Le riforme italiane nella tassazione di impresa negli anni ’90 in una

prospettiva europea

Silvia GianniniUniversità di Bologna

Seminario di Economia PubblicaIstituto di Economia e Finanza – Master in Economia Pubblica

Università Cattolica del Sacro Cuore – 22 febbraio 2001

• S.Giannini, The Reform of the Italian Corporate Income Tax: Evaluation and perspectives, Conferencia internacional sobre a reforma de tributação do rendimento das sociedades, Coimbra 19-20 Ottobre 2000

• M.Bordignon, S. Giannini, P.Panteghini, "Reforming Business Taxation: Lessons from Italy?", in corso di pubblicazione su International Tax and Public Finance

• S. Giannini, M.C. Guerra, "Dove eravamo e dove siamo: il sistema tributario dal 1990 al 2000,  in La finanza pubblica italiana, (L. Bernardi, ed.), Il Mulino, Bologna, 2000.

• S. Giannini, "Mercato interno e fiscalità: aspetti economici",  Congresso internazionale sul "Coordinamento fiscale nell'Unione Europea" Osservatorio"Giordano dell'Amore", Stresa, 19-20 Maggio 2000, in corso di pubblicazione negli atti del convegno

Objectives of the paper• to review the characteristics and economic

effects of the Italian 1997-98 corporate tax reform;

• to compare it with other international experiences and reform proposals;

• to show that it faces problems and conflicting needs that are common to small open economies;

• to illustrate that it can be seen as an original attempt to trade off these needs and can provide some lessons to other countries too.

Policy makers in small open economies have to trade off different conflicting needs:

• To reduce corporate (capital) taxation in order to face the increasing international tax competition

• To increase the neutrality of the tax system with respect to investment and financing choices

• To maintain tax revenue without shifting (too much) the tax burden from mobile (capital) to immobile (labour) factors

• To preserve the equity of the tax system, i.e. a “fair” relation between personal labour and capital income tax rates and the corporate tax rate.

Major common features of other countries’ reforms (1980s and 1990s)

• overall reduction in the statutory corporate tax rate• often accompanied by an enlargement of the tax base• hence, the marginal effective tax rates (EMTR), which

measure the effect of taxation on the cost of capital and take into account also the determinants of the tax base, changed less than statutory rates (sometime even increased)

• no country moved in the direction of a fully neutral tax system, under which the EMTR would be zero, but which would require a higher statutory rate to maintain a given revenue

• moreover, rapid diffusion of preferential tax regimes (such as Belgian co-ordination centres, Dublin financial service centres, Dutch holding companies)

These reforms were a rationale response, from the single country perspective, to the increasing international integration

and the lack of tax co-ordination (example of international tax competition)

The reduction in the statutory rates and the development of special regimes have the

major objective of attracting profits and the more mobile economic activities

But whereas special preferential regimes are clearly considered Harmful Tax Competition (EC Code of conduct), a general reduction of

the corporate tax rate is not, even though economic externalities are similar.

The declining trend is showing no sign of stopping!

Why statutory corporate tax rates are so important for a small open economy?

1. A divergence in statutory rates creates incentive to locate the tax base towards jurisdictions with lower tax rates (profit shifting):

• transfer pricing • thin capitalisation• other tax planning devices

2. Economic activities will tend to locate where the overall profits generated by the investment are less taxed. The most useful indicator to measure this incentive is the effective average tax rate (EATR), which highly depends on the statutory rate, above all for some types of very mobile activities (like financial services, that do not have significant depreciation allowances) and for very profitable multinationals.

What is an effective average tax rate (EATR)?

Why does it differ from an effective marginal tax rate (EMTR)?

Which is their relation with the statutory rate?

• Both effective marginal tax rates (EMTR) and effective average tax rates (EATR) consider the interaction between various aspects of the tax systems: the statutory corporate tax rates, other taxes on profits and capital, depreciation allowances, other deductibilities from the tax base, etc....

• Both are ex-ante concepts…

…..but

...... EMTRMeasures the percentage tax

wedge on the before and after tax return

on a marginal investment (an

investment which only covers its costs, including “normal”

profits)

Whereas EATRMeasures a similar tax

wedge on an inframarginal investment (an

investment producing rents, i.e.

extra-profits)

EMTRIs important to determine the scale of

investment (how much to invest)And

May not vary or may even decrease with an increase in the statutory rate (depending on

the deductions from the tax base)

Traditional analysis (King and Fullerton, 1984; Oecd, 1991; Ruding Report, 1992)

EATRis important to determine the location of

investment (where to invest)and

usually tends to increase towards the statutory rate with the increase in the profitability

(because deductions become less important)

Recent analysis (Devereux, Griffith, 1998,1999, EC Commission, forthcoming)

The reduction in the overall (national and local) statutory rate: Italy did not participate to the tax competition race!

Countries 1980 1991 1997Belgium 0,48 0,41 0,40Denmark 0,37 0,38 0,34France 0,500 0,420 0,367German: retained earnings 0,62 0,50 0,551Germany: distributed profits 0,440 0,411Ireland 0,45 0,40 0,36manufacturing and special zones 0,10Italy 0,363 0,478 0,532Luxemburg 0,455 0,330 0,390Netherlands 0,46 0,40 0,35Portugal: retained earnings 0,512 0,360 0,376Portugal: distributed profits 0,44Spain 0,33 0,35 0,35United Kingdom 0,52 0,34 0,31Greece 0,46 0,35Austria 0,34Finland 0,28Sweden 0,28UE Average (without Italy) 0,4694 0,3955 0,3604

Effects of the high statutory rate before the reform

• discouraged foreign direct investment in the country (unless financed through debt)

• highly favoured debt finance and penalised equity finance

• stimulated tax evasion and avoidance• discriminated with respect to the

organisational form

The 1997-8 tax reform in Italy - Corporate sectorPre reform

• Local income tax (ILOR): 16.2% on profits

• Wealth tax: 0.75% on net worth

• Corporate profit tax (IRPEG): 37%

Post reform• Regional tax (IRAP):

4.25% on value added of the net income type (revenue from sales less costs for intermediate goods and depreciation)

• Dual income tax (DIT):a) 19% on “ordinary income”

(normal profits)b) 37% on residual profits

(extra-profits)

The 1997-8 tax reform in Italy - Non corporate sectorPre reform

• Local income tax (ILOR): 16.2% on profits (exemptions and rebates)

• Wealth tax: 0.75% on net worth

• Personal income tax rates: from 10% to 51%

Post reform• Regional tax (IRAP):

4.25% on value added of the net income type

• Dual income tax (DIT):a) 19% on “ordinary

income” (normal profits)

b) personal income tax rates (from 19% to 46%) on residual profits

Features of the regional tax on productive activities (IRAP)

• it is neutral with respect to different financing sources (profits, interest and labour costs are all included in the tax base) and “fairly neutral” with respect to different productive factors (labour and capital)

• it has a very broad base: to collect a given revenue it requires lower statutory rates (thus reducing the excess burden of taxation)

• it applies to all types of productive activities: it is neutral with respect to different forms of organising business

• it allowed a significant reduction of the corporate statutory rate (from 53.2 to 41.25%): differently from other countries this was obtained by extending taxation at the business level to other types of income (different from profits), rather than by widening the definition of profits to be used as the tax base (as most other countries did, by reducing for example, depreciation)

Original solution (similar experiences: New Hampshire (USA), Michigan

(USA); some similarities also with the Comprehensive Business Income Tax (CBIT) suggested by the US

Treasury Department in 1992, but IRAP extends the tax base to labour costs too)

Features of the Dual income tax system (DIT)

• it gives an allowance for equity finance: the “ordinary income” - which is a measure of the “normal return” on equity capital - is taxed with the lower 19% rate (which was equal to the basic personal tax rate on labour income) rather than with the normal 37% corporate tax rate

• the “ordinary income” is computed by applying to the equity capital invested into the business the market interest rate on private and public bonds, eventually increased up to 3 percentage points for risk adjustment (LF 2001: può essere differenziato per settore, dimensione, localizzazione)

• when the reform was originally introduced the equity capital to compute the ordinary return was measured by the increase in equity financing (new subscription of capital and retained earnings) from 1996 onwards.

• a minimum 27% average tax rate was also introduced.

Both limitations aimed at minimising revenue losses. In fact the reform was undertaken under a very tight budgetary constraint

Subsequently, with the improvement of the budgetary conditions the government introduced some

important innovations.

For corporations:• the base to compute the “ordinary income”

is multiplied by 1.2 in 2000 and by 1.4 from 2001 onwards (so called super-Dit). This further decreases the cost of equity capital and accelerates the transition towards a DIT where the measure of equity capital to split profits will be the whole equity invested into the company.

• the minimum 27% average tax rate has been abolished from 2001 (LF 2001)

For non corporate businesses:• starting from 2000 the base to compute the

“ordinary income” is the whole stock of equity capital held into the business activity

• as from 2002 partnerships and individual entrepreneurs will be allowed to choose between the present principle of transparency or the separate taxation reserved to corporations, with the same tax rates and regime (LF 2001)

• changes in IRPEF tax rates…

The Italian DIT: are there similar experiences or tax reform proposals?

• Allowance for corporate equity (ACE) proposed by the IFS (1991);

• Nordic dual income tax systems introduced at the beginning of the 1990s in the Nordic countries

Both share with the Italian DIT the idea of splitting profits into two components: an imputed return

(“normal profits”) and a residual component (extra-profits) but differ under many respects: the Italian DIT lies in between the Nordic Dit and the

English ACE

ACE systemFeatures• “normal” profits: tax exempt • extra profits: taxed with a corporate tax rate

equal to the top rate of the personal income taxProperties • it is neutral with respect to investment and

financing decisions Major drawback• to maintain revenue requires a higher statutory

rate (highly detrimental for small open economies)

Nordic DITFeatures• capital income and corporate income are usually taxed

with the basic rate of the personal income tax• the division of profits applies only where labour and

capital income accrue jointly (individual firms, partnerships)

Properties • it may be neutral with respect to financing decisions

(if dividends and capital gains are exempt)• compared to ACE it requires a lower tax rate to raise a

given revenue (also “normal profits” are taxed)

Nordic DITMajor drawback • it is not neutral with respect to organisational

form and incentivates incorporations: corporate profits are taxed with a lower tax rate than non corporate profits, which are divided between capital and labour income (Achille’s heel of the reform). To prevent tax avoidance some countries extend the division system to closed companies with active shareholders (Norway) or to companies not listed on the Stock exchange (Finland), or tax dividend income in the hands of the shareholders.

Italian DIT

Features• normal profits are taxed with the basic

income tax rate, like under the Nordic DIT, but (differently from the Nordic DIT) ...

• ... extra-profits in both the corporate and non corporate sector are taxed with a higher rate, like under the ACE proposal

By applying this dual system of profit taxation to all types of business activities the Italian DIT is able to overcome some of the flaws of both the

ACE and Nordic DIT

Italian DITProperties• it trades off the need to reduce the statutory rate

and the effective average tax rate, in order to face the international tax competition, with the objectives of:

a) increasing the neutrality of the tax system with respect to investment and particularly financing decisions

b) minimising revenue lossesc) ensuring equity and neutrality with respect to

different organisational forms of undertaking business activities

Overall (national and local) corporate tax rates

Countries 1980 1997 2000 2003Belgium 0,48 0,4017 0,4017 0,4017Denmark 0,37 0,34 0,32 0,32France 0,50 0,3667 0,3667 0,3333Germany: retained earnings 0,617 0,551 0,497 0,384Germany: distributed profits 0,440 0,411 0,4054Ireland 0,45 0,36 0,24 0,125manufacturing and special zones 0,10 0,10Italy (max) 0,363 0,532 0,4125 0,3925Italy (min) 0,3125 0,2125Luxemburg 0,455 0,390 0,3745 0,3745Netherlands 0,46 0,35 0,35 0,35Portugal: retained earnings 0,512 0,376 0,354 0,354Portugal: distributed profits 0,44Spain 0,33 0,35 0,35 0,35United Kingdom 0,52 0,31 0,30 0,30Greece 0,40 0,40 0,35Austria (max) 0,34 0,34 0,34Austria (min) 0,25 0,25Finland 0,28 0,29 0,29Sweden 0,28 0,28 0,28UE Average (without Italy) 0,4694 0,3639 0,3474 0,3252UE Average 0,4597 0,3818 0,3584 0,3297

Effect of the reform on the cost of capital (5% interest rate)

0,0

2,0

4,0

6,0

8,0

10,0

12,0

14,0

Machinery Buildings Inventories Machinery Buildings Inventories

pre reform post reform 27% constraint 2001 2003

Equity finance

Debt finance

Effect of the reform on EMTR (5% interest rate)

-150,00

-100,00

-50,00

0,00

50,00

Machinery Buildings Inventories Machinery Buildings Inventories

pre reform post reform 27% constraint 2001 2003

Equity finance

Debt finance

Effect of the reform on effective average tax rates (rate of return 20%)

0,0

10,0

20,0

30,0

40,0

50,0

60,0

Machinery Buildings Inventories Machinery Buildings Inventories

pre reform post reform 27% constraint 2001 2003

Equity finance

Debt finance

Effect of the reform on effective average tax rates (rate of return 100%)

0,0

10,0

20,0

30,0

40,0

50,0

60,0

Machinery Inventories Machinery Inventories

pre reform post reform 27% constraint 2001 2003

Equity financeDebt finance

Conclusions: the tax reform• reduced inter-asset distortions• significantly increased the neutrality between debt and

equity finance• strongly reduced the cost of capital for an equity

financed investment (and slightly increased it for a debt financed investment)

• almost completely eliminated any discrimination depending on the organisational form

• may be considered satisfactory on equity grounds too• increased the competitiveness of the Italian tax system

by reducing the statutory, marginal and average tax rates, even though this might not be sufficient in the present context of international tax competition….