Business Taxation in a Federal System Fall 2020

This paper uses an event study approach to estimate the effect of capital gains taxation on realizations at the state level, and then develops a framework for determining revenue-maximizing rates at the federal level. Agersnap and Zidar find that the elasticity of revenues with respect to the tax rate over a ten-year period is -0.5 to -0.3, indicating that capital gains tax cuts do not pay for themselves, and that a 5 percentage point rate increase would yield $18 to $30 billion in annual federal tax revenue. Their long-run estimates yield revenue-maximizing capital gains tax rates of 38 to 47 percent.

This paper is the first to use information from individual country-by-country (CbC) reports to assess the extent of profit shifting by multinational enterprises (MNEs). Unlike other data often used to evaluate the extent of profit shifting and tax avoidance, CbC reports provide a complete coverage of the global distribution of profits and production factors for MNEs that exceed a certain revenue threshold. Using information from CbC reports filed by German MNEs, Fuest, Hugger, and Neumeier find that subsidiaries located in tax havens are notably more profitable than subsidiaries in non-havens. However, only 9 percent of German MNEs' profits are reported in tax havens. Results from regression analyses suggest that about 40 percent of the profits reported in tax havens are a result of tax induced profit shifting. The associated annual loss in tax revenues for Germany amounts to roughly EUR 1.6 billion. Adding estimates of profit shifting by firms not covered by the CbC data leads to an overall estimate for the German tax revenue loss due to corporate profit shifting to tax havens of EUR 5.7 billion per year.

Global firms finance themselves through foreign subsidiaries, often shell companies in tax havens, which obscures their nationality in aggregate statistics. Coppola, Maggiori, Neiman, and Schreger associate the universe of traded securities with their issuer's ultimate parent and restate bilateral investment positions to better reflect the true financial linkages connecting countries around the world. The researchers find that portfolio investment from developed countries to firms in large emerging markets is dramatically larger than previously thought. The national accounts of the United States, for example, understate the U.S. position in Chinese firms by nearly 600 billion dollars, while China's official net creditor position to the rest of the world is overstated by about 50 percent. Coppola, Maggiori, Neiman, and Schreger additionally show how taking account of offshore issuance is important for their understanding of the currency composition of external portfolio liabilities, the nature of foreign direct investment, and the growth of financial globalization.

Half of the jobs in the U.S. feature pay-for-performance. Doligalski, Ndiaye, and Werquin study nonlinear income taxation in a model where such labor contracts arise as a result of moral hazard frictions within firms. They derive novel formulas for the incidence of arbitrarily nonlinear reforms of a given tax code on both average earnings and their sensitivity to output risk. The researchers show theoretically and quantitatively that, following an increase in tax progressivity, the higher sensitivity of earnings to performance caused by the crowding-out of private insurance is almost fully offset by a countervailing performance-pay effect driven by labor supply responses. As a result, earnings risk is hardly affected by policy. Doligalski, Ndiaye, and Werquin then turn to the normative analysis of a government that levies taxes and transfers to redistribute income across workers with different levels of uninsurable productivity. They find that setting taxes without accounting for the endogeneity of private insurance is close to optimal. Thus, the common concern that standard models of taxation underestimate the cost of redistribution is, in the context of performance-based compensation, overblown.

Business owner-managers are an important part of the workforce and highly responsive to taxes. Miller, Pope, and Smith use newly linked tax records to show that the large responses of UK company owner-managers to personal taxes are due to intertemporal income shifting and not to reductions in real business activity. The researchers use a simple model to highlight that understanding why individuals shift income across time, and the constraints they may face in doing so, matter for the efficiency properties of tax policy. Around half of the observed intertemporal shifting is short-term and helps ameliorate the effect of progressive personal taxes on volatile incomes. The remainder reflects systemic retention of profits within a company over long periods, and likely creates efficiency costs by distorting the intertemporal allocation of consumption. Miller, Pope, and Smith find no evidence that this tax-induced retention increases business investment. Properly accounting for intertemporal shifting reduces the deadweight loss associated with a marginal increase in personal taxes by around 80%.

Existing evidence shows that R&D tax incentives boost countries' private sector R&D. As multinational enterprises (MNEs) account for nearly all private sector innovations, it is unclear, however, whether firms engage in genuinely new R&D or whether R&D is reallocated across borders. Drawing on data on unconsolidated R&D activity of MNEs in Europe, Knoll, Riedel, Todtenhaupt, Schwab, and Voget show that R&D tax incentives serve as beggar-thy-neighbor instruments: More generous tax incentives in one country increase MNEs' R&D investments in affiliates located there, while lowering R&D investments in affiliates of the same MNE group located in other countries. Globally, firms hardly respond to changed R&D tax incentives.

Angel investor tax credits are used globally to spur high-growth entrepreneurship. Exploiting the staggered implementation of these tax credits in 31 U.S. states, Denes, Howell, Mezzanotti, Wang, and Xu find that while they increase angel investment, they have no significant effect on entrepreneurial activity. Tax credits induce entry by inexperienced, local investors and are often used by insiders. A survey of 1,411 angel investors suggests that a "home run" investing approach alongside coordination and information frictions explain low take-up among experienced investors. The results contrast with evidence that direct subsidies to firms have large positive effects, raising concerns about using investor subsidies to promote entrepreneurship.