THE TAXATION OF DISCRETE INVESTMENT CHOICES

Transcription

1 THE TAXATION OF DISCRETE INVESTMENT CHOICES Mchael P. Devereux Rachel Grffh REVISION 2 THE INSTITUTE FOR FISCAL STUDIES Workg Paper Seres No. W98/6

2 The axao of dscree vesme choces Mchael P. Devereux Warwck Uversy ad Isue for Fscal Sudes Rachel Grffh Isue for Fscal Sudes February 999 Absrac Tradoal aalyss of he axao of come from capal has focused o he mpac of ax o margal vesme decsos; he prcpal mpac of ax o vesme s hrough he cos of capal, ad s geerally measured by a effecve margal ax rae. I hs paper, we cosder cases whch vesors face a choce bewee wo or more muually exclusve proecs, boh of whch are expeced o ear a leas he mmum requred rae of reur. Examples clude he locao decsos of mulaoals, frms choce of echology, ad he choce of vesme proecs he presece of bdg facal cosras. I hese cases he choce depeds o he effecve average ax rae. We propose a measure of hs rae ad demosrae s relaoshp o he coveoal effecve margal ax rae. Esmaes of boh are preseed ad compared for domesc ad eraoal vesme Germay, Japa, he UK ad USA bewee 979 ad 997. JEL classfcao: H25, H32 Ackowledgemes The auhors would lke o hak Sephe Bod ad Mchael Kee for helpful commes o earler drafs of hs paper. Resposbly for errors remas ours. Ths research was fuded by he ESRC Cere for Mcroecoomc Aalyss of Fscal Polcy a he Isue for Fscal Sudes; Devereux was suppored by a Leverhulme Trus fellowshp. Correspodece Professor Mchael P. Devereux, Deparme of Ecoomcs, Warwck Uversy, Covery, CV4 7AL, UK emal: M.P.Devereux@warwck.ac.uk Rachel Grffh, IFS, 7 Rdgmou Sree, Lodo WCE 7AE, UK emal: rgrffh@fs.org.uk

3 . INTRODUCTION Sce he semal works of Jorgeso (963) ad Hall ad Jorgese (967) he sadard approach o vesgag he mpac of axao o frms ceve o ves has bee o exame s mpac o he cos of capal - he mmum pre-ax rae of reur o a vesme requred by he vesor. The vas maory of boh heorecal ad emprcal work focuses o he mpac of axao o margal vesme o he assumpo ha all poeal vesme proecs ha ear a leas he cos of capal wll be uderake. However, may crcumsaces vesme choces do o correspod o he framework adoped hs leraure. Where a vesor faces a choce bewee wo or more muually exclusve proecs ha are expeced o ear more ha he mmum requred rae of reur he choce of whch proec o uderake depeds o he level of he pos-ax ecoomc re ha would be eared from each proec. The mpac of ax hs case s measured by he proporo of he pre-ax ecoomc re ake by he goverme - he effecve average ax rae. Codoal o choosg oe of he proecs, he level of vesme may be affeced by axao hrough he cos of capal he usual way. Ths dsco s aalogous o he labour supply decso where s well kow ha he mpac of ax o a dvdual s ceve o parcpae he labour marke s hrough he average ax rae, whle he umber of hours worked s affeced by he margal ax rae. I Devereux ad Grffh (998) was show ha he effecve average rae of corporae come ax ha a frm mgh expec o face o a vesme proec s a emprcally sgfca facor for US mulaoal frms choosg where wh Europe o se up a produco facly. I he model ha paper, he frm expecs o ear a ecoomc re o s acvy by explog some frm specfc advaage, such as a pae, bu due o 2

4 ecoomes of scale produco wll o buld more ha oe pla. The effecve margal ax rae s releva deermg he opmal scale of he vesme codoal o he locao havg bee chose. The choce of locao depeds o he level of pos-ax ecoomc re; he mpac of ax s hrough s effec o hs level, deermed by he effecve average ax rae. I hs paper s argued ha hs model has a broader applcao ha smply frms locao choces. For example, cosder a frm ha faces a choce bewee a umber of alerave meas of produco, wh a suable vesme R&D a produco facly may be made more auomaed, compared wh a relavely labour-esve produco process he absece of he R&D. Codoal o choosg whch sraegy o uderake, he effecve margal ax rae may affec he level of vesme uderake. However, he frm wll oly follow he sraegy ha yelds he hghes pos-ax level of ecoomc re, whch depeds o he effecve average ax rae. Aoher example s a frm operag a dffereaed goods marke, choosg he ype or qualy of good o produce. If produco of he goods s axed dfferely - for example because hey use dffere quales or quaes of pus whch are axed dfferely - he he dfferece he effecve average ax raes may affec he frms choce. There are wo commo elemes hese examples - he vesor faces a choce bewee muually exclusve vesme proecs ad a leas wo of hese proecs mus be expeced o geerae posve ecoomc re before ax. The muually exclusve aure of he vesme proecs may arse for dffere reasos, bu s lkely o requre he exsece of ecoomes of scale. I he frs wo examples above, s assumed ha he A umber of heorecal models, based loosely o he OLI framework of Dug (977,98), have hs propery. See for example, Caves (996), Horsma ad Markuse (992) ad Markuse (995). 3

5 frm faces a gve demad schedule, ad s choosg bewee alerave ways of meeg demad. By assumpo, would be less profable for he frm o uderake more ha oe of s sraegc opos. For example, he mulaoal may face fxed coss of seg up each locao. Seg up wo locaos would mea payg fxed coss wce, whch for a gve demad - s lkely o mply a lower overall pos-ax ecoomc re. Smlarly, he secod example, he R&D creaes ecoomes of scale - havg uderake he R&D, would be less profable o use boh he old ad ew echologes, raher ha oly he ew echology. I he hrd example s assumed ha produco of more ha oe varey s cosraed by a gve demad schedule. The secod commo eleme of hese examples s ha a leas wo sraeges mus exs whch are expeced o geerae a posve ecoomc re before ax. If oly oe sraegy s expeced o geerae a posve ecoomc re he wheher should be uderake ca be aalysed whou referece o oher possble sraeges (assumg o-egave ax lables). Ths meas ha he frm mus operae codos of mperfec compeo. The precse form of mperfec compeo s o mpora; all ha s requred for he ax o ecoomc re o play a role s ha a leas wo muually exclusve proecs have he poeal o ear ecoomc re. Prevous emprcal work usg average ax raes has eded o rea hem as a mperfec approxmao o he effecve margal ax rae ad has measured hem usg accoug or ax reur daa. 2 These measures geerally ake he curre ax lably as a proporo of curre come. Several problems arse usg he realsed amous o aalyse vesme sraeges. For example, accoug measures of average ax raes ypcally cosder he frm a a sgle po me, reflecg vesmes made by he frm over 2 See, for example, Sweso (994), Gruber ad Mu (996) ad Colls ad Shackelford (995). 4

6 may prevous perods as well as he curre perod, he reur o hose vesmes ad he way whch hey were faced. They may also reflec he dyamc ax poso of he frm; for example, a year whch he frm ears hgh come may o cur ay ax lably because earler losses may be brough forward. Accoug daa o ax lables may also reflec ax paymes oher ursdcos whch he frm operaes. Usg hese accoug or ax reur based measures o make eraoal comparsos s also problemac due o dffereces accoug defos ad he mg of ax paymes. Ths paper ses ou a framework o aalyse he mpac of ax o frms choce bewee dscree vesme decsos. We propose a ew measure of he effecve rae of axao of vesme proecs, a effecve average ax rae (EATR). Ths bulds o he sadard approach o measurg he effecve margal ax rae (EMTR). 3 Ths approach developed, for example, by Auerbach (979) ad Kg ad Fullero (984), ad a he eraoal level by Alworh (988), Kee (99) ad OECD (99), cosders he e prese value of he come sream from a vesme ad he e prese value of he cos of he vesme. 4 Seg hese equal defes he margal vesme ad he requred pre-ax rae of reur ca be derved. Ths ype of approach perms he aalyss of he mpac of curre (ad expeced fuure) ax regmes o he e prese value of a ew vesme proec. I also provdes a useful ool for polcy makers o aalyse he mpac of he ax sysem solao from oher ecoomc facors. However, alhough 3 Noably Kg ad Fullero (984), Alworh (988), OECD (99) ad Kee (99). 4 A alerave approach, ake for example by Fershma e. al. (997), s o esmae he mpac of ax chages ecoomercally. 5

7 que complex elemes of he ax sysem ca be aalysed, several assumpos abou he srucure ad facg of he vesme mus be made. A umber of mpora real world feaures, such as he ax plag acves of mulaoal frms, cao be deal wh compleely. To compue he EATR, he e prese value of he come sream s derved for a vesme whch ears a gve pre-ax rae of reur. The ecoomc re geeraed s smply he dfferece bewee hs value ad he e prese value of he cos of he vesme. I prcple, he EATR ca be measured as he proporoae dfferece bewee he pre-ax ad pos-ax ecoomc re, for a gve pre-ax rae of reur. However, pracce, we propose a slghly dffere measure for wo reasos. Frs, such a measure s udefed for a vesme whch s margal pre-ax, ad hece has a zero pre-ax ecoomc re. Secodly, he proposed measure of he EATR has he aracve propery ha, for a margal vesme, s equal o he EMTR. I ca herefore be erpreed as summarsg he dsrbuo of ax raes for a vesme proec over a rage of profably, wh he EMTR represeg he specal case of a margal vesme. I he emprcal seco of hs paper esmaes of he EATR are preseed for four coures Germay, Japa, UK ad USA - over he perod A aalyss of how ax reforms hese coures have chaged he shape of he ax schedule s gve. How hese ax schedules mgh affec vesme ceves ad choces a umber of suaos s llusraed. The srucure of he remader of he paper s as follows. The followg seco dscusses more deal some crcumsaces whch he EATR s he approprae measure for vesgag he mpac of axao o frms vesme decsos. Seco 3 ses ou a framework whch he EATR s he derved ad aalysed a domesc coex. Ths 6

8 s exeded Seco 4 o he case of eraoal vesme. I seco 5 emprcal values of he EATR for four coures are preseed. Seco 6 brefly cocludes. 2. CONCEPTUAL FRAMEWORK A umber of suaos are descrbed whch he EATR may affec vesme choces. A smple framework makes easer o hghlgh he commo elemes of hese choces. Ths framework ca be exeded a umber of drecos o model ay parcular choce more deal. Cosder he prof-maxmsg behavour of a sgle frm ha faces wo vesme opporues, deoed sraeges =, 2. The precse form of he compeo s o crucal; however, he possbly of earg a posve pre-ax ecoomc re mus exs. The cos srucure of each of he wo sraeges cosss of a vesme a fxed asse, F, ad varable cos per u of oupu. Deoe he pre-ax e prese value of he sream of come e of varable coss as Y *, where he asersk dcaes a pre-ax value. The pre-ax ecoomc re, R *, assocaed wh sraegy s assumed o be posve: * * R = Y - F > 0. (2.) There are hree opos avalable o he vesor: sraegy, sraegy 2, or boh. Uderakg boh sraeges would cur vesme of F F. Uless varable coss are 2 creasg wh oupu, he ay gve oupu could be produced a lower cos by followg oly oe of he sraeges. Oly he case whch ecoomes of scale rule ou uderakg boh sraeges s cosdered. Gve hs assumpo, he absece of ax, he vesor would choose he sraegy wh he hghes level of R * (as log as hs s o-egave). Defg a bary dcaor X * of wheher sraegy s chose he absece of ax, wll ake he values, 7

9 X * * { R, } * f R = max 2 = (2.2) 0 oherwse * R Now cosder how ax wll affec hs choce. The sauory corporae come ax rae s deoed ad he e prese value of ax allowaces per u of vesme s deoed A. Assume ha come s axed ad varable coss are fully ax deducble. If he level of oupu s depede of he sze of he vesme (ha s, F s a fxed cos) he full deducbly of varable coss mples ha he opmal level of oupu he presece of ax ad codoal o choosg sraegy, Y, s he same as s level he absece of ax, Y *. Ths mples ha he e prese value of he come sream becomes ( τ ) * Y, ad he e cos of he vesme s ( A ) F of sraegy s herefore:. The pos-ax ecoomc re R * ( ) Y ( A ) F = τ. (2.3) Pos-ax he vesor wll choose he proec wh he hghes level of R (aga, as log as hs s o-egave). Tha s, defg a bary dcaor, X, of wheher sraegy s chose he presece of ax, wll ake he values: X { R, R } f R = max 2 = (2.4) 0 oherwse I s sraghforward o geeralse hs o he case whch oupu depeds o he level of vesme. I hs case, he opmal level of vesme for ay sraegy, codoal o havg chose ha sraegy, wll be deermed by he equaly of margal reveue ad margal cos, mplyg a role for he effecve margal ax rae (EMTR). I hs case R ( ) Y ( A ) F = τ, ad he EATR s deermed wh referece o Y raher ha o Y *. I hs case, he EATR cao summarse all of he dfferece bewee vesme choces he absece of ax ad he presece of ax. However, hs s rue of almos all 8

10 such measures. For example, s sadard o compue he EMTR wh referece o he acual requred pos-ax rae of reur raher ha he requred rae of reur he absece of ax. Neglecg he dsco bewee Y ad Y *, he key ssue s wheher he ax sysem ca affec he rakg of proecs, ha s wheher X * π X. Clearly hs s possble f he proecs face dffere ax regmes, as s ofe he case. However, ca also be rue eve f all proecs face a decal ax regme, represeed by = = ad A = A = A 2 2. For he case where Y = Y * he ecessary ad suffce codo for ax o chage he rakg of he proecs, R > R bu R < R, s ha * * 2 2 * * ( )( F F ) < ( τ )( Y Y ) < ( A)( F F ) τ. (2.5) 2 2 I hs case, where he ax sysem s he same for he wo proecs, he rakg of proecs ca oly chage f he fxed coss are uequal, F fully deprecaed he frs perod, ha s A <. 2 π F, ad f hey cao be 2 For emprcal ad polcy purposes s useful o be able o summarse he mpac of ax o he rakg of proecs a sgle measure. The effecve average ax rae (EATR) provdes such a measure. The mos obvous approach would be o defe a effecve average ax rae, * ˆ ( ) mplyg ha I ˆ R R = R * Î, such ha ( I ) R = R *. Wh hs defo, he choce of he hghes R s decal o he choce of he hghes ( I ˆ ) * R. However, hs measure suffers from he dsadvaage ha s udefed for vesme proecs whch are margal pre-ax, ha s for R * = 0. Isead, we defe effecve average ax rae as he dfferece bewee he pre ad posax ecoomc re scaled by he e prese value of he pre-ax come sream: * * ( R R ) Y * I =. I choosg bewee sraeges, smply applyg hs rae o R 9

11 would o be approprae. However, s sraghforward o compare wo sraeges, as log as Y * ad F are boh kow. Choosg he sraegy wh he hghes R s equvale o choosg he sraegy wh he hghes R * * ( I ) Y ( I ) Y > ( F F ) Y. Equvalely, R > R ff * * 2 A umber of ecoomc suaos whch he EATR s he approprae measure of he mpac of corporae come axao o frms ceves o ves are ow cosdered. 2. Alerave locaos of produco Cosder a frm whch has decded o serve a foreg marke, ad whch could do so by producg a home ad exporg (sraegy ), or by producg he foreg locao (sraegy 2). I has a advaage over local frms ha ows a superor echology, so ha here s a barrer o oher frms eerg he marke. I wll choose o produce he locao whch wll ear he hgher pos-ax ecoomc re. There may be addoal coss o seg up abroad, relave o expadg exsg home capacy so ha fxed coss of sraegy are lower ha 2, F < F2. O he oher had, exporg he produc o he foreg locao s cosly, so ha varable coss are hgher uder sraegy, Y < Y2. The rakg of hese wo sraeges herefore depeds o he relave sze of fxed versus varable coss. Tax regmes dffer across coures so ha, π ad/or A π A. I s clearly possble for ax o chage he rakg of proecs so 2 2 ha, for example, R < R bu R > R so ha he absece of ax he frm would * * 2 2 prefer o produce abroad, bu he presece of ax he frm would prefer o produce a home. 5 If he opmal level of oupu s affeced by ax, he hs codo should use Y raher ha Y *. 0

12 Models of he locao decso of mulaoals, such as Horsma ad Markuse (992), have employed hs framework. Ths example ca easly be exeded o may possble foreg locaos. Codoal o decdg o produce abroad, a frm may face a umber of alerave ses. Examples would clude a US car maufacurer decdg where o produce Europe order o serve he Europea marke, or a Korea elecrocs producer choosg a Norh Amerca locao from whch o eer he Norh Amerca marke. Dffereces he ax regmes facg he frm may aler he rakg of aleraves. A model of hs ype was developed Devereux ad Grffh (998), whch he opmal level of oupu uder each sraegy depeds o he effecve margal ax rae, bu he choce bewee sraeges depeds o he rakg of pos-ax ecoomc re, ad hece o he effecve average ax rae. 2.2 Alerave produco echologes The dffere fxed coss, F ad F 2, may reflec vesme alerave produco echologes. For example, sraegy may represe hgh expedure o R&D whch s expeced o yeld a more auomaed ad cheaper produco process. By coras, sraegy 2 could mea lower vesme R&D. Ths would mply ha fxed coss are hgher uder sraegy, F > F, bu varable coss lower, Y > Y2. Eher sraegy would 2 be more profable ha followg boh. The ax sysem ca chage he rakg of he wo sraeges; whch sraegy s chose wll deped o he pos-ax level of ecoomc re whch s affeced by he effecve average ax rae. A ceral cocer he leraure o effecve margal ax raes has bee he dsoros whch mgh be roduced by dffereal axao of alerave forms of produco, whch mgh duce vesors o choose a sub-opmal mx of asses. Ths has geerally

13 bee measured by comparg he coss of capal for vesme alerave asses. 6 Bu hs approach reles o he assumpo ha he mx of asses ca be couously vared, wh he oucome ha he quay of each asse s chose so ha s margal produc s equal o s cos of capal. By coras, he framework preseed here s assumed ha here are a lmed umber of produco sraeges from whch o choose, each sraegy correspodg o a parcular asse mx. 2.3 Choce of produc ype or qualy Cosder a frm ha s operag a dffereaed produc marke, choosg bewee supplyg a produc of eher low or hgh qualy. Suppose ha he wo producs are hghly subsuable demad so ha he addoal reveue derved from producg boh producs would be less ha he addoal cos. The ax sysem could affec he rakg of he pos-ax ecoomc re ad hus dsor he frm s choce bewee he goods. A exreme example would be he choce of wha propery o buld o a pece o lad (where here s o possbly of cosrucg more ha oe ype of buldg) wheher, for example, o buld prvae houses, a aparme block or a hoel. Emprcal work lookg a he mpac of ax o produc choce has eded o focus o he mpac of excse ad commody axes. 7 I hs paper we focus o he mpac of corporae come axes o frms vesme choces. Because reveue from dffere 6 For example,goolsbee (998) develops a model where he ax reame of vesme affecs frms choce of qualy of vesme good. Ths s because ax apples oly o he purchase ad sallao of he capal good, whle fuure maeace ad rag coss are o coued as par of he vesme bu are expesed whe curred. Goolsbee s resuls dcae ha whe he cos of capal falls a larger proporo of hgh qualy vesme goods are purchased. 7 For example, Cremer ad Thsse (994) show ha a crease commody axao a vercally dffereaed produc marke, where frms compee o prce, chages he qualy mx of producs provded. Fershma e. al. (997) look a he mpac of ax he Israel auomoble marke, whch hey assume o be olgopolsc. They smulae he affec of ax o frms behavour ad are hus able o show how he mposo of he ax has affeced he profle of goods sold ad her relave prces. 2

14 sources s geerally axed a he rae same, he mpac of corporae ax o produc choce wll be hrough he dffereal reame of pus, for example due o dfferece deprecao allowaces. 2.4 Choce of vesme gve facal cosras There s a szeable leraure vesgag he exe o whch frms vesme plas are cosraed by he avalably of facal capal, eher from eral or exeral sources. 8 Oe mpora effec of he average ax rae s he mpac has o he amou of eral fuds avalable for vesme. The sze of eral fuds wll clearly deped o he average ax rae. Bu hs s a dffere cocep o he oe deal wh hs paper our measure s forward-lookg ad based o he prese value of reurs ad coss of a ew vesme. The exsece of facal cosras roduces a role for he measure developed hs paper. Facal cosras may make dffcul for he frm o uderake all of s poeally profable vesme proecs. Suppose ha here s a absolue lm o he fuds whch ca be rased for ew vesme. The frm wll choose oly hose proecs whch are expeced o yeld he hghes pos-ax ecoomc re based o a rakg whch may be affeced by axao. 8 See, for example, he survey by Hubbard (998). 3

15 3 THE EFFECTIVE AVERAGE TAX RATE ON DOMESTIC INVESTMENT Ths seco descrbes he proposed measure of he effecve average ax rae (EATR) as apples a domesc seg. A sadard model s se up whch ca corporae dscree vesme. I he ex seco hs s exeded o a eraoal seg. The properes of he EATR he eraoal case are equvale o hose for he domesc case. Cosder a value-maxmsg frm. I he rado of Kg (974), he value of he frm ca be derved from he capal marke equlbrum codo. Rsk s gored. The value of he frm perod s he e prese value of he pos-ax come sream, gve by V : d ( ( m ) m )V = D N V z(v V N ) (3.) c where s he omal eres rae, D s he dvded pad perod, N s ew equy ssued perod, m s he persoal ax rae o eres come, d m s he persoal ax rae o dvded come, c s he rae of ax cred avalable o dvdeds pad, ad z s he accruals-equvale capal gas ax rae. The rgh had sde of () s he reur from purchasg he equy of he frm; he absece of arbrage opporues ad rsk, hs s equal o he reur from ledg he value of he frm s equy. Rearragg () yelds a expresso for V ; hece V represes V : V { γd N V }/( ρ) = (3.2) d where γ = ( m )/( c )( z ) s a erm measurg he ax dscrmao bewee ew equy ad dsrbuos ad ρ = ( m ) /( z ) s he shareholders omal dscou rae. 4

16 Ne dvdeds pad by he frm ca be foud from he equaly of sources ad uses of fuds each perod: D N = Q( K T (3.3) ) I B ( ) B where Q( K ) s oupu perod, whch depeds o he begg of perod capal sock, K, I s vesme, B s oe-perod deb ssued perod ad T s he ax lably. Choosg he approprae us of capal ad oupu, he prces of oupu ad capal goods are ormalsed o uy perod. The ax lably s defed as: T T { Q K ) B ( I K )} = τ φ (3.4) ( where τ s he sauory ax rae, φ s he rae a whch capal expedure ca be offse agas ax, ad T K s he ax-wre-dow value of he capal sock a he ed of perod defed as K ( φ I. (3.5) T T = ) K I s useful o defe he e prese value of allowaces per u of vesme as A, where 9 φ φ A = τφ ρ ρ 2... = τφ( ρ). (3.6) ρ φ The e cos of oe u of physcal vesme perod s herefore ( A). Fally, he equao of moo of he capal sock s sadard: K I. (3.7) = ( δ)k 9 Ths expresso correspods o he case of expoeal, or declg balace, deprecao. The expresso s for sragh le deprecao s gve by equao (A.) Appedx A. 5

17 3. Measurg effecve ax raes Measures of effecve margal ad average ax raes o domesc vesme ca ow be derved. The sadard approach dervg he cos of capal, ad hece he effecve margal ax rae, EMTR, s o cosder a perurbao of he capal sock oe perod, say perod. Seg ecoomc re equal o zero a he marg, dv dk = 0, defes he cos of capal ad perms he opmal capal sock perod o be foud. We follow he spr of hs approach developg a measure of he effecve average ax rae, EATR. Cosder a vesme whch creases he physcal capal sock of he frm by oe u perod oly, so ha he chage s dk = ad dk s = 0 s. Ths requres a crease vesme perod of oe u: di = ad a reduco vesme perod such ha di = ( δ )( π ), where π s he omal crease prces bewee perods ad. The addo o K creases oupu perod. Ths geeraes a chage oupu of dq = p δ, where p represes he facal reur ad δ reflecs he oe-perod cos of deprecao, ad a chage e reveue of ( π ) = ( δ )( π ) dq p. Here we have smplfed he aalyss by assumg ha π s a geeral flao rae commo o capal ad oupu. We herefore absrac from specfc flao of he prce of capal, alhough hs would be sraghforward o roduce. Modellg of he facal polcy of he frm s ypcally arbrary models whch cosruc measures of he effecve margal ax rae. For example, he well-kow expressos used by Kg ad Fullero (984) mply facal cash flows whch are dffcul o usfy by modellg a smple oe perod vesme. The approach here s mplcly ha of seg facal cosras parcular, o-egavy cosras o dvded paymes, ew equy ssues ad deb ssues. Edwards ad Kee (984) 6

18 demosrae ha such a model he cos of capal depeds o wheher hese cosras are bdg each of perod ad perod. Gve hese hree cosras each perod mples ha here may be e dffere combaos of facg he vesme ad recevg he reur from he vesme. I order o geerae measures ha are close o hose commoly used, s ecessary o assume ha he cosra o o-egave dvdeds s o bdg perod. Sce dvdeds are he resdual hs model, hs mples ha, a he marg, ay reur from he vesme made perod s dsrbued as a dvded perod. 0 I he case of ew equy, mos ax sysems rea a repurchase of equy a s orgal prce o be a repayme of capal whch s o axed. I s assumed ha he frm akes advaage of hs opporuy for he case of ew equy face. Ay payme o shareholders above hs amou s axed as a dvded, ad s herefore reaed here as a dvded payme. Ths reduces he umber of possbles o hree, correspodg o he cases whe he vesme s faced by reaed eargs, ew equy ad deb perod. Raher ha model he cosras explcly, chages o hese forms of face perods ad are cosdered. The cases for domesc vesme are show Table 3., where dn ad db are he chages ew equy ad deb respecvely perod ( F s defed below). I he case of reaed eargs, he vesme s faced by a reduco dvded paymes perod ; hece deb ad ew equy ssues are uaffeced. I he case of ew equy face he frm ssues ew equy perod of φτ; hs faces a physcal vesme of sce a mmedae ax allowace worh φτ ca be clamed. As oe above, perod he frm repurchases ha equy a he 0 Ths assumpo s also followed elsewhere; see, for example, Kee (99) ad Devereux, Kee ad Schaarell (994). 7

19 orgal prce. I he case of deb faced vesme he frm borrows ad repays ha amou plus eres (a rae ) perod. φτ perod Table 3.: Facal cosras o vesme by source of face Reaed Eargs New Equy Deb dn db s = s db s = 0 s dn - φτ ; dn dn = 0 > = 0 s F = 0 dn = = F = ( φτ ) s s ( ρ) dn s = 0 s db = φτ ; db = 0 s > 0 s F ρ( γ ) γ ( φτ ) = ( ρ) { ρ ( τ )} I geeral, defe R o be he e prese value of hs vesme - equal o he e prese value of he ecoomc re geeraed. I geeral, hs s defed as: R = ( ρ) dv = s= 0 = dd γdd s dn s ( ρ) dn s dv. (3.8) To mpleme hs defo cosder he chage dvdeds, dd mpled by (3.3) s ad subsue o ha expresso he values of he chage vesme perods ad, he chage e reveue perod, ad chages he source of face from Table 2.3. The resulg expresso ca be usefully spl o wo pars: () he re arbuable o vesme faced by reaed eargs, RE R, ad () he addoal cos of rasg exeral face, F, defed (3.0) ad Table 3.. I sum, R = R F. RE The wo elemes of he pos-ax ecoomc re are: R RE γ = γ ( A) {( π )( p δ )( τ ) ( π )( δ )( A) } (3.9) ρ ad 8

20 ( τ) F = γdb ( γ ) dn. (3.0) ρ ρ Ths framework easly perms he dervao of sadard measures of he cos of capal: se R = 0 ad solve for he margal facal rae of reur, deoed ~ p : ~ ( A) F ( ρ) R = 0 p = { ρ δ ( π ) π} δ. (3.) ( τ )( π ) γ ( τ )( π ) The ax clusve effecve margal ax rae (EMTR) s gve by EMTR = ( ~ p s )/ ~ p, where s s he pos-ax real rae of reur o he shareholder: s ( m ) π =. (3.2) π Ths EMTR ca be llusraed he case whch m = z = 0 ad hece ρ =, he omal eres rae. Defe r o be he real eres rae: ( r )( π) = ( ). The he cos of capal for vesme faced by reaed eargs ( F = 0 ) becomes: p~re ( A ) = r ( τ) { δ} δ (3.3) ad he equvale EMTR s: EMTR RE = ( r ( r δ)( τ A ). (3.4) δ )( A ) δ( τ) The geeral expresso for he cos of capal (3.) s smlar o measures of he cos of capal derved elsewhere. There are wo prcpal dfferece from he Kg ad Fullero (984) formulao. Frs, here he e prese value of deprecao allowaces, A, s derved usg he shareholders dscou rae, ~ p. Secod, he mpac of alerave forms of facg s lmed o perods ad he case of ew equy ad perod he case of deb. Ths mples ha he allowace perod - ha s φτ - s mpora, 9

21 raher ha smply he e prese value of allowaces, A. We choose hs approach o he grouds ha he facal flows mpled by he Kg ad Fullero formulao for ew equy are very dffcul o usfy. The effecve average ax rae, EATR, s defed for p ~ p, as descrbed he prevous seco, by dvdg he dfferece bewee pre- ad pos-ax ecoomc re by he e prese value of he come sream. Evaluag he pre-ax ecoomc re a he eres rae he presece of ax yelds a expresso for he pre-ax ecoomc re, * R of: * R = p r = r {( π )( p δ ) ( π )( δ )} (3.5) Noe ha he absece of ax, he addoal erms due o facg by ew equy or deb (he pre-ax equvale of F ) boh have a e prese value of zero ad so do o affec he pre-ax ecoomc re. As oed above, a aural measure of he EATR would be he proporoal dfferece bewee R * ad R e. * * ( R R )/ R. However, hs s udefed whe R = 0. * * Isead, we scale he dfferece ( R R ) by he e prese value of he pre-ax come sream, e of deprecao: p /( r ). Hece he measure of he EATR proposed here s: EATR * R R = p r. (3.6) A geeral expresso for he EATR whch uses he value of R from (3.9) ad (3.0) ad he value of R * from (3.5) s gve he Appedx expresso (A.5). Here we llusrae s properes he absece of persoal axes o eres come ad capal 20

22 gas: m = z = 0, mplyg ha ρ =. Subsug hese values o he expresso for R ad smplfyg yelds: γ R = r {( p δ)( τ) ( r δ )( A )} F Combg (3.6), (3.9a) ad (3.5) ad rearragg yelds:. (3.9a) EATR { r[ γ ( A) ] γδ ( τ A) F ( r) } = γ ( τ ). (3.7) p Ths measure of he EATR has several eresg ad aracve properes whch are ow dscussed usg sx proposos. The frs hree proposos cocer he dsrbuo of he EATR over a rage of profably. They dcae he upper ad lower bouds o he values ake by he EATR, ad hece he codos uder whch he EATR rses or falls as he rae of prof rses. Proposo I he absece of persoal axes o eres come ad capal gas ( m = z 0 ), he effecve average ax rae for a margal vesme s equal o he effecve margal ax rae, R = 0 EATR = Proof. For a margal vesme, ecoomc re s zero ad he rae of reur s equal o R = 0 ad hece p = ~ p. Dervg p = ~ p from (3.9a) yelds: ~ rγ ( A) δγ ( τ A) F ( r) R = 0 p = (3.a) γ ( τ ) Subsug for p ~ p = from (3.7) ad rearragg yelds: ( τ ) γ ~ p r ~ p r EATR = γ ( τ ) ~ = = EMTR p ~. (3.7a) p 2

23 Proposo 2 I he absece of persoal axes o eres come ad capal gas ( = z = 0 ), he effecve average ax rae for a very profable vesme approaches m a adused sauory ax rae: p EATR γ( τ). Proof Immedae from (3.7). Proposo 3 I he absece of persoal axes o eres come ad capal gas ( = z = 0 ), he effecve average ax rae creases wh profably f ad oly f he m adused sauory ax rae exceeds he effecve margal ax rae, e. EATR p > 0 EMTR < γ( τ). Proof. Dffereag (3.7) wh respec o p mples: [ γ( A )] γδ( τ A ) F( r 0 EATR p > 0 r ) >. Usg he expresso for p ~ (3.a) hs ca be wre as: EATR > 0 r > γ ( τ ) p p ~. Subsug usg he expresso EMTR = r / ~ p ad rearragg yelds: EATR p > 0 EMTR < γ( τ). These hree properes of he EATR are aracve. The EATR ca be see as reflecg he whole schedule of effecve ax raes over he rage of profably from a margal vesme, where EATR=EMTR, o a very hgh rae of profably, where he EATR eds owards he sauory ax rae, adused for he ax reame of dvdeds, γ( τ). The EMTR ad he adused sauory ax rae hus represe he upper ad lower bouds of values of he EATR. 22

24 Three furher feaures of he EATR are worh og, comparso wh well-kow properes of he EMTR. Frs, Auerbach (979) showed ha he EMTR for vesme faced by reaed eargs s depede of he axao of dvdeds pad o he shareholder. Ths does o hold for he EATR a posve values of ecoomc re. Proposo 4 I coras o he EMTR, he EATR s o depede of he ax rae o dvdeds ( γ ) for a vesme faced by reaed eargs. Proof. Immedae from (3.7). Addg persoal axes clearly does o affec hs depedece. The remag wo proposos descrbe he value of he EATR for wo specal forms of axao. Proposo 5 I he absece of persoal axes o eres come ad capal gas ( m = z = 0 ), a eural busess ax, wh EMTR=0 ad a classcal ax sysem ( γ = ), has a EATR wh a lower boud of zero for a margal vesme ad approaches he sauory ax rae for a very profable vesme. Proof. Immedae from Proposos ad 2, gve EMTR = 0 ad g =. Proposo 6. I he absece of persoal axes ( m = z = m = 0 ), for a domesc ax sysem whch gves relef for rue ecoomc deprecao bu o relef for he cos of face, he EATR s equal o he EMTR ad also equal o he sauory ax rae, τ, rrespecve of profably. d Proof. A ax sysem ha gve relef for rue ecoomc deprecao mples ha A = δτ r δ δ r r 2... = r δτ δ. Subsug hs value, ad F = 0, o (3.7) yelds p~ = r /( τ) whch mples ha EMTR = τ. I he absece of persoal 23

25 axes o dvdeds ad ay relef for equy face, he γ =. Ths mples ha boh he lower ad upper bouds o he EATR are equal o τ, ad hece EATR = EMTR = τ. 4 THE EFFECTIVE AVERAGE TAX RATE ON INTERNATIONAL INVESTMENT The approach used he prevous seco ca be used also o measure he effecve margal ad average ax raes for a eraoal vesme. I hs seco we skech he dervao of hese effecve ax raes; he dealed measures are gve he Appedx. The basc approach s o cosder a pare frm locaed he resdece coury whch uderakes vesme he source coury hrough a whollyowed subsdary. The pare frm s assumed o be owed by shareholders locaed. We ake accou of axes leved by he goverme of o come eared by he subsdary, corporae axes leved by he goverme o he same come ad persoal axes leved by he goverme o he shareholders. The precse aure of he combed ax sysem s smlar o ha Kee (99) ad OECD (99) ad s summarsed he Appedx. However, s useful o here o oe wo ax parameers: σ s he overall corporae ax rae leved o dvded paymes from he subsdary o he pare ad ω s he overall corporae ax rae leved o eres paymes from he subsdary o he pare. I geeral, ax parameers are equvale o hose defed he prevous seco; o oe ha hey apply o coury hey carry a subscrp. Suppose ha he prevous seco refers o he domesc acves of he pare frm. Allowg for hs frm o have a foreg subsdary does o affec he geeral expresso for he value of he frm (3.2); hs remas he frm s maxmad. However, he 24

26 sources ad uses of fuds saeme (3.3) mus be exeded o allow for facal flows o ad from he subsdary, ogeher wh ay cosequeal ax effecs. Ths cludes ew equy he subsdary provded by he pare ad ledg o he subsdary by he pare. I also cludes dvdeds ad eres receved by he pare, e of axes pad o he source coury goverme. Fally cludes furher axes due he resdece coury o he come eared he source coury. These flows are show deal he Appedx. As he domesc case, we cosder a perurbao he capal sock of he frm hs case he subsdary perod. Ths s acheved by chagg vesme he subsdary perods ad he same way as he prevous seco. We cosder hree ways whch he subsdary faces he crease vesme, aga correspodg o domesc case: reaed eargs, ew equy ssued o he pare ad borrowg from he pare. I he laer wo cases, we ur allow he pare o choose bewee he hree sources of face. We do o cosder he case of borrowg he source coury ; hs would be a sraghforward exeso. The e prese value of he ecoomc re geeraed by he perurbao of he subsdary s capal sock akes he same form as for he domesc case. Droppg me subscrps, we label hs RE R = R F F where for coveece we have dropped he me subscrp. The frs eleme, RE R, correspods o he ecoomc re geeraed by a perurbao he capal sock faced by reaed eargs. The secod eleme, F summarses he e prese value of he cash flows assocaed wh ew equy ad deb facg of he pare frm, ad s decal o he expresso (3.0). The hrd eleme, F, summarses he e prese value of cash flows assocaed wh ew equy ad deb face of he subsdary. The frs ad hrd erms have he followg values (see he Appedx for deals.): 25

27 R RE = γ ( σ )( A) γ ( σ ρ ) { E( π )( p δ )( τ ) E( π )( δ )( A )} (4.) ad F γdb = ρ { E[ σ ( ( τ )) ω ] γσ } γσ E dn. (4.2) ρ where varables have he same meag as he prevous seco, excep where he subscrp represes he source coury. The exchage rae s ormalsed a uy perod ad akes he value E perod. The expresso E( π ) herefore reflecs he omal prce chage expressed he currecy of he resdece coury. These expressos correspod closely o (3.9) ad (3.0). The ew varables σ ad ω reflec he mpac o overall ax lables of chagg he flows from he subsdary o he pare of dvdeds ad eres respecvely. Thus, for example, all cash flows assocaed wh a vesme he subsdary faced by reaed eargs drecly affec he flow of dvdeds (whch are reduced by facg he vesme perod, bu creased by he reur o he vesme perod ): boh cases he value o he ulmae shareholder s herefore mulpled by he facor σ. Smlarly, for gve vesme, flows of ew equy ad deb o ad from he subsdary also have a drec mpac o he flow of dvdeds ad hece roduce σ. Payme of eres from he subsdary o he pare assumed o be a he marke eres rae roduces he e ax rae o such flows: ω. As he domesc case, hs framework perms dervao of measures of he cos of capal for eraoal vesme. Defe he cos of capal o be he real reur he 26

28 home currecy for whch R = 0. Deoe hs ~ ρ = E( π ) p /( π). I s sraghforward o show ha hs s: R = 0 ~ p ( A ) = ( π )( τ ) { ρ δe( π ) [ E( π ) ] } ( F F )( ρ) γ ( σ )( π )( τ δe( π ) ) ( π ) (4.3) The EMTR for a eraoal vesme s EMTR = ( ~ p ~ s )/ p, where s s he pos-ax rae of reur o he shareholder. We follow he same approach as for he domesc case defg a measure of he EATR. I he absece of ax, F F = 0, ad so he pre-ax ecoomc re (aga = evaluaed a he same eres rae, ) s R { E( )( p ) ( ) } * π = We defe he EATR for eraoal vesme as:. (4.4) EATR = * R R E( π ) p (4.5) where he deomaor s aga he e prese value of he come sream from he perurbao o he capal sock of he subsdary, R * s defed (4.4) ad R s defed as he sum of (4.), (3.0) ad (4.2). A dealed expresso for hs EATR s gve he Appedx. However, o gve more uo here, oe ha for he specal case of purchasg power pary, E( π ) = ( π ), ad o persoal axes he resdece coury o eres come or capal gas ( = z = 0 ), hese expressos smplfy o: m 27

29 R RE p r =, (4.6) r γ( σ ) R = r {( p δ )( τ ) ( r δ )( A )} F F (4.7) ad EATR * R R = = γ ( σ p r { r[ γ ( σ )( A )] δγ ( σ )( τ A ) ( F F )( r) } )( τ ) p (4.8) Ths expresso s smlar o ha for he domesc case, gve (3.7). There are hree ma dffereces. Frs, mos of he ax varables refer o he source coury,, raher ha he resdece coury. Secod, a addoal erm σ appears several places, reflecg he addoal ax o dvdeds pad by he subsdary o he pare. Thrd, here s a addoal facg erm, reflecg he ax mplcaos of facg he subsdary as well as he pare. Ths measure of he EATR for eraoal vesme has equvale properes o ha for he domesc vesme descrbed above. We brefly repea he frs four hs coex. Proposo a I he absece of persoal axes o eres come ad capal gas ( = z = 0 ), he effecve average ax rae for a margal eraoal vesme s m equal o he effecve margal ax rae, R = 0 EATR = EMTR. Proof. Ths s mos easly see for he case of purchasg power pary, alhough he proposo s o lmed o hs case. I hs case, smplfyg (4.3) for E( π ) = ( π ) yelds: 28

30 R rγ ( σ )( A ) δγ( σ )( τ A ) ( F F )( r ) = 0 p~ = (4.3a) γ( σ )( τ ) Usg hs expresso, for a margal vesme, (4.8) ca be wre as EATR { r p~ γ( σ )( τ )} = γ( σ )( τ ). p~ Rearragg yelds: p~ r EATR = = EMTR. p~ I he absece of purchasg power pary, bu wh = z = 0, usg he defo of ~ p from (4.3) yelds he same resul. m Proposo 2a I he absece of persoal axes o eres come ad capal gas ( = z = 0 ), he effecve average ax rae for a very profable vesme approaches m a adused sauory ax rae: p EATR γ ( σ )( τ ). Proof Immedae from (4.8). The absece of purchasg power pary would clearly o affec hs resul. Proposo 3a I he absece of persoal axes o eres come ad capal gas ( = z = 0 ), he effecve average ax rae creases wh profably f ad oly f he m adused sauory ax rae exceeds he effecve margal ax rae, e. EATR p > 0 EMTR < γ( σ )( τ ). Proof. Ths s aga mos easly show for he case of purchasg power pary, alhough hs s o ecessary for he proposo o hold. Dffereag (4.8) wh respec o mples: p 29

31 [ γ( σ )( A )] γδ( σ )( τ A ) ( F F )( r ) 0 EATR p > 0 r > Usg he expresso for p~ (4.3a) hs ca be wre as: EATR p > 0 r > γ( σ ~ )( τ) p. Subsug he expresso: EMTR = r / ~ p ad rearragg yelds: EATR p > 0 EMTR < γ( σ )( τ ). The EATR for eraoal vesme ca hus also be see as reflecg he whole schedule of axes from a margal vesme o a hghly profable vesme. Fally, us as he EATR for a reaed-eargs faced domesc vesme depeds o he dvded ax rae γ, so he EATR for a reaed eargs-faced eraoal vesme also depeds o he ax rae o dvdeds pad from he subsdary o he pare, σ. Proposo 4a I coras o he EMTR, he EATR for eraoal vesme faced by reaed eargs s o depede of he ax rae o dvdeds pad by he subsdary o he pare ( σ ). Proof. Immedae from (4.8). 5 EMPIRICAL APPLICATION I hs seco some of he properes of he EATR are examed usg daa o he ax reame of vesme sx asses four coures - Germay, Japa, he UK ad he See Harma (985). 30

32 USA over he perod A descrpo of he ax sysems ad he assumpos used o calculae he effecve ax raes s gve he Appedx B Tax schedules Germay, Japa, he UK ad USA The four paels of Fgure 2. each llusrae he developme of he domesc corporao ax sysem over he perod 979 o 997 for each coury. I each case, he persoal ax raes of he margal vesor are assumed o be zero. The ax raes show each pael are: he sauory ax rae o reaed eargs; he EMTR for domesc vesme pla ad machery faced by reaed eargs; he adused sauory ax rae, γ ( τ ), ad values of he EATR, for he same vesme for profably raes of 30%, 70% ad 00%, p = 0.3, 0.7,.0. Fgure 2. llusraes several of he properes of he EATR dscussed above. A lower levels of profably he EATR eds o follow a smlar paer o he EMTR, whle a hgher levels of profably eds o follow a smlar paer o he adused sauory ax rae. However, he relave magude of he EMTR ad he adused sauory ax rae vares boh bewee coures ad over me. I Germay, for example, he EMTR s srogly correlaed wh he sauory ax rae, ad s always hgher ha he adused sauory ax rae, γ ( τ ). Alhough he sauory ax rae Germay has bee cossely hgh, Germay operaed a sysem close o full egrao hroughou hs perod ad hus γ was also hgh, mplyg a very low value of γ ( τ ). The oppose s rue of he USA, where he 986 reforms had he effec of reducg he sauory ax rae bu creasg he EMTR. Sce he USA operaed a classcal sysem over he whole 2 A more dealed descrpos of he ax sysems each of hese coures s gve Cheells ad Grffh (997). 3

33 perod, g = he absece of persoal axes, ad so γ ( τ ) = τ. Hece a low raes of prof, he EATR creased followg he 986 reforms; bu a hgh raes of prof fell. Ths process was eve more exreme he UK, where he 984 reforms reduced he sauory ax rae sages from 52% o 35%, bu a he same me reduced deprecao allowaces, summarsed here by A. The combao of hese reforms led o a crease he EMTR, bu a reduco he adused sauory ax rae: fac hese wo raes crossed 984. As a cosequece, before he 984 reforms he EATR creased wh profably; bu afer he 984 reforms, he reverse was rue. The 997 reforms reduced γ o.0 for ax-exemp shareholders, rasg γ ( τ ) swchg he sg of EATR back aga. p o he sauory ax rae, ad The poso Japa has varous elemes of hose see he oher coures. For example, lke Germay he EMTR s posvely correlaed wh he sauory ax rae. Also lke Germay, he frs half of he perod, he EMTR was above he adused sauory ax rae, mplyg ha he EATR was lower for hgher raes of prof. However, 99, γ fell from.27 o.0 for ax-exemp shareholders. Lke he 997 reform he UK hs rased γ ( τ ) EATR / p. equal o ad had he effec of swchg he sg of 5.2 Alerave produco echologes Oe of he ecoomc suaos whch was argued above ha he EATR may affec vesme s he choce bewee a umber of alerave dscree mehods of produco. If hese alerave mehods use dffere asses, or he same asses dffere proporos, he he EATR may affec frms choce bewee echologes. To 32

34 explore hs, for each coury usg he 997 ax sysem, he four paels of Fgure 2.2 plo he EATR for domesc vesme faced by reaed eargs sx dffere asses dusral buldgs, dusral pla ad machery, veores, curre R&D expedure, R&D buldgs ad R&D pla ad machery agas he rae of prof of he vesme, summarsed by p. Tax sysems all four coures rea hese asses dfferely from each oher by allowg dffere raes of deprecao ad some cases by gvg addoal allowaces or ax creds. Each le he fgure begs a he po where he proec s margal ha s p = ~ p ad he EATR s equal o he EMTR. 3 The mos oable feaure of Fgure 2.2 s ha all coures, as profably creases, he EATR for vesme dffere asses coverges o γ ( τ ), whch s depede of ax deprecao raes ad creds (summarsed by A). The reaso s clear: as profably creases, he value of deprecao allowaces ad oher ax creds becomes smaller relave o he ax o he reur. Tha s, varaos A across asses become less mpora. Ths suggess ha sudes whch use he EMTR o exame he dsoros produco echology may exaggerae he dffereces he releva effecve ax rae faced by vesors hese asses. I ur, hs mples ha esmaes of he mpac of ax o asse choce usg he EMTR raher ha he EATR may uderesmae he rue srucural coeffces. 5.3 Choce of locao of produco Aoher of he ecoomc suaos dscussed above s he choce bewee alerave locaos for produco. Ths ssue s addressed emprcally Devereux ad Grffh 3 For preseao reasos he le for R&D curre expedure for he USA does o sar a he cos of capal, bu a 0% profably. Ths s because he EMTR for hs vesme s very large ad egave. 33

35 (998) ad s llusraed here wo ways: by cosderg how he ax rae vares across locao choces facg a US-resde frm decdg where o locae produco; ad by cosderg how vares for foreg-resde frms vesg he USA. I calculag he effecve ax raes show Fgures 2.3 ad 2.4 he pare frm s assumed o be faced by reaed eargs bu alerave forms of rasfer bewee he pare ad he subsdary are allowed Ivesme by US-resde frm The frs of hese quesos s examed deal Devereux ad Grffh (998) where a frm level pael s used o esmae he mpac of he EATR o he locao decso of US frms servg he Europea marke. The emprcal resuls dcae ha he EATR plays a drec ad sgfca role deermg frms locao choces. The 4 paels of Fgure 2.3 plo he EATR agas he rae of prof of a vesme 997. Pael (a) shows he poso of a domesc frm uderakg vesme pla ad machery faced by reaed eargs. The oher paels show he EATR faced by a US pare vesg pla ad machery each of he 4 coures, each for a dffere form of facg of he foreg subsdary (he le represeg domesc vesme he USA s he same each of he 4 paels). As Fgure 2.2, each le begs a he margal vesme, p = ~ p. Pael (a) shows he EATR for 997, correspodg o Fgure 2.. The Germa domesc EATR falls as he rae of prof creases, whle he domesc EATR he oher hree coures creases wh he rae of prof. Pael (b) shows he case of a subsdary of a US pare locag each coury faced by reaed eargs. As oed Proposo 4 above, he EMTR hs case s depede of he overall ax rae (cludg US ax) o dvdeds pad by he subsdary o he pare, s. Hece, a he 34

36 marg for ax exemp shareholders of he pare frm, oly source coury axes affec he EMTR. However, hs s geeral o rue for he EATR. Alhough he rakg of he EATR across he four possble locaos does o chage as he rae of prof creases, he dffereces bewee hem do vary. For example, a a hgh rae of prof, Japa has a subsaally hgher EATR ha he oher hree coures, all of whch are close o each oher. A he marg, however, he EATR Japa s oly margally hgher ha ha Germay, boh of whch are subsaally hgher ha hose he UK ad USA. Paels (c) ad (d) vesgae alerave mehods of he pare facg he subsdary, by ew equy ad deb respecvely, hereby roducg he F erms from (4.2) ad Table A.4. I mos cases roducg hese exra erms creases he EATR, dcag ha eraoal vesme faced by boh ew equy ad deb s more heavly axed overall ha vesme faced by reaed eargs. A excepo o hs s he case of ew equy vesme o Germay, whch beefs from he hgh level of γ applyg o US pares vesg Germay. 4 Noe hough, ha hs beef s greaes a low raes of prof; hs s because he beef o ew equy vesme depeds o he cos of he vesme, bu o o he rae of prof eared. Ths mples aga ha he EMTR compued for a margal vesme - represes a exreme case comparg alerave forms of face. 4 US pares do o receve he same egrao ax cred as Germa resde shareholders; however, hey do beef from he Germa spl rae corporao ax, whch, effec, also geeraes a hgh value of γ relave o oher forms of vesme. 35

37 5.3.2 Ivesme by foreg-resde frm The paels Fgure 2.4 provde smlar formao o hose Fgure 2.3 bu show he ax rae o vesme o he USA by pare compaes each of he oher coures. For comparso, pael (a) repeas he poso for domesc vesme. I he oher paels, he pare frm s faced by reaed eargs, ad he EATR s aga show separaely for each of he hree ways whch he subsdary may be faced: reaed eargs pael (b), ew equy pael (c), ad deb pael (d). Pael (b) llusraes Proposo 4 from Seco 3.4. The EMTR for eraoal vesme faced by reaed eargs depeds oly o source coury axao; hs mples ha s he same for vesme by each of he foreg subsdares vesg he USA, as well as for domesc frms. Sce a hs po he EMTR s equal o he EATR, he poso of all four poeal vesors s he same a hs po. However, as he expeced rae of prof, p, creases he EATRs vary by locao of vesor. I parcular, whle he EATR for domesc vesme ad ward vesme from Japa ad he UK creases wh p, he reverse s rue for ward vesme from Germay. The poso for Germay s due o he hgh value of γ, whch uder he crcumsaces assumed here, mples ha Germa shareholders ca, effec, clam back much of he ax pad he USA. 5 Paels (c) ad (d) reflec he addoal ax coss ad beefs from he F erms Table 2.4. These paels provde a srkg llusrao of he dffereces across vesors he EATR faced a dffere raes of prof. For example, for margal vesme faced 5 Ths requres he Germa pare o pay dvdeds ou of domesc come for ax purposes, bu effec faced from foreg source come. See Wechereder (996, 997) for a fuller aalyss of hs possbly. 36

38 by deb (pael (d)), Germay appears subsaally dsadvaaged relave o oher vesors: hs s because eres pad from he USA o Germay receves relef a he relavely low US sauory ax rae, bu s axed a he relavely hgh Germa ax rae. However, a hgher raes of prof, he mporace of hs facor (whch s urelaed o he rae of prof) s ouweghed by he beef of he hgh γ Germay, so ha he EATR for Germa vesors he USA becomes subsaally lower ha he EATRs for oher vesors he USA. 6 SUMMARY Ths paper has vesgaed he role of axao cases whch a vesor faces a choce bewee wo or more muually exclusve proecs ha ear more ha he mmum requred rae of reur. I s argued ha here are a umber of crcumsaces whch such a choce s lkely o occur, cludg choce of locao ad choce of echology. The choce of whch proec o uderake depeds o he level of he posax ecoomc re ha would be eared from each opo. The mpac of axao o he choce cao herefore be measured he sadard way by aalysg a margal vesme. Isead, he mpac depeds o he proporo of ecoomc re capured ax. A ew measure - a effecve average ax rae (EATR) s proposed, whch aemps o summarse he mpac of ax such choces, ad whch bulds o he sadard approach o measurg he effecve margal ax rae (EMTR). Ths measure of he EATR has several aracve properes cludg ha, for a margal vesme, s equal o he EMTR. I ca herefore be erpreed as summarsg he dsrbuo of ax raes for a vesme proec over a rage of profably; he EMTR represes he specal case of a margal vesme. Esmaes of he EATR are preseed for four coures 37

39 Germay, Japa, UK ad USA - over he perod They llusrae several feaures of he EATR. REFERENCES Alworh, J. (988) The face, vesme ad axao decso of mulaoals, Basl Blackwell: New York Auerbach, A.J. (979) Wealh maxmzao ad he cos of capal, Quarerly Joural of Ecoomcs, 2:07-27 Auerbach, A.J. (983) Corporae axao he Ued Saes, Brookgs Papers o Ecoomc Acvy, 2: Bloom, N., Cheells, L., Grffh, R. ad Va Reee, J. (999) How Has Tax Affeced he Chagg Cos of R&D? Evdece from Egh Coures forhcomg The Regulao of Scece ad Techology, H.L.Smh (ed.), Macmlla: Lodo Caves, R. (996) Mulaoal Eerprse ad Ecoomc Aalyss, 2 d edo, Cambrdge, Eglad: Cambrdge Uversy Press Cheells, L. ad Grffh, R. (997) Taxg profs a chagg world, Isue for Fscal Sudes. Colls, J.H. ad D.A. Shackelford (995) Corporae Domcle ad Average Effecve Tax Raes: The Cases of Caada, Japa, he UK ad USA, Ieraoal Tax ad Publc Face, Vol 2, Devereux, M.P. ad R. Grffh (998) Taxes ad he locao of produco: evdece from a pael of US mulaoals, Joural of Publc Ecoomcs, 68(3), Devereux, M.P., Kee, K.J. ad F. Schaarell (994) Corporao ax asymmeres ad vesme: evdece from UK pael daa", Joural of Publc Ecoomcs, 53, Dug, J.H. (977) Trade, locao of ecoomc acvy ad MNE: a search for a eclecc approach, B. Ohl, P.O. Hesselbor ad P.M. Wkma eds. The Ieraoal Allocao of Ecoomc Acvy, Lodo: Macmlla, Dug, J.H. (98) Ieraoal Produco ad he Mulaoal Eerprse, Lodo: George Alle ad Uw. Edwards, J.S.S ad M.J. Kee (984) Wealh maxmzao ad he cos of capal: a comme, Quarerly Joural of Ecoomcs, XCVIII, Fershma, C., N. Gadal ad S. Markovch Esmag he effec of ax reform dffereaed produc olgopolsc markes Tel Avv Uversy Workg Paper No Goolsbee, A., Taxes ad he qualy of capal, Uversy of Chcago ad NBER mmeo Gruber, H. ad J. Mu (996) Do axes fluece where US mulaoal corporaos ves? paper preseed a TAPES coferece, Amserdam, 996 Hall. R.E. ad D. Jorgese (967) Tax polcy ad vesme behavor, Amerca Ecoomc Revew, 57, Harma D.G. (985) Tax polcy ad foreg drec vesme, Joural of Publc Ecoomcs, 26, Horsma, I. ad Markuse, J. (992) Edogeous marke srucures eraoal rade (aura fac salum) Joural of Ieraoal Ecoomcs, 32, Hubbard, R.G. (998) Capal-marke mperfecos ad vesme, Joural of Ecoomc Leraure, XXXVI, Jorgese, D.W. (963) "Capal heory ad vesme behavour", Amerca Ecoomc Revew, 53, Judd, K. (997) Opmal axao ad spedg geeral compeve growh models, Joural of Publc Ecoomcs (7) (999) pp. -25 Kee, M.J. (99) Corporao ax, foreg drec vesme ad he sgle marke L.A. Wers ad AJ Veables (eds.) The Impac of 992 o Europea Trade ad Idusry, Cambrdge Uversy Press: Cambrdge 38