Slovenia has a longer timeline too, but as a country in transition, one associated with data and conversion difficulties. Over time countries have adjusted tax rates and tax bases, so as to achieve carbon-energy taxes more in accordance with theoretical prescriptions, but in the short run pragmatic considerations have prevailed. For this reason effective fuel tax rates vary considerably from sector to sector and while it is not always immediately clear what kind of exemptions, liability caps or special arrangements that specific industries or target groups have obtained, these circumstances are of course crucial when a proper ex-post evaluation of impacts and effectiveness is to be made.
In order to tackle the specific challenge of disentangling and attributing the specific impact of the tax shift COMETR relies on a suitable macro-economic framework: the E3ME model of Cambridge Econometrics which is a comprehensive time-series estimated macro-economic model of economy-energy-environment relations within the EU, which also can account for EU trade relations with the rest of the world 4.
For the purposes of modeling changes in fuel consumption and CO 2 emissions as a result of relative price changes and feed-backs in the economy, the model has a high resolution, featuring here eleven different fuels and more than 40 economic sectors. The COMETR project carefully improved and sharpened the modeling base of E3ME by retrieving country-specific data for carbon and energy taxes, including all the relevant sector-specific exemption arrangements, in order to be able to model and disentangle the impacts with E3ME.
The 25 billion euro in new carbon-energy taxes came on top of pre-existing energy taxes amounting to about 80 billion euro annually. Exemptions, non-payments and negotiated agreements for specific industrial sectors are included as accurately as possible as they happened, subject to the total revenues matching the published figures in each case. Both the ex-post and ex-ante parts of the modelling were undertaken with the same set of equations, for instance for the labour market wage formation Barker et al.
The size of this reduction is dependent both on the tax rates imposed how they are applied to the various fuels and fuel user groups, how easy it is for fuel users to substitute between the various fuel types and non-fuel inputs and the scale of the secondary effects from resulting changes in economic activity. On average the reduction in fuel demand estimated for was 2. No reduction was identified in Slovenia, which in fact mainly relabelled its pre-existing mineral oils tax into a CO 2 -tax.
Source: Cambridge Econometrics. For example, a tax system that encourages the use of coal is likely to produce higher emissions than one that encourages the use of natural gas or biofuels. E3ME includes explicit equations for fuel shares of hard coal, heavy oil, natural gas and electricity. Assumptions are made about the other fuel types linking them to the closest modeled alternative e. For middle distillates petrol, diesel, etc. The reason for this is that demand for these fuels is dominated by the transport sectors. This sector does not generally use any other fuels, so fuel share equations are not required.
The effects closely follow the results for total fuel consumption, with the largest reductions estimated for the countries with the highest tax rates. Finland and Sweden, for example, experience the largest reductions in emissions, in most cases exceeding the decline in fuel demand, providing evidence for the efficiency of ETR in reducing emissions. In contrast, the German ETR was not particularly efficient in reducing emissions as it did not include coal. According to E3ME the European environmental tax reforms had by caused reductions in greenhouse gas emissions of 3.
These funds were made available in a Danish Energy Agency supervised program. Auditors provided an independent review of company energy practices and made recommendations for improvements as well as for investments based on up to four year returns. For Denmark, Enevoldsen et al.
From a few initial remarks in his book Porter elaborated the argument and cautioned that many environmental regulations presently violate the principles for a positive impact on competitiveness as they involve command-and-control requirements for specific pre-defined technologies, often end-of-pipe, rather than leaving room for adaptation, flexibility and innovation. References to the Porter hypothesis in the literature tend to neglect that use of market-based instruments for environmental policy implementation is the premise for improvements in competitiveness Porter, Since environmental taxes serve to correct market failures, by definition they do not share the distorting properties of many other taxes.
By adopting a fiscally neutral package that exchanges existing taxes for carbon-energy taxes, the opportunity arises to reap positive benefits in terms of a higher employment rate, which may improve short-term economic performance, while also delivering a long-term environmental dividend. However, complications arise where environmental taxes are introduced in the realistic context of pre-existing taxes that are distorting to the economy.
The strong version is the claim that any environmental tax that replaces another tax will by definition improve social welfare, which is regarded as a controversial claim. The weak version, on the other hand, focuses on the revenue-recycling aspect and states that once environmental taxes have been introduced, using revenues to reduce distortional taxes is preferable to a lump-sum return of revenues—merely to reduce on the pure costs and not a controversial claim.
An intermediate version of the double dividend argument implies, according to Goulder, that whether overall social welfare will indeed be improved as a result of ETR depends on the specific properties of the distortional tax which is being replaced with an environmental tax—in other words whether the sign of the costs is positive or negative depends on context and circumstances of the specific tax shift in question.
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Many have accepted this call for a much more careful examination of the opportunities for a double dividend, which also was a lead for the COMETR project to examine outcomes of ETRs in Europe. In essence, the negative tax interaction effect will usually exceed the positive revenue-recycling effect, except under special circumstances where highly distortional taxes are replaced. The formal argument hinges on the crucial assumption that income taxation a priori minimises the excess tax burden, as well as on the presumption that ETR is introduced on top of existing environmental taxes or regulations that sufficiently internalise externalities Weinbrenner, In a second article where they explore the relationships in the context of a dynamic model, the findings are relaxed somewhat: if the ETR leads to lower regulatory pressure on companies then a double dividend may arise Bovenberg and de Mooij, Nielsen et al.
They show that unemployment will be reduced if a pollution tax is introduced. In this case the tax interaction effect also influences the value of the unemployment benefit, causing more unemployed to enter the labour market. The overall effect on the rate of economic growth could, however, still become negative. Goodstein questions the basic assumption of the tax interaction effect that higher prices will reduce labour supply, as in empirical studies based on micro-data the relationship is found to be ambiguous.
When dual wage earner families are considered, higher prices are seen to lead to an increase in labour supply, as workers seek to compensate the reduction in family income generated by the price increases Gustafson and Hadley, Provided that the net increase in environmental taxes is offset by a lowering of payroll taxes, a pass-over in product prices will not be required and the labour market implications for real wages need not materialise.
Ekins and Barker argue that in this specific case one would not expect a negative tax interaction effect from ETR. Sweden and Finland have mainly recycled revenue by lowering income taxes. For Sweden it has for many years been a tax policy aim to lower the pressure of income taxation on labour. The tax reforms in these two countries have aimed at lowering direct income taxes, and the carbon-energy taxes have contributed to securing alternative revenues for some, but not all, of the income tax reductions.
It also applies to Finland for the more comprehensive tax shifts introduced since However, because of the imbalance between energy consumption on the one hand and number of employees on the other, lowering social security contributions at the company level does not necessarily lead to full compensation for the individual company. In Denmark as well as in the UK the imbalance has been then mitigated via various mechanisms for energy-intensive industries, such as agreements and reduced rates for heavy industries. The real purpose of the exemptions seems to have been to avoid the tax interaction effects.
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The Dutch reduced income taxation in the initial phase, and a particular issue here was social concerns, which led to an increase in the basic tax free allowance for income as well as to complicated formulae for exempting basic consumption of electricity and gas Vermeend and van der Vaart, The political pragmatists are so labeled because reforms were designed so as to accommodate the pressing concerns with the tax systems and the electorate, rather than fiscal theory.
In Sweden, the effects took slightly longer to come through, as the very large increase in household electricity taxes depressed real incomes in the short run. The degree of this is likely to be dependent on the scale of the increase in fuel costs, how easy it is for industry and consumers to switch between fuels to cheaper alternatives and non-energy inputs , and how much of the cost is passed by industry on to consumers this is dependent on the level of competition in the industry, which is estimated econometrically for each region and sector.
In Denmark and the UK there were no significant increases in the overall price index. In the UK this is because the tax was relatively small and was compensated by slightly cheaper labour costs. In Denmark the tax was larger but again was compensated by lower labour costs see Figure 5.
The reason for this is that the consumer price index is a weighted average of the price of consumer products, including energy. In the cases where the tax is levied on households the whole tax is reflected in the consumer price index rather than just the share that is passed on by industry.
Therefore it is not unexpected that the largest increases in the consumer price index are seen in the Netherlands and, in particular, Sweden see Figure 5. The Swedish experience suggests that combining carbon-energy taxes on households with reductions in income taxes could cause inflation rates at a level triggering a possible tax interaction effect, but further analysis is required to corroborate this. The logic behind the ETR implemented in the UK and Denmark is that there is no discernable effect on the consumer price index; this is because the revenue recycling here is mainly via lowering of social security contributions.
They often have a small labour stock, while they consume large amounts of energy. Their sensitivity depends on the degree to which they use carbon-intensive fuels. In Sweden, Finland and Slovenia the energy-intensive industries benefit from the availability of hydropower and nuclear power, and so are less sensitive to carbon-based energy taxes.
However, in other member states complicated schemes have been designed to balance, cap or reduce the tax burden of energy-intensive industries. These opportunities are to some extent modeled on the basis of the decision regarding the Danish CO 2 taxation scheme 5 , Denmark being the first member state to obtain approval of its carbon-energy taxation system. However, detailed analysis in COMETR indicates a lower net burden when considering the impact of lower payroll taxes and the energy efficiency gains which can be attributed specifically to the tax Andersen and Ekins, Member states can extend the trading system to other energy-intensive industries.
National allocation plans have in most cases provided certificates to industry that match historical emissions, whereas allocation to power plants often have been restricted to levels lower than historical emissions, as power producers are able to pass on the added costs to the consumer. In those periods where non-carbon energy carriers set the marginal price in the electricity market, it is not likely that power operators will be able to factor in the value of the certificates.
The International Energy Agency IEA points to the Nordic electricity market Nordpool as one region where electricity trade has been successfully liberalised and where pass-on of ETS costs should be expected Reinaud, These observations suggest that, with effect from , ETS has effectively increased the CO 2 costs per MWh to a carbon price level comparable to that of smaller business users in member states with carbon-energy taxes—a significant increase and for all consumers—also highly energy-intensive industries.
The EU ETS system was introduced with effect from , whereas most of the unilateral carbon-energy taxes had been introduced before that year.
Effective Tax Burden in Europe
The co-existence of unilateral carbon taxes for emitters subject to cap-and-trade have evoked concerns over double regulation. According to EU case law, even reductions in energy taxes count as state aid, as a functional perspective applies. Hence, while member states are free to introduce unilateral carbon-energy taxes, paradoxically they must obtain Commission approval for any reductions in these.
The statutory effective tax rate is one of the indicators to express the weight of corporate tax burden. However, when we use it for international comparison, we have to pay attention to its "tax base" and "tax rate. So, let' s briefly discuss this problem. In taxation, the method that should be used as the tax base to calculate the amount of tax is important.
In corporate taxation, there are generally two methods; one is to use income as the tax base and the other is to use something other than income as the tax base for example, capital or employee numbers. The latter is called "taxation by the size of business. The Corporation Enterprise Tax is a tax imposed on the business of corporations and is based on the idea that corporations, since they receive various administrative services of local public bodies in their business activities, should bear part of the necessary expenses. Discussion on taxation by the size of business has a long history 1.
The Shoup Report recommended that the tax base for the enterprise tax should be "the amount of the value added by the corporation to the value of goods, such as materials, that had been purchased from other businesses. The argument on taxation by the size of business has long history. The Government Tax Commission reviewed specific proposals for taxation by the size of business and concluded that the following four are desirable tax bases; 1 business activity value value added , ii total wage, iii a combination of physical and personal bases, and iv amount of capital, etc.
The business activity value value added , which is said to be "theoretically the best" among the four pro forma tax bases, is an income-based added value that adds together profits, total compensation, interest paid and rental of a corporation in one business year. There are several ways to grasp the value added, as is shown in Figure 1 2.
The introduction of taxation by the size of business is an important reform for stabilizing the main local tax that supports decentralization, clarifying the characteristics of tax as a benefit-based taxation, ensuring fair distribution of the tax burden, easing the income tax burden, promoting business activities for greater profits, vitalizing the Japanese economy, and promoting economic structural reforms.
On the other hand, among the major problems pointed out as being involved in the introduction of the system are tax burden fluctuations, treatment of small and medium-sized enterprises, and employment considerations. The AGI foresees anti-tax avoidance rules to safeguard against possible cascading effects and tax planning. First, the common base will require scrapping some tax incentives while introducing others.
Second, consolidation will automatically imply cross-border loss offset. This benefits multinational businesses but narrows the Europe-wide corporate tax base, including for Belgium. For one part, the countries have introduced targeted preferential regimes, including through innovation boxes, which primarily serve to attract mobile tax bases from MNCs. For another part, they engage in tax competition using their headline CIT rates.
For instance, the empirical tax competition literature provides firm ground for strategic complementarity in CIT rates, implying that countries respond to the reductions in CIT rate elsewhere by lowering their own IMF, During the past three decades, this has induced a gradual decline in the CIT rates in Europe.
Figure 7 illustrates this trend since in the Euro area and Belgium: in the Euro area, the mean CIT rate dropped from Further, the AETR declined over the past decade, namely from Although the pace of tax cuts in Europe has somewhat stalled during the last few years, several countries have recently announced further reductions.
In light of this international tax competition, the relatively high CIT rate in Belgium imposes two important risks:. BEPS risk. The high rate makes the Belgian tax base of multinational companies increasingly vulnerable to BEPS behaviors. Indeed, the incentive for MNCs to shift profits out of Belgium to low-tax jurisdictions is governed by the difference in statutory tax rates with other countries. Empirical studies, for instance, suggest a robust relationship between tax rate differentials and measures of reported profitability Dharmapala, ; Heckemeyer and Overesch, Relocation risk.
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This makes Belgium less attractive for foreign investors who seek a location for their new businesses through greenfield FDI. Of course, as long as reductions in the CIT rate are financed by base broadening, the mean value of the AETR across Belgian firms will not decline; reductions for some companies will then be merely offset by increases for others. The net effect on firm location will therefore be uncertain and dependent on the responsiveness of various types of capital to tax. Yet, lowering the statutory CIT rate might have the additional advantage of providing more certainty to international business compared to targeted incentives in the tax base that have come under increased international scrutiny.
A reduction in the CIT rate without offsetting measures would result in revenue loss. With a CIT revenue productivity of 0. The revenue loss might be smaller, however, if dynamic scoring effects are considered, that is, the broadening of the tax base due to endogenous responses to the lower rate. Such effects— which may occur primarily in the medium to longer term— are captured by the elasticity of corporate taxable income, that is, the percentage change in the tax base due to a one percentage point change in the CIT rate.
Based on a survey of the available international evidence, De Mooij and Saito arrived at a consensus value of —0. This would mean that rate cuts to 25 and 20 percent would, in the long run, cost approximately 0. Clearly, these are still sizable revenue losses. Moreover, if base broadening measures are adopted to compensate for this revenue loss, these themselves might induce opposing dynamic effects by exacerbating the distortionary impact of the CIT.
Caution is therefore required in allowing dynamic scoring effects to determine the revenue implications of the reform. Given that Belgium faces tight fiscal constraints and has limited scope for shifting the tax burden away from corporations given the already high taxes on labor and consumption , cuts in the CIT rate should be accompanied by offsetting measures either within the CIT system, or to other capital income taxes on individuals.
CIT reform would also need to consider effects on tax neutrality in the business legal form, with a view to limiting distortions and tax arbitrage. Figure 8 shows what would happen with the average and marginal tax rates on different types of business incomes as in Figure 3 , if the CIT rate structure were reduced from the current progressive structure to a uniform 20 percent rate dotted lines.
Thereby, it is assumed that withholding taxes on dividends and PIT rates on non-corporate business income remain unchanged. We see that the marginal and average tax burden for distributed corporate profits are moved well below those for non-corporate business income, thus inducing a stronger incentive for businesses to incorporate.
This could broaden the CIT base, but would come at the expense of a narrower base of the PIT and reduce the level of social security contributions. For retained profits, the current tax preference will be reinforced further by the CIT rate cut and will thus induce an even stronger incentive to realize income as a capital gain. They record a total of CIT rate cuts and base broadening measures at the same time, there were also 37 CIT rate increases and base narrowing measures. A reduction in the headline CIT rate cut can promote investment, employment and productivity by itself. However, base broadening measures to finance such a rate cut can have an opposite effect.
The importance of the latter depends on the type of base broadening. Some incentives, for instance, might be efficient ways to encourage investment or innovation; others, in contrast, can distort the level playing field across firms or magnify existing distortions. A case-by-case approach is therefore required to assess the economic merits of various base-broadening measures, necessary to finance a cut in the CIT rate.
Below, we provide a brief assessment of the main options, thereby making use of High Council of Finance The system in Belgium before had a range of options for base broadening that would help balance growth and revenue objectives. This additional revenue would come entirely from large MNCs. Progressive CIT rates could also induce firms to split their business in multiple parts to optimize the preferential treatment, with negative implications for organizational efficiency. Distributional considerations also provide little rationale for progressivity in the CIT, as the connection between the income of a legal entity and the personal income of the owners is often weak or absent.
Some CIT exemptions and deductions could be curtailed with only marginal growth effects. For instance, it would be useful to review the efficiency of several special deductions, for example, internships, cars, gifts and restaurants. The High Council of Finance found that the combined effect of those measures could broaden the CIT base such that the CIT rate could be reduced by several percentage points.
The innovation box regime could be reformed. While the Belgian innovation box has been made less generous in to comply with the new international standards, the Belgian government simultaneously increased the exempt amount from 80 to 85 percent and widened the range of qualifying IP assets to include copyrighted software and qualified orphan drugs.
Some options for base broadening are less promising, and there are some areas where the current regime is already quite restrictive. Making depreciation allowances less generous could boost the CIT base during the first few years after the reform; yet, they will have no structural revenue implications. In fact, since less generous tax depreciation allowances will raise the book value of assets in the tax accounts, they will increase the cost of the NID in later years. Indeed, the present value of the sum of depreciation allowances and the NID allowance is independent on the rate at which firms write down their assets.
Loss offset provisions, which are critical for investment and growth, are already restrictive. Less generous loss offset would discourage entrepreneurs to experiment and undertake risk, which is vital for innovation IMF, b. In Belgium, the absence of: i a consolidation regime; ii loss carry backward provisions; and iii interest on deferred losses, already impose important limitations to loss offset. Further restrictions will likely hurt economic growth.
In fact, to enhance growth, Belgium could consider expanding loss offset provisions, for example, by adopting a consolidation regime. There are several options for restoring balance between different forms of business income and limiting tax arbitrage. As discussed above, a reduction in the CIT rate would aggravate the tendency for tax arbitrage and excessive incorporation of small businesses. A higher dividend withholding tax would be one option that could restore tax neutrality between salary payments and dividend payments, if the CIT rate is reduced.
Moreover, introducing a capital gains tax could help address the increased imbalance between distributions and retained earnings. Allocation rules for domestic businesses could also be strengthened. Thus, businesses with little investment, whose value-added is derived largely from labor, are subject to the progressive PIT on most of their income.
The challenge with such allocation rules, however, is with the enforcement, which can be complex. If small corporations are pass-through entities, the owners could be taxed on all their assigned income at the progressive PIT. The NID could be reformed to both enhance its growth-promoting properties and mitigate its undesirable spillover effects to other countries through tax planning. This reduces its effectiveness in encouraging investment and financial stability.
Therefore, several aspects of the NID may warrant reconsideration:. As discussed above, the Belgian NID rate is linked to the government bond rate. However, the appropriate rate necessary to exploit the neutrality features of the NID should be higher to account for the corporate risk. The Annex, for example, argues that a risk premium of 2 or 3 percentage points could be added to the long-term government bond rate.
While this would support investment and growth, it also increases the revenue cost of the NID. To mitigate these fiscal implications, Belgium could implement this additional risk premium on an incremental basis, that is, only for equity increases relative to the year of introduction. While this would preserve the incentive effects of the NID for new investments, it would avoid providing a windfall gain for the existing stock of equity. Restoring the carry forward of unused NID is an option that would strengthen the incentives to invest.
It would imply more certainty that the NID can indeed be used, even if a firm incurs current losses. Moreover, it would also help absorb macroeconomic shocks by mitigating financing constraints that tend to be cyclical. The use of the NID by SPVs as a form of international tax planning could be curtailed by imposing an anti-avoidance rule that declines the NID provision in specific circumstances Zangari, The price paid will likely be the departure of most SPVs from Belgium, as the tax planning route that justifies their existence is cut off. Yet, the impact on the real economy in Belgium is likely to be small.
While this should in principle give rise to an addition to the tax base for that holding company, the NID base in Belgium is capped at zero.
Full text issues
This creates opportunities for domestic tax planning, as the zero lower bound can imply duplication of NID relief IMF a. Eliminating the zero lower bound on the NID base is the most direct way to address this form of domestic tax avoidance and restore the neutrality of the NID. Alternatively, anti-avoidance provisions may prevent this form of tax planning, for example, interest deductions could be disallowed for debt that is used solely to finance equity participations. In , the Belgian government made a start with the implementation of several changes to the CIT system, including a gradual reduction of the statutory CIT rate from 34 to 25 percent in It also implemented the antiavoidance package of the EU, a tax consolidation regime and a streamlining of the provisions for small businesses.
These reforms can be characterized as strengthening the robustness of the system and are likely to be conducive to growth. Yet, the reform also includes changes that are likely to be the opposite. In particular, with respect to the NID, the government effectively repealed the current system and replaced it with an incremental NID of limited duration.
Specifically, starting form , the base of NID will be the incremental equity in excess of the average equity of the preceding five years. This is a significant reduction that may have negative implications for growth and economic resilience in Belgium. First, past investments have been made under the assumption that the old NID would remain in place. Eliminating it will raise the tax on these investments, which reflects a classic example of a time inconsistent policy: the government increases the tax on investment returns; after that, capital has been installed and sunk costs have been absorbed.
This can have repercussions for the credibility of Belgium government, rendering the new incremental NID ineffective as investors may fear for future repeal.