All taxes distort the behaviour of private economic agents, but some do so more than others. Economists have recently investigated the costs associated with high rates of personal income tax – which could arise from lower effort or moving to a different jurisdiction, as well as the real costs associated with evasion and avoidance. Recent research by Michael Devereux, Li Liu and Simon Loretz has developed techniques for assessing the costs of taxes on corporate profit.
This research uses data from the population of UK corporation tax returns between 2001 and 2008 available in a new secure Datalab in HMRC. The empirical procedure is to estimate the elasticity of corporate taxable income with respect to the statutory corporation tax rate. Under certain circumstances this elasticity can be a “sufficient statistic” for evaluating the social costs of corporation tax – measured by the “marginal deadweight cost”. Devereux and Liu also developed a method for assessing how far differences in personal and corporate taxes affect the share of total income declared in the two different forms.
The research exploits two types of variation in corporation tax rates to identify the effects of the tax. The first arises from a number of reforms to the corporation tax regime for small companies, including the introduction, reform and abolition of a starting rate between 1999 and 2006. The second arises from discrete changes to the marginal tax rate at various points in the tax schedule. For example, in sum years, the marginal tax rate jumped from zero to 23.75% as profit increased above £10,000.
Overall, the results suggest that at profit levels around £300,000, the marginal deadweight cost of corporation tax is around 8% of the revenue collected. But at lower levels this was much higher
at around 25% of revenue – that is, for every additional £4 of tax revenue generated from small companies, the cost to the companies is around £5.
Michael Devereux, Li Liu and Simon Loretz, The elasticity of corporate taxable income: new evidence from the UK tax records, CBT Working Paper 12/23. Forthcoming in American Economic Journal: Economic Policy