Measures based on past tax codes

Given the complexity of the forward-looking tax measures described in section 2.2.2., their calculation is not an easy task. Sufficient data does only exist for a small number of countries and for some years. Since the alternative use of statutory tax rates offers only limited benefits when measuring the tax burden of investment, so called implicit average tax rates have been used often to measure tax incentives instead.

The basic idea of these measures is to express total tax payments as a proportion of a measure of (pre-tax) profits or the tax base. A particular example of such a tax rate, and one which has been widely used, was developed by Mendoza et al. (1994) for use with aggregate data. Their approach is to derive tax ratios on the basis of the OECD Revenue statistics and National Accounts. They define the tax rate on corporate income as the fraction of tax revenues from taxes on income, profits, and capital gains on corporations, to the operating surplus of the economy minus the operating surplus of private incorporated enterprises. The most serious problem with this approach comes from the definition of the tax revenue categories used in the numerator of the implicit tax measure. These categories are often broadly classified and do contain tax payments that can hardly be assigned to only one macroeconomic sector. To give an example: All of the income of the self-employed represents capital income, although this income does partly reflect the reward to their labour input as well. In this respect, it is not surprising that a number of scholars have criticised the definition of tax ratios used by Mendoza et al. (1994) and proposed their own, perhaps more sophisticated, definitions20_.

20 _{Volkering and de Haan (2001) provide an extensive survey of the conceptual and practical} problems when calculating implicit tax rates. Carey and Rabesona (2004), argue that the definition of the corporate tax ratio neglects a number of important categories of taxation (namely corporate recurrent taxes on net wealth and immovable property). In a subsequent study, Volkering et al. (2002), propose a refined version of the implicit tax rate. It is shown, however, that the results of several empirical studies are robust with respect to the exact definition of implicit tax rates.

The attractiveness of this approach lies in its simplicity. Aggregate data are easily available from most statistical institutes, and ratios can be calculated in a convenient and quick way for different countries and years. Moreover, such tax rates implicitly consider the entire tax code and may also reflect the enforcement policy of a country. Nevertheless, these rates suffer from a number of shortcomings. In fact, the actual tax payments used to calculate the tax ratio do not only depend on the current tax code. To a large degree, these payments are determined by the history of the tax system, the history of the investment of a firm up to this point, and by the history of the losses of the firm21_{. As}

historical data plays a crucial role in determining the implicit tax rate, it can be best characterized as a backward-looking concept relying on past tax codes. Consequently, this concept can give a proper picture of the tax burden of already existing capital, but it can not be used to measure the incentives of the tax system on new investment. To give an example, think of the recent German capital tax reform. With this reform, several firms were allowed to deduct losses stemming from the early eighties from their actual tax payment. In aggregate, although conditions for new investment have not been affected by this particular provision, this led to a dramatic decrease in corporate tax revenue which resulted in a sharp decline in the tax ratio.

Another fundamental problem of this measure is that it is a very broad one. With the approach taken, it is not possible to distinguish the effects of taxes on different investments, e.g. among sectors or industries. Moreover, this measure may be contaminated by the influence of foreign tax systems on the tax payments of local firms, e.g. by double taxation agreements under which foreign income of multinational enterprises is taxed/not taxed in the home country. An alternative approach that can cope with some of these difficulties is the concept of implicit microeconomic tax rates.

Implicit microeconomic tax rates

The concept of implicit microeconomic tax rates is based on firm specific data instead of revenue statistics. Similar to the macroeconomic case, tax rates are

calculated as the tax liabilities of the firm, relative to its profits. Data can either be taken from individual financial statements or consolidated returns. Country specific tax rates can then be obtained from firm specific tax rates with several techniques. For example, the tax ratio of a representative firm can be taken as a measure for the tax burden in the country. As current tax liabilities of the firm, again, do largely depend on the history of the investment, this concept shares some of the shortcomings of the macroeconomic average tax rate when determining the tax burden of new investments. However, compared with the latter approach, microeconomic tax rates offer the advantage that they can be calculated for different sectors and industries. Based on firm specific data, it is also feasible to calculate tax rates for differently sized firms22_{. Moreover, with}

this approach, it is also possible to cope with another problem. Tax rates can either be calculated from all firms in the sample or on the basis of national firms which do no business abroad only. If the latter method is used, tax liabilities are not influenced by foreign tax systems and the national tax system can be isolated from any interference with these systems. It is often argued that using backward-looking tax measures in empirical studies entails some problems regarding endogeneity since it is not that clear whether tax rates determine investment decisions of multinational enterprises, or, the other way round, the investment decision of multinationals determines the tax rate of a country. Calculating microeconomic implicit tax rates on the basis of purely national firms can obviously solve this problem since these rates can be assumed to be largely independent from multinational activities.

When comparing the macroeconomic with the microeconomic approach to calculate backward-looking tax rates, the advantages discussed above have to be related to the disadvantages of firm level based data. These disadvantages stem from the required efforts in data collection. Although there exist several databases which contain detailed information on the balance sheet of individual firms, e.g. the Worldscope- or the Bach-database, these efforts are relatively high when compared to the approach based on revenue statistics.

12 _{By carrying our regressions, the microeconomic approach makes it also possible to identify the} items of the balance sheet that determine the effective corporate tax rate of a firm.