worker reduces output per
worker, and hence income per capita
Some preliminaries
• Investment (I) is a flow measure of
expenditure on additions to the stock of
tangible fixed capital assets (plant, machinery,
equipment, buildings) that contribute to
production
• Capital (K) is a stock measure of the value of
tangible fixed capital assets that are now
contributing to production, reflecting past
investments as well as current investment
Some preliminaries
• The capital stock can be thought of as a
weighted sum of current and past investments
– with lower weights for more distant investments,
reflecting wear and tear, obsolescence, scrapping
• Alternatively we can think of:
Capital at end of this period =
Capital at end of previous period
less Depreciation during this period
plus Investment during this period
Some preliminaries
• In shorthand:
𝐾 𝑡 = 𝐾 𝑡 − 1 − 𝐷𝑒𝑝 𝑡 + 𝐼(𝑡)
• The capital stock remains constant when
investment during period t just offsets
depreciation during period t
• The capital stock grows when (gross)
investment exceeds this replacement level
Some preliminaries
• A common assumption is that depreciation
during period t is proportional to the capital
stock at the start of the period:
𝐷𝑒𝑝 𝑡 = 𝛿𝐾 𝑡 − 1
where δ is the rate of depreciation
• In this case we have:
𝐾 𝑡 = 𝐾 𝑡 − 1 − 𝛿𝐾 𝑡 − 1 + 𝐼 𝑡
• Or:
𝐾 𝑡 − 𝐾 𝑡 − 1 = 𝐼 𝑡 − 𝛿𝐾(𝑡 − 1)
Some preliminaries
𝐾 𝑡 − 𝐾 𝑡 − 1 = 𝐼 𝑡 − 𝛿𝐾(𝑡 − 1)
• Dividing both sides by K(t-1):
𝐾 𝑡 −𝐾 𝑡−1
𝐼 𝑡
=
−𝛿
𝐾(𝑡 − 1)
𝐾(𝑡 − 1)
• The rate of investment (I(t)/K(t-1)) is the
growth rate of the capital stock plus the rate
of depreciation
Some preliminaries
• Note that data on investment spending is
much more reliable that data on capital stocks
– since no-one really knows true rates of
depreciation, or equivalently how much weight to
give to past investments relative to current
investment
• Capital stock data is so poor that many studies
making cross-country comparisons avoid using
capital stock data at all
Some preliminaries
𝐼(𝑡)
𝐼(𝑡)
𝐾(𝑡 − 1)
=
×
𝑌(𝑡) 𝐾(𝑡 − 1)
𝑌(𝑡)
• Investment as a share of GDP (I(t)/Y(t)) reflects
both the rate of investment (I(t)/K(t-1)) and
the capital-output ratio (K(t-1)/Y(t))
• If variation across countries in rates of
investment (or capital stock growth rates) is
not too great, investment as a share of GDP
serves as a proxy for capital-output ratios
Some preliminaries
• Levels Vs. Growth Rates
• A policy reform which permanently raises the
level of GDP per capita will raise the growth
rate of GDP per capita temporarily
– during the transition from the old level to the new,
higher level
• But will not raise the growth rate permanently
• Still the average resident enjoys a permanently
higher standard of living
Log of GDP
per capita
Transition
period
New path
Old path
Time
Growth rate of GDP per capita ( = slope of line) is
higher only temporarily, during the transition from
the old path to the new path
Some preliminaries
• If a policy reform permanently raises the
capital-output ratio, but not the long-run
growth rates of capital or output
• Investment as a share of GDP will be higher in
the long run, in line with the permanent rise
in the capital-output ratio (𝐼 𝑌 = 𝐼 𝐾 × 𝐾 𝑌)
• Investment as a share of GDP will be higher
than this during the transition period, when
the growth rate of the capital stock (≈ 𝐼 𝐾) is
temporarily higher
Thesis
• Reforms to corporate income taxes which
permanently lower the cost of capital
• Would permanently raise capital-output ratios
and levels of capital per worker
• And thereby permanently raise GDP per capita
and standards of living
• Growth rates of capital per worker and GDP per
capita would be higher during the transition
Corporate taxes and the cost of capital
• The (user) cost of capital is a summary measure
of the cost of owning capital assets, which
reflects both the cost of purchasing assets, and
the cost of holding assets
• Holding costs include both depreciation (falling
value of assets owned) and foregone interest
(return which could have been earned if funds
had been invested in a safe security)
Corporate taxes and the cost of capital
• Corporate income taxes generally raise the
cost of capital
• More generous allowances for depreciation
tend to mitigate this (e.g. bonus depreciation
provisions used in USA in 2001-04 and again
since 2008)
• For investment financed by borrowing,
deductibility of interest payments also
mitigates impact on cost of capital
– favouring debt finance over equity finance
Corporate taxes and the cost of capital
• Two countries, Belgium (2008) and Italy (2012),
have recently introduced an Allowance for
Corporate Equity (ACE)
– in essence, an allowance for the foregone interest
component of the holding cost for equity-financed
capital assets
• In principle, an ACE can eliminate the tax
advantage of debt over equity finance, and
remove any impact of the corporate tax on the
cost of capital
– see, for example, Tax by Design: The Mirrlees Review
Corporate taxes and the cost of capital
• In most other developed countries, the effect of
corporate taxation on the cost of capital has
tended to fall over the last three decades, as
statutory tax rates have fallen
– see, for example, Loretz (2008) and Bond-Xing (2014)
• Ireland was a pioneer and is still a leader
• Most countries could still achieve a significant
reduction in the cost of capital through more
fundamental corporate tax reform
– e.g. by introducing an ACE, similar to Belgium/Italy
The cost of capital and corporate investment
• Standard economic theory suggests that a
lower cost of capital would raise capitaloutput ratios
– much as a lower cost of milk raises the demand
for milk
• With a lower milk price, consumers can
choose to substitute milk for other products
• Similarly, with a lower cost of capital,
producers can choose to substitute capital for
other inputs
The cost of capital and corporate investment
• Theory does not tell us about the size of the
effect on capital-output ratios, nor the time
frame over which adjustment occurs
• Until quite recently, empirical evidence was
somewhat inconclusive
• But recent advances in data availability and
empirical methods have produced strong
evidence that taxes affect investment in the short
run and capital-output ratios in the long run, the
effects are sizeable, and occur quite quickly
Cummins, Hassett & Hubbard (1994)
• Studied the cross-sectional pattern of
investment responses to the 1986 US tax
reform, which affected the cost of capital
differently for firms operating in different
sectors, depending on the mix of capital assets
• Showed that the largest falls in investment
were concentrated in sectors where the tax
reform produced the largest increases in the
cost of capital
Zwick & Mahon (2014)
• Use administrative IRS tax return data
• Study investment responses to US bonus
depreciation provisions introduced in 2001-04
and from 2008, which again affect firms in
different sectors differentially, depending on
the mix of capital assets
• Estimate that bonus depreciation increased
equipment investment by 17% between
2001-04, and by 30% between 2008-10
Bond & Xing (2014)
• Use new (EU KLEMS) data for 14 OECD
countries over 1982-2007, with internationally
comparable capital stock measures
• Find strong evidence of a substantial long-run
effect of the cost of capital (and, specifically,
of the tax component of the cost of capital) on
capital-output ratios
– particularly for plant, machinery, equipment
Bond & Xing (2014)
• At end of sample period in 2007, introducing
ACE would cut the cost of capital for
equipment investment by about 10% on
average, across 14 sample countries
• We estimate that this would raise (equipment)
capital-output ratios by 3%-7%
– with half the adjustment complete after 5 years,
and three quarters complete after 9 years
Investment and GDP per capita
• The large “empirical growth” literature, using
variation across countries and over time,
establishes a robust positive correlation
between investment as a share of GDP and
the level of GDP per capita
– Perhaps surprisingly, the “empirical growth”
literature has much less to say about
determinants of long-run growth rates
Investment and GDP per capita
• A subset of this literature uses statistical
methods to investigate causality
– Are investment and GDP per capita correlated
because higher investment raises GDP per capita,
or because richer countries tend to invest a higher
share of their income?
• Mostly finding support for a causal effect:
autonomous or ‘exogenous’ increases in
investment as a share of GDP subsequently
raise the level of GDP per capita
Investment and GDP per capita
• This is not surprising, recalling that investment
as a share of GDP proxies for the capitaloutput ratio
• More capital per worker will raise output per
worker (and hence income per capita) in
almost any reasonable view of the production
process
– “give us the tools and we’ll do the job”
Synthesis
• There is clear evidence that reforming
corporate income taxes in ways which reduce
or eliminate the effect of corporate taxation
on the cost of capital would raise business
investment in the short run, and raise capitaloutput ratios in the long run
• Evidence also suggests that higher capitaloutput ratios would raise the level of GDP per
capita
Policy options
• More generous allowances for depreciation on
capital assets
– as used successfully in the USA
• An Allowance for Corporate Equity (ACE)
– as pioneered in Belgium and Italy, and discussed
further in Tax by Design: The Mirrlees Review
Policy options
• Simulations by de Mooij and Devereux (2009)
suggest that a revenue-neutral introduction of
ACE in the UK could raise GDP per capita by
1.4%
• Persistently low levels of business investment
in many countries in the aftermath of the
2008 financial crisis suggest that this may be
an opportune time to consider eliminating the
bias against investment found in most
corporate income taxes
Two questions not addressed
• Could policy reforms which stimulate higher
investment also raise long-run growth rates?
– Comparatively little evidence on this, partly
because long time spans of data are needed to
detect changes in long-run growth rates
– Findings in Bond, Leblebicioglu and Schiantarelli
(2010) suggest there may be a positive growth
effect in developing countries, but not in
developed countries
Two questions not addressed
• Could corporate tax reform raise GDP per
capita through channels other than higher
business investment?
– Influential OECD research suggests gains from
switching between corporate income tax and
other taxes, holding investment as a share of GDP
constant (Arnold et al., 2011)
– Xing (2012) finds the empirical evidence for this
claim to be extremely fragile
References
Arnold J, Brys B, Heady C, Johansson A, Schwellnus C, Vartia L
(2011), “Tax policy for economic recovery and growth”,
Economic Journal
Bond S, Leblebicioglu A, Schiantarelli F (2010), “Capital
accumulation and growth: a new look at the empirical
evidence”, Journal of Applied Econometrics
Bond S, Xing J (2014), “Corporate taxation and capital
accumulation: evidence from sectoral panel data for 14
OECD countries”, Oxford University Centre for Business
Taxation Working Paper WP 10/15
Cummins J, Hassett K, Hubbard R (1994), “A reconsideration of
investment behavior using tax reforms as natural
experiments”, Brookings Papers on Economic Activity
References
De Mooij R, Devereux M (2009), “Alternative systems of business
tax in Europe: an applied analysis of ACE and CBIT reforms”,
European Commission, DG TAXUD, Taxation Papers no. 17
Loretz S (2008), “Corporate taxation in the OECD in a wider
context”, Oxford Review of Economic Policy
Mirrlees J et al. (2011), Tax by Design: The Mirrlees Review,
Oxford University Press
Xing J (2012), “Tax structure and growth: how robust is the
empirical evidence?”, Economics Letters
Zwick E, Mahon J (2014), “Do financial frictions amplify fiscal
policy? Evidence from business investment stimulus”, Oxford
University Centre for Business Taxation Working Paper WP
14/15