Effects of Global is at Ion on Corporate Taxation

8/3/2019 Effects of Global is at Ion on Corporate Taxation

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GLOBALISATION SEMINAR

EFFECTS OF GLOBALISATION ON NATIONAL POLICY : THE CASE OF

CORPORATE TAXATION

Prof. Dr. Michael Von Hauff

Int.Dipl.-Vw. Elena Brosch

Yasemin Ku

378993


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OUTLINE :

A. Introduction

....3

B. Theoretical Background on Global Effects of Corporate Taxation....

.....3

B.1. What Is Corporate Taxation ?...................................................................................3

B.2. The Effects Which Globalization Bears on Corporate Taxation ;....4

B.2.1. Governments Attitudes After Global Effects......4

B.2.2. Tax Policy When Firms Are Mobile.......5

C. FDI And TNC...

..6

C.1. Positive And Negative Effects ..9

C.2. Effects of Corporate Taxation on FDI.....13

D. Race To The Bottom .......13

E. References15

Table Of Figures And Tables

Five most attractive destinations for FDI 2004-2005 by region..8

The Worlds Top 50 Non-financial TNCs.. 8

Leading Sources Of FDI..9

Main products targeted by TNCs in foreign locations, by region...11


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Overseas Land Investment For Agriculture Production, Highlighting Investor And Target

Regions12

A. Introduction

This paper reviews the effects of globalization on national policy about corporate taxation

and how government reacts to these effects. In order to understand the effects, first we

should understand what corporate taxation is .In first chapter, you will find a general

explanation about what corporate taxation is, how it effects companies and what

government does in this situation.

After we understand what corporate tax is, paper reviews briefly what global effects

corporate tax have on companies and governments. In sub-chapters of global effects, in

the first chapter, you can see the analysis of the best tax policy government can implement

when firms are internationally mobile. There is a brief explanation of optimal tax policy,

and a result about ability to do it. A theory suggested by Haufler & Schjelderup and Fuest

& Hemmelgran is also presented. In the next chapter, you will find information about FDI

and transnational corporations which implement FDI. Also for what reasons, TNCs

choose developing countries to invest, how this choice affects home and host country,

what happens afterwards.

The questions of how governments react to FDI, why governments of home countries want

FDI in their countries, what happens when they have it, are answered. I mention briefly how

TNCs are considered as global citizens. Since the relationship is a long term relationship

between home and host countries, for stability; they are active in environmental and social

problems that world or country suffers from.

You will also find information about the effects of corporate taxation on FDI.

In the final chapter, a brief information about race to the bottom which is caused also by such

reasons; corporate taxation, FDI.

B. Theoretical Background On Global Effects Of Corporate Taxation

In order to explain the effects of corporate taxation; in sub-chapters I am going to analyze

the effects which corporate taxation bears and focus on how government reacts to these

effects and what results occur.

B.1. What is Corporate Taxation?


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Corporate tax consists of a fraction of income which is determined by government

according to the income of corporations. Tax is progressive which means as size and

income of corporations rise, tax rates also rise. It reduces the burden of people or

companies those who have low incomes. Tax rate can also change depending on the

location and industry.

Earning more may decrease the income of corporations. Income is taxed in different steps;

meaning income; earned in different rates is taxed in different rates. It means if you earn

one cent more than the non-taxable amount, then you have a certain rate of tax liability.

There are many pay-low-tax strategies found and implemented by corporations such as by

using debt rather than equity finance, investing in assets that can be depreciated and which

have tax credits. Corporations avoid it because rates affect the decision of locating capital,

timing, size and implementation of corporate investment in plant and equipment,

inventories, research and development, and other business assets. Higher tax rates

generally reduce investment. Corporate taxation also increases the cost of producing

corporate output, thereby raising output prices, lowering demand.

Corporate taxation is also an important source of government revenue and a major

consideration in planning business activities (James R. Hines Jr.,2001).

B.2. The effects which globalization bears on National Policy;

One of the elements that makes corporate taxation in this situation today is globalization.

It has effects on many areas of life. It could be one little detail that includes our actions,

way of thinking, way of living, way of making money and deciding. It is not something

tangible or something that shows its results immediately. However, as time goes by, we

can see its effects in everything.

Although government wants to have a big fraction of revenue, which means keeping rates

high, it doesnt keep high. Because government realizes that the best attitude to take, is

keep up with the world. Governments want their countries to be investment country and

develop their countries, they keep taxes low for many reasons, if we look from the point

of host countries. Governments in home country keep taxes low because they want

corporations to invest in their own countries, so they can also take credit for it.

B.2.1. Governments attitudes after global effects

Since taxes are an important revenue of government, corporations are automaticallyimportant. (James R. Hines Jr. 2001, 2-10)


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Governments attitudes are affected by many factors which are connected to each other.

Below, in sub-chapters, you will find the effects of corporate taxation bears on

corporations as globalization increases.

B.2.2. Tax policy when firms are mobile

Open economy is an economy which is free to trade with other economies of different

countries. Most of the countries in the world follow the open economy since the world has

become a global village. Small open economy is an economy that takes a role in

international trade, but pretty small compared to its trading partners. Its policies do not

change the world prices, rates, incomes. It is considered price takers not setters. Below,

small open economies are examined to show examples.

Standard optimal tax theory is the study of how best to design a tax to minimize distortion

and inefficiency subject. A neutral tax is a theoretical tax which avoids distortion and

inefficiency completely.

Theory suggests that small open economies should not have taxes based on capital

especially when capital is mobile (Gordon (1986), Sinn (1990)). If capital is taxed at

source, investments are not implemented correctly and national welfare declines. For this

reason, a new tax system is proposed which can be summarized under the name

consumption tax systems .The main feature of these systems is, if your project returns to

you equaling to the cost of capital, tax payments are zero. This system is called present

value of depreciation allowances (PVDA) which is considered %100 equal to the purchase

price of good. Rationally we expect a raise in PVDA and decrease in taxation in normal

return. However, according to empirical observations, it is seen that countries did the

other way around in tax reforms.

There are four quadrants which are; while Revenue is neutral (because one variable of one

tax parameter is financed by other parameter of tax) tax rate increase, tax base narrows

(e.g Canada) or

Tax rate decrease, tax base broadens (e.g Germany, Japan, USA).

While revenue is increasing, tax rate increase and tax base broadens (e.g France, Ireland).

While revenue is decreasing tax rate decrease and tax base narrows (e.g Portugal)

(Devereux et al. (2002)).

Tax base means the assessed value of assets, investments or income. Anything can be

taxed has a tax base.
http://en.wikipedia.org/wiki/Distortions_(economics)http://en.wikipedia.org/wiki/Distortions_(economics)


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What tax policy do governments choose in the case of when firms are mobile?

Lets say that government use tax rate and tax base as policy parameters and firms differ

in mobility costs and profitability. If the mobile firms are more profitable than the

immobile firms in the country, the optimal policy would be a tax rate decreasing, tax base

broadening policy (Johannes Becker, Clemens Fuest, 2007). The reason is that this policy

redistributes the tax burden from mobile to immobile firms. Thus, mobile firms can be

prevented from leaving the country without losing too much tax revenue. But if the

marginal mobile firm is less profitable than the average firm in the economy, a tax rate cut

base broadening policy reduces welfare. In this case, the optimal tax policy consists of

subsidizing the normal return to capital and increasing the statutory tax rate.

Haufler & Schjelderup (2000) show that, if multinational firms earn supernormal profits

and if they may shift these profits to low tax countries via transfer pricing, it is

optimal to reduce tax rates and broaden tax bases, despite the distortion of investment

caused by this policy. Fuest & Hemmelgarn (2005) show that a tax rate

cut, base broadening policy may be optimal in the presence of income shifting even if

there are no pure profits. Another argument is provided by Bond (2000) .He proposes to

implement the tax rate cut, base broadening to be the optimal tax policy reaction to the

existence of mobile and highly profitable firms. Bond concludes that a government then

might increase domestic investment by lowering the statutory tax rate and accepting a

broader tax base, even though this results in a higher cost of capital.

As a conclusion, it can be said that governments choose lowering taxes as best optimal

policy to keep the mobile firms which are profitable relative to the immobile firms in the

country. In reality it may not be that easy to implement this policy. If another instrument

such as labor is taxed, this time labor suffers.

C. FDI and TNC

Foreign Direct Investment means simply an investment in a foreign country by a domestic

firm. The entity who invest is called Direct Investor and invested country is called

Direct Investment Enterprise. An entity at least should have 10 percent of shares and

power of voting (which means direct investor are able to influence management) in

foreign enterprise to be regarded as direct investor (which is determined by OECD and


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IMF) and the main features are, lasting interest of direct investor and and a long-term

relationship . (UNCTAD 1996)

FDI flows can be categorized into three components: equity capital, reinvested earnings

and intra-company loans. Equity capital consists of the shares of companies in foreign

countries. Reinvested earnings include the earnings which are not distributed to

shareholders but reinvested into the company. Intra company loans relate to financial

transactions between a domestic company and itsaffiliates (UNCTAD 2006).

The relationship between FDI and economic growth is visible. For many reasons such as;

Increased risk sharing opportunities between foreign and domestic investors might help to

diversify risks. This ability to diversify, encourages firms to take more total investment,

and allows enhancing growth. Direct investors often introduce a variety of new financial

instruments and techniques and also foster technological improvements in domestic

markets.

The entry of foreign always increase the competition both in home and host country and

this leads to a better quality in output. Host countries trade with TNCs, buy inputs or sell

outputs. Therefore, this trade brings the liability to produce goods of good quality.

It allows access to international financial markets for developing countries.

It also allows both of the countries to follow the economies of each other, transfer of

technology, risk sharing.

FDI is implemented by companies from private sector and these companies are called

Transnational Corporations which control assets of other entities in other economies other

than its home economy. It at least should have 10% or more of capital share and voting

power. (UNCTAD 2004)

There are 64,000 TNCs controlling 870,000 affiliates around the world (UNCTAD 2003).

Expansion of trade barriers by globalization has given the chance to companies search for

lower cost, efficiency. In FDI, developing countries are chosen for reasons such as lower

taxes, lower wages, flexible governmental regulations.

Corporations are globalizing not only to reduce production costs, but also expand

markets, evade taxes, acquire knowledge and resources, and protect themselves against

currency fluctuations and other risks. (Jeremy Brecher and Tim Costello, 1994)


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Five most attractive destinations for FDI 2004-2005 by region

Source: UNCTAD-DITE, Global Investment Prospects Assessment 2004, in UNCTAD

(2004c), P 6.


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UNCTAD (2003) p 187

Leading Sources of FDI

UNCTAD-DITE, Global Investment Prospects Assessment 2004, in UNCTAD (2004a),p6.

C.1. Positive And Negative Effects of FDI

What are the positive effects of TNCs?

If we look from the point of FDEs, effects are;


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- TNCs raise employment, contribute to governments revenue by taxes, raise exports,

raise productivity and help the economic development.

- TNCs are also external financial resource for developing countries.

- They also can mend the lack of technological capability of most developing countries.

- Since they pay higher wages to workers, it can have a spillover effect.

Spillovers occur when multinationals are unable to capture all the productivity effects that

follow in the host countrys local firms as a result of the presence of the multinational

(Caves, 1996). Positive effects that spillovers have can be mentioned this way;

Spillover effect occurs via imitation. TNCs pay higher to workers, so to attract workers

from TNCS, domestic firms tend to pay higher wages. By purchasing or selling goods to

foreign firms, will increase the efficiency and quality of output. It will also raise the

variety of goods and returns which means a rise in productivity.

The estimation results offer some support for the existence of positive spillovers. There

seems to be stronger evidence that domestic industries benefit from foreign presence in

the related industries within the province (Sarah Y.Toun, Angela Youxin Hu, 2003).

In spite of many positive effects, it has also some negative effects ( from the point of

DIEs);

- As TNCs bring money, employment, technology to the country, they can also take it

away by leaving the country for a better opportunity and lead to unemployment (such as

Sony Corporation left West Java).-Developing countries also fear that new industries which they want to develop may be

damaged.

- TNCs like in some cases misuse the power that they have such as ChevronTexaco in

Ecuador ( For more info. See chevrontoxico.com). There may be competitions between

countries, even states within a country because they want FDI for the positive effects

mentioned above. It can lead to race to the bottom which is going to be explained in

another chapter.

For the positive reasons mentioned above, government in developing countries want to be

DIE.


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TNCs are seen as a world citizen. Good Corporate Citizenship in international

investment agreements, the agreements which define the relationship between TNC home

and host country governments.

For such reason above; TNCs choose to function effectively as good global citizens. For

example, that they are active in promoting control of greenhouse gases because they see it

as being in their interests (Maitland (2002)). Prevention and treatment of HIV/AIDS is

another area that TNCs are interested. Coca Cola, for one example, plans to spend as

much as $5m per year on treatment for the employees of its bottlers in Africa (Ruggie

(2002) ).

Considering good and bad effects of TNCs mentioned above, many programs have been

started to make the TNCs and development more harmonized and effective such as

Equator Principles which is for specifically banks and their lending criteria. Another

vehicle for enhancing the TNC/development is the Caux Roundable, which promotes

moral capitalism (Refer to the website: http://www.cauxroundtable.org/index.html ).

Another study, The Global Compact, which is introduced as a personal decision by United

Nations Secretary General Kofi Annan. What it emphasizes is 10 principles relating to

human rights, labor, corruption and the environment ( For more information see

www.unglobalcompact.org)

C.2. Effects of FDI on Governments Attitudes

The former chapter, positive and negative effects on DIEs are given. In this chapter, you

will find the analysis of what positive and negative effects of FDI in home country (direct

investor) are and how government reacts.

Positive effects of TNCs in home country ;

- The main reason companies implement FDI is, TNCs are profit-seeking organizations

Since they want to gain profit, they choose developing countries where taxes are lower,

maybe government regulations are more flexible, sources are waiting to be issued. For

example, we can see in the figure which countries aim to implement FDI for agricultural

reason as a sample;

Main products targeted by TNCs in foreign locations, by region, up to 2009
http://www.cauxroundtable.org/index.htmlhttp://www.cauxroundtable.org/index.html


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Source: UNCTAD

Overseas Land Investment For Agriculture Production, Highlighting Investor And

Target Regions, 2006- May 2009


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TNCs also pay less to workers relative to workers in home country. So they definitely

gain profit from FDI. As Robert E. lipsey says "It is rare that multinational firms are not

mentioned, as the presumed leaders and chief beneficiaries of globalization.(2002)

- TNCs pay lower taxes.

- TNCs pay less wages even if its higher than the wages in host country relative to

home country.

- FDI also provides a good range of products. There may be cases such as, a developing

country with fertile lands, rich kind of resources and of course various ideas.

There are some negative effects which TNCs actions bear in home country such as;

- TNCs influence wages and employment in a bad way by taking production away.

Instead of investing in home country, TNCs prefer to invest in a developing country

which has better conditions to gain profit. This takes away chances from having new areas

for employment.

- It also causes a decline in governments revenue, which causes ;

- a hitch in governmental responsibilities such as building schools, roads etc.

- For these causes government may want to keep corporations in its country and invest

in home country. What can government do in this situation?

The main reason TNCs choose developing countries for is existence of lower taxes.

Assuming government lowers the taxes for TNCs to keep TNCs in, domestic firms will ask

for decline in taxes too and so on. Even government agrees to reduce taxes, there will be hard

results such as decline in tax revenues. And this will cause a hitch in governmental

responsibilities as mentioned above.

We also conclude corporations also can be mobile because of FDI.

C.2 Effects of Corporate Taxation on FDI

In the literature, the observation that profitability tends to be lower in high tax countries is

usually interpreted as reflecting that firms shift book profits to low tax countries.( Grubert &

Mutti (1991), Hines & Rice (1994)

High tax countries are likely to attract investment projects which yield

low profits in the host country and contribute little to its corporate tax revenue whereas low

tax countries can expect the opposite. We call this the composition effect of corporate taxationon foreign direct investment. (Johannes Becker, 2007)


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When governments increase the tax rates, it has two effects. While it increases the tax revenue

by increasing tax burden in corporations, it decreases the number of investments or

corporations.

D. Race to the bottom

Tax competition can be explained as reducing tax rates in order to attract capital from abroad.

After researches, we can say that governments lower tax rates as a result of increasing

globalization.

Tax competition is also named race to the bottom which could be between both countries and

states. Races to the bottom between the states or administrative regions within nations, which

often seek to attract businesses and jobs. The standard behavior is determined by the law of

state about corporations. Companies may be founded in any state that provides most of what

companies want. States can implement what is favored by management. When one state does

it and others dont follow it, corporations may leave that state. Each government may benefit

from higher tax revenues by having a high tax on corporate profits. However, governments

can benefit individually with a lower corporate tax rate relative to the other governments in

order to attract businesses away from the jurisdictions of other governments. This action

would hurt all governments except the one that undercut the others. In order to maintain the

equilibrium, each of the other governments would have to lower their corporate tax rates to

match the "defector" (the government that first lowered the tax rate). The end result is that

each government adopts a lower corporate tax rate and so collects less revenue overall. The

optimal option for all governments would be an agreement to maintain tax harmonization.

The degree of such intra-national races is limited by the power and tendency of central

national governments to act against them. These competitions regularly work to reduce the

ability of governments to protect labor standards such as workers' compensation, or to raisetaxation in order to fund social services and correct externalities (such as pollution and social

distortions). It can also affect reliability of government.

The occurrence of races to the bottom between countries is reduced by the costs of moving

investment and production between countries, by consistence of comparative advantages

(such as skilled workforces, infrastructure or proximity to natural resources), and by the

presence of minimum standards, rules or conventions which prevent them. Another suggested

method for avoiding races to the bottom is moral purchasing. Moral purchasing can influence
http://www.wordiq.com/definition/Workers'_compensationhttp://www.wordiq.com/definition/Taxationhttp://www.wordiq.com/definition/Externalityhttp://www.wordiq.com/definition/Moral_purchasinghttp://www.wordiq.com/definition/Workers'_compensationhttp://www.wordiq.com/definition/Taxationhttp://www.wordiq.com/definition/Externalityhttp://www.wordiq.com/definition/Moral_purchasing


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decisions of individual buyers, or it can involve forbidding or applying heavy tax, tariff and

trade sanctions to nations that permit the export of offensive goods.

As a result

When this tendency lowers the price of goods and services through the improved efficiency,

the effect may be good. But when corporations and governments lower costs by

reducing environmental protection, wages, salaries, health care, and education, the

result can be bad -a "downward leveling" of environmental, labor, and social

conditions (Jeremy Brecher and Tim Costello, 1994).

F. References

Geoffrey Jones, John H. Dunning, 1997, Transnational corporations, p.2-10, 23-32

Grazia Ietto-Gillies, 2005, Transnational corporations and international production: concepts,

theories, and effects, Edward Elgar Publishing, USA, p.7-30

Mauro Ghinamo, Paolo M. Panteghini, Federico Revelli, April 2007, FDI And Corporate Tax

Competition In Volatile World

Johannes Becker, Clemens Fuest, November 2005, Optimal Tax Policy When Firms AreInternationally Mobile

Lucas Bretschger, Frank Hettich, September 2000, Globalisation, Capital Mobility and Tax

Competition: Theory and Evidence for OECD Countries, p.2-26

Fredrik Carlsen, Bjorg Langset, Jorn Rattso, June 2005, The Relationship Between Firm

Mobility And Tax Level: Empirical Evidence Of Fiscal Competition Between Local

Governments, Discussion Papers No. 424, Norway
http://www.wordiq.com/definition/Tax%2C_tariff_and_tradehttp://www.wordiq.com/definition/Tax%2C_tariff_and_tradehttp://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22Geoffrey+Jones%22http://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22John+H.+Dunning%22http://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22John+H.+Dunning%22http://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22Grazia+Ietto-Gillies%22http://www.wordiq.com/definition/Tax%2C_tariff_and_tradehttp://www.wordiq.com/definition/Tax%2C_tariff_and_tradehttp://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22Geoffrey+Jones%22http://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22John+H.+Dunning%22http://www.google.com.tr/search?tbs=bks:1&tbo=p&q=+inauthor:%22Grazia+Ietto-Gillies%22


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Johannes Becker, Clemens Fuest, Quality Versus Quantity The Composition Effect Of

Corporate Taxation On Foreign Direct Investment, October 2007, Category 1: Public Finance,

Cesifo Working Paper No:2126, 3-6, 16-23

Gatan Nicodme, June 2006,Corporate tax competition and coordination in the European

Union: What do we know? Where do we stand?

Jimmy J. Zhan, October 2006, FDI Statistics: A Critical Review and Policy Implications

Hafiz Mirza and one Miroux, Foreign Direct Investment And Other Forms Of TNC

Participation In Agricultural Production: Trends And Implications

Ronald B. Davies, Robert R. Reed III, April 2005, Population Aging, Foreign Direct

Investment, and Tax Competition

Qing Hong, Michael Smart, October 2006, In Praise Of Tax Havens: International Tax

Planning And Foreign Direct Investment, University of Toronto, p.18-24

Leandra Lederman, 2002, Understanding Corporate Taxation, George Mason University

Kwang-Yeol Yoo, 1991-2001, Corporate Taxation Of Foreign Direct Investment Income,

OECD Economics Department Working Papers, No. 365, p.5-6,42-44

Sarah Y. Tong, Angela Youxin Hu, December 2003, Do Domestic Firms Benefit from

Foreign Direct Investment? Initial Evidence from Chinese Manufacturing, The University of

Hong Kong

Robert E. Lipsey, May 2002, Home and Host Country Effects of FDI, Liding Sweden

Julian L. Clarke, Competition Policy And Foreign Direct Investment, World Trade

Institute,p.15-17

Hans-Werner Sinn, 2003, The New Systems Of Competition, chapter III


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Sarinthorn Sosukpaibul, Feb 2007, The Relationship among Foreign Direct Investment Flows,

Government Policy and Investment Strategy: The Case of Thailand

John Douglas Wilson, Jun 1999, Theories of tax competition, National Tax Journal, p.5-8

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University (Korea), p.2-6

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Government Policies More Important than Taxation in Attracting FDI?

James R. Hines Jr. , Feb 2001, Corporate Taxation, University of Michigan and NBER

Marius R. Busemeyer, March 6-7, From myth to reality: Globalization and Public Spending

in OECD Countries revisited, Max Planck Institute for the Study of Societies, p.2-10

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Public Companies, vol.38:317, 5-12

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Development,http://www.unctad.org/en/docs//wir99_en.pdf, chapter 8

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Pillage, http://www.thirdworldtraveler.com/Brecher/Race%20to%20Bottom_GVGP.html

What is Corporation Tax and who is subject to Corporation Tax requirements?,

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