Luận văn thạc sĩ UEH impact of economic volatility on corporate income tax rate, the case of 20

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM – NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

IMPACT OF ECONOMIC VOLATILITY ON

CORPORATE INCOME TAX RATE:

THE CASE OF 20 ASIAN COUNTRIES

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

BY

TRUONG HOANG YEN

Academic Supervisor

Dr. NGUYEN HOANG BAO

HO CHI MINH CITY, JANUARY 2015

LUAN VAN CHAT LUONG download : add [email protected]

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM – NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

IMPACT OF ECONOMIC VOLATILITY ON

CORPORATE INCOME TAX RATE:

THE CASE OF 20 ASIAN COUNTRIES

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

TRUONG HOANG YEN

Academic Supervisor

Dr. NGUYEN HOANG BAO

HO CHI MINH CITY, JANUARY 2015

LUAN VAN CHAT LUONG download : add [email protected]

ABSTRACT

This paper examines the impact of economic volatility on the corporate income tax

rate in the context of globalization and international taxation competition. The

impact is analyzed by two models, direct and indirect effect model. The former

investigates directly the relationship of corporate income tax rates and economic

volatility in terms of real interest rate, exchange rate, and growth rate. The latter

applies a system of equations to examine simultaneously the determinants of tax

rate and tax base. The study finds out that economic volatility impacts negatively on

corporate income tax rate and also negatively on foreign direct investment (FDI)

inflows. Moreover, corporate income tax rate affects negatively and significantly on

FDI inflows, meanwhile FDI inflows influence corporate income tax rate with

positive and significant impact.

LUAN VAN CHAT LUONG download : add [email protected]

CONTENTS

CHAPTER ONE: INTRODUCTION ..........................................................................1

1.1. Problem statement ..............................................................................................1

1.2. Research objectives and research questions.......................................................4

1.3. The structure of research ....................................................................................5

CHAPTER TWO: LITERATURE REVIEW.............................................................6

2.1. Theoretical literature...........................................................................................6

2.1.1. Roles of corporate income tax rate ..............................................................6

2.1.2. Economic volatility......................................................................................7

2.1.3. Foreign direct investment ............................................................................9

2.1.4. Tax competition .........................................................................................11

2.2. Empirical literature ...........................................................................................15

2.2.1. Economic volatility....................................................................................15

2.2.2. Corporate income tax rate..........................................................................17

2.2.3. FDI inflows................................................................................................19

2.2.4. FDI outflows..............................................................................................19

2.2.5. Country size ...............................................................................................20

2.2.6. Capital openness ........................................................................................21

2.2.7. Government expenditure............................................................................22

2.2.8. Productivity................................................................................................23

2.2.9. Employment rate and demographic structure of population......................23

2.2.10. Personal income tax rate.........................................................................24

LUAN VAN CHAT LUONG download : add [email protected]

CHAPTER THREE: ECONOMIC VOLATILITY AND CORPORATE

INCOME TAX: DESCRIPTIVE AND DATA ANALYSIS ....................................25

3.1. Variable measurements.....................................................................................25

3.1.1. Measurement of economic volatility .........................................................25

3.1.2. Measurement of corporate income tax rate ...............................................26

3.1.3. Measurement of capital openness index ....................................................26

3.2. Summary of variables description and data sources.........................................28

3.3. Descriptive statistics.........................................................................................29

CHAPTER FOUR: METHODOLOGY AND RESULTS .......................................33

4.1. Analytical framework .......................................................................................33

4.2. Direct effects.....................................................................................................34

4.2.1. Model specification....................................................................................34

4.2.2. Method specification..................................................................................37

4.2.3. Results........................................................................................................38

4.2.4. Indirect effects...............................................................................................43

4.3.1. Model specification....................................................................................43

4.3.2. Method specification..................................................................................46

4.3.3. Results........................................................................................................48

CHAPTER FIVE: CONCLUSIONS AND IMPLICATIONS.................................53

5.1. Major findings ..................................................................................................53

5.2. Policy implications ...........................................................................................55

5.3. Limitations and suggestions for further study..................................................56

REFERENCES.............................................................................................................57

LUAN VAN CHAT LUONG download : add [email protected]

APPENDICES ..............................................................................................................63

A. Graphs...............................................................................................................63

B. Tests..................................................................................................................67

C. Estimations .......................................................................................................70

D. Others................................................................................................................78

LIST OF FIGURES

Figure 1.1 Average top statutory corporate income tax rate in 20 Asian countries.........2

Figure 1.2 FDI inflows in 20 Asian countries..................................................................3

Figure 2.1 Theoretical framework..................................................................................15

Figure 3.1 Corporate income tax rate, capital openness index and FDI inflows

(1982-2011)....................................................................................................................33

Figure 3.2: Corporate income tax rate, Real interest, Exchange rate, Growth

volatility, and FDI inflows (1982-2011)........................................................................35

Figure 4.1 Direct effect framework................................................................................39

Figure 4.3 Method for Direct effect model....................................................................41

Figure 4.2 Indirect effect framework .............................................................................49

Figure 4.4 Method for Indirect effect model..................................................................52

LIST OF TABLES

Table 3.1 Variables description and data sources..........................................................29

Table 3.2 Descriptive statistics ......................................................................................31

Table 4.1: List of variables in direct effect model .........................................................38

Table 4.2: Direct approach in various methods with interest rate volatility..................43

Table 4.3: GMM estimation with and without volatility in three proxies .....................47

Table 4.4: List of variables in indirect effect model......................................................48

Table 4.5: Indirect approach with interest rate volatility through various estimators ...53

LUAN VAN CHAT LUONG download : add [email protected]

1

CHAPTER ONE: INTRODUCTION

1.1. Problem statement

Taxation is the major source of government revenues for funding public

expenditure, such as infrastructure, education, public health, and other social

investment programs. Governments adjusted their taxation policies to facilitate

economic growth (Barro, 1991; Bleaney, Gemmell, and Kneller, 2001). On the

purpose of providing an economic environment to foster economic growth,

corporate income tax plays a crucial role in the taxation system, especially an

important part in tax reform (Arnold et al., 2011).

Corporate income tax serves the economy with three vital functions. Firstly, the

corporate income tax rate is regarded as an effective way to raise tax revenues.

Secondly, corporate income tax is popularly perceived as fair charges for public

goods and services consumed by companies. Lastly, corporate income tax is

considered as a reasonable substitute for personal income tax. Because it is hard to

administer personal tax on capital income, especially the gains which are retained in

a company (Bird, 1996; Devereux and Sørensen, 2006).

In high tax rate countries, governments have to allow some profit shifting because

of tax competition from lower tax rate countries (Becker and Fuest, 2012).

Therefore, governments also restrain that process by competing in reducing the

effective average tax rate and statutory tax rate (Devereux, Lockwood, and

Redoano, 2008). During the period from the 1980s to the late 1990s, the average

corporation tax rate decreased from nearly 40% to around 30%, specifically, in the

European countries from 38% in 1990 to 33% in 2000 (De Mooij and Ederveen,

2003; Devereux et al., 2008). Figure 1.1 presents the dramatic downturn of average

top statutory tax rate on corporate income of 20 Asian countries from more than

40% in 1982 to approximated 25% in 2011. Different from European countries,

Asian countries decrease their statutory corporate income tax rate roughly after

LUAN VAN CHAT LUONG download : add [email protected]

2

2007. The highest rate of statutory corporate income tax is 60% in Pakistan in 1989

whereas the lowest one is 12% in Macau from 2005 to 2011. In 2011, policy makers

in Pakistan reduce this variable to 35%, nearly 50% reduction. This may imply a

serious competition on corporate income tax rate between these countries for recent

three decades (Devereux et al., 2008).

25

30

35

40

Corporate tax rate (%)

1980 1985 1990 1995 2000 2005 2010

Year

Source: Author’s collected dataset

Figure 1.1 Average top statutory corporate income tax rate in 20 Asian countries

In order to attract more capital inflows, governments compete each other by

reducing corporate income tax rate (Genschel and Schwarz, 2011), because a

corporate income tax rate rise conducts to a decline in multinational investment

(Hong and Smart, 2010). As illustrated in Figure 1.2, the inward FDI volume is

increasing sharply and significantly. From the roughly zero initial level in 1982,

FDI inflows increase approximately to the landmark of 200 billion US dollars in

2011. Despite the crises in 1997 and 2008, this tendency still continues over time.

The combination of downward trend in corporate income tax rates and upward

tendency in capital inflows illustrates the tax competition among countries for the

purpose of capital attractiveness.

LUAN VAN CHAT LUONG download : add [email protected]