Order 1046644: The Effect of Corporate Taxes on Australian Economic Development

The issue of corporate taxes and its effect on economic growth is a widely covered topic. Corporate taxes are fundamental to any country as they provide a stable source of income. On that account, there are numerous studies that assess the relationship between the two variables. These studies are centered on the ideology that corporate tax rates are key to attracting investments, which in turn power economic growth. The following literature review will discuss four recent studies that examine the relationship between corporate taxes and economic development. The review of these studies can be used to determine how corporate taxes can affect economic development in Australia.

Common Findings

In the paper titled Corporate tax effects on the quality and quantity of FDI, Becker, Fuest, and Riedel (2012) examine the comparative importance of quantity and quality impact of corporate taxes on foreign direct investment (FDI). Governments, according to the researchers, search for FDI since it is generally suggested that nations gain from the inflow of capital. A key determinant of the benefits is the degree to which FDI underwrites a country’s corporate tax base (Becker, Fuest, and Riedel 2012). To that extent, the quality of FDI is key, not simply the quantity. The general perception on international funds suggests that countries with high taxes have lower balances of FDI inflows, however, the marginal component of investment contributes more to tax revenue to nations with low taxes due to the enhanced tax rates and higher marginal return (Becker, Fuest, and Riedel 2012). Therefore, at the margin, nations with high taxes get investment of higher quality than countries with low taxes. The authors assert that taxes decrease the balance of incoming foreign funds in a given state (quantity impact) and reduce the degree to which investment contributes to the base of corporate taxes (quality impact).

Forbin (2011) wrote a paper titled Effects of Corporate Taxes on Economic Growth: The Case of Sweden, to investigate the effect of corporate taxes on economic development in Sweden. He suggests that one of the most debated topics in any economy is the association between economic development and tax rates. In particular, the taxation of companies is of key importance since the base of corporate taxes is an extremely dynamic factor of production and at the same time tax competition is presently still harder because of the needed economic development especially in the setting of an economic crisis (Forbin 2011). Forbin (2011) arrives at a similar inference as Becker, Fuest, and Riedel (2012); countries with high taxes attract lower quality FDI than countries with low taxes, that is, investment in nations with high taxes contributes a lesser amount to the tax base in these nations than FDI in countries with low taxes.

The journal article, Taxation of Corporations and Their Impact on Economic Growth: The Case of EU Countries, by Baranová Veronika and Janíčková Lenka compares the effect of social insurance and corporate taxes on unemployment and FDI. Veronika and Lenka (2012) arrive at four main inferences. First, the ideal size of the welfare nation hinges on the unemployment rate and the rate of risk-aversion as a determinant of labor income risk; the rate of unemployment partially highlights a nation’s exposure to globalization (Veronika and Lenka 2012). Second, social insurance and corporate taxes have the same effect on FDI inflows and unemployment. Third, whereas a rise in the corporate tax can increase revenue from corporate taxes, it will probably worsen the fiscal position of a country. A decrease of corporate taxes, therefore, can be self-funding because of fiscal growing returns in the setting of a large public sector (Veronika and Lenka 2012).Lastly, corporate tax should be utilized to underwrite welfare state funding only in certain settings when the creation of jobs is excessive and the rate of unemployment is so low that it is inefficient.

The paper titled Taxation and skills investment in frictional labor markets by Jean-François Tremblay investigates the impact of corporate taxes and income taxes on training investment in labor markets that are frictional. The article arrives at similar findings as Veronika and Lenka (2012), albeit with a different explanation. Tremblay (2010) asserts that due to labor market frictions, the structure of wage is compressed and laborers are not adequately compensated for their work. Consequently, both workers and firms have motivations to reinforce part of the expenses of training investments (Tremblay 2010).

Differences

The difference across the four articles stems from the methodology used to come up with the findings. To determine their results, Becker, Fuest, and Riedel (2012) came up with a concept with heterogenous investment initiatives to examine the interrelated impact of taxes on investment quality and quantity. The predictions of the model were examined using data from a wide sample of multinational firms in Europe. The results of the study revealed that the quality impact accounts for around 50% of the overall impact of taxes on the scope of the tax base. On that regard, Becker, Fuest, and Riedel (2012) assert that authorities should care about both the size of FDI flowing into a country and its specific features.

Forbin (2011) examines past studies to investigate the indirect relationship between economic growth and tax burden. He asserts that the rate of correlation between the two variables is not apparent. Based on this deduction, he explores the negative association between sustainable economic growth and corporate taxation in Sweden. Forbin (2011) bases his analysis on the neoclassical growth concept. The concept related the variable highlighting the numerous possibilities to determine the tax burden on companies, particularly tax quota differentiated on income taxation on companies, the implicit rate of tax on capital and actual tax rates reinforced by micro-forward observing methods (Forbin 2011). The results from the model show that taxation impacts the method by which multinational companies organize their global production of input goods.

Veronika and Lenka (2012) use the four aforementioned pre-conditions to come up with his assertions. He states that if companies are experience a high level of bargaining power, which leads to an inefficient rate of unemployment, and if the ideal size of the welfare nation is small in a given economy, a positive corporate tax could practically complement the tax financed insurance initiative to mitigate excessive creation of jobs.

The analysis done by Tremblay (2010) facilitates some insights into how discrepancies in tax frameworks can also contribute to illustrating divergences in rates of training investments. To determine this, corporate taxes and income taxes are implemented in a non-complicated two-period concept of investment in general training created by Acemoglu and Pischke in a past study. Decisions to invest in skill training are done in the first period and the skills trained enhance productivity in the preceding period (Tremblay 2010). Frictions on the labor market imply that companies can gain from an investment in training. Nonetheless, firms may not have the ability to realize the full benefit from their investment and due to the turnover of labor caused by random factors, part of the benefit may be realized by future employers (Tremblay 2010). On that account, the examination by Tremblay (2010) highlights that the impact of corporate taxes and income taxes on training may vary on how the taxes impact the supply of marginal benefits and marginal expenses across the original employer, the future potential employers, and the worker. Indeed, the examination by Tremblay (2010) reveals that when investment decisions in regards to training are made by a collaboration of workers and firms, a wage tax enhances the level of investment in skills whilst a corporate tax reduces it. In this instance, the implementation of a small income tax clearly enhances efficiency. The impact of income taxes and corporate taxes on training are inverted when investment decisions are made by companies alone (Tremblay 2010). In any instance, a corporate tax is not impartial in regards to decisions to invest in training even if the total cost of investment is removed from taxable income in the time when it is incurred and the tax framework facilitates total offset of loss.

Managerial Implications

The review of the aforementioned studies reveal that the level of corporate taxes clearly affects the level of investment in a country and, hence, economic development. Since Australia is a high tax country, the quantity of FDI inflows is low; however, the studies show that the quality of FDI inflows will be higher than in low tax nations. Therefore, to enable sustainable economic development, the Australian government should consider the effect of the corporate tax rate on both the size of FDI flowing into a country and its specific features.

Limitations

Whereas the articles provide some useful insights into how a government should plan its corporate tax rates they still have certain limitations. Becker, Fuest, and Riedel’s article does not explicitly state the nature of a quality investment and how the stated quality contributes to economic growth. Forbin’s article is limited by scope as it only investigates one jurisdiction, that is, Sweden. Veronika and Lenka’s article fails to define a welfare state and the characteristics of such a state. Lastly, Tremblay’s applies an outdated methodology to come up with the findings. On that account, all the articles suggest that future research should be based on a uniform methodology to enable the independent investigation of the variables of the factors that determine the corporate tax rate to clearly illustrate how it affects economic growth in different jurisdictions.

Bibliography

Becker, J., Fuest, C, and Riedel, N. 2012. Corporate tax effects on the quality and quantity of FDI. European Economic Review, 56(8), 1495–1511

Forbin, E. 2011. Effects of Corporate Taxes on Economic Growth: The Case of Sweden (Bachelor’s thesis). Jönköping University.

Baranová, V and Lenka, J. 2012.Taxation of Corporations and Their Impact on Economic Growth: The Case of EU Countries. Journal of Competitiveness

Tremblay, J. F. 2010. Taxation skills investment in frictional labour markets. International Tax and Public Finance, 17(1), 52-66.