The Belgian tax system already creates de facto incentives for individuals to register as a corporation and to accumulate retained earnings, rather than distributing dividends. Figure 4 shows that the average and marginal tax burden is quite similar for a non-corporate business and a corporate business that pays dividends.
Hence, there is little reason for entrepreneurs to run their business in either the corporate or the non-corporate legal form; nor is there reason to pay dividends instead of wages. However, Figure 4 also shows that a corporate business that retains profit and realizes income as a capital gain is taxed much lighter than others. This reflects the absence of a personal capital gains tax in Belgium. This leads to a lock-in effect capital gets locked in existing companies , which distorts the allocation of capital, thus inducing efficiency loss.
Although Belgium is not unique in this regard, only four other European countries leave personal capital gains entirely untaxed Malta, Cyprus, Czech Republic, and Luxembourg. This tax incentive may be responsible for the gradual but significant increase in the share of Belgian businesses run in the corporate form over the last few decades.
A report by the High Council of Finance in , for instance, shows that in , less than 20 percent of all businesses were incorporated, while more than 80 percent were run in the non-corporate form. In , the share of businesses in the corporate form had risen to over 50 percent and was still increasing. Today, many professionals and selfemployed people, such as lawyers, doctors, architects, engineers, contractors, journalists, interpreters, and so on, are organized as closely-held corporations.
The economic implications of this tax-induced development in business form may go beyond the pure fiscal aspects and create welfare losses due to organizational inefficiencies and misallocation of capital. The lower CIT rate as part of the reform is likely to exacerbate this distortion.
Companies that receive dividends or qualified capital gains from abroad benefit from a 95 percent participation exemption to avoid double taxation with the remaining 5 percent taxable in Belgium. Foreign subsidiaries and branches in Belgium are taxed on their source income through the CIT and possibly withholding taxes on dividends, interest and royalties.
These latter taxes are often agreed upon in 93 bilateral tax treaties that Belgium has signed with other countries. In the past, Belgium has used various targeted tax incentives to attract foreign direct investment from MNCs, such as the regime for coordination centers before , the NID after see below , the innovation box, and specific rulings such as an excess profit tax ruling.
This strategy has been relatively successful in the past. This is much higher than in most other European countries. This suggests that a large share of FDI comprises purely financial flows running through Belgium—rather than greenfield investments that contribute to the Belgian economy. These financial flows may be a part of the tax planning strategies by MNCs and create negative spillovers on the tax base of other countries.
The tax incentives have therefore recently come under increased international scrutiny see next section. In response to this, Belgium has already revised some of its incentives, such as the excess profit ruling. The Belgian tax code contains modest anti-avoidance provisions to protect its CIT base against base erosion and profit shifting by MNCs.
For instance, its transfer pricing regulations are consistent with OECD guidelines, and there is a general anti avoidance rule that can be used to challenge aggressive forms of tax planning. However, compared to other countries, the current anti-avoidance provisions are relatively modest. For instance, Belgium adopts relatively weak interest-deductibility limitations which aims to limit base erosion through debt shifting and applies very limited controlled foreign corporation rules CFC rules, which would bring into tax the passive income earned in low-tax foreign affiliates of Belgian MNCs.
Inspired by Boadway and Bruce , who proposed to replace interest deductibility with a notional deduction for all capital, ACE supplements the current deductibility of interest with a similar deduction for the normal return on equity. This advocacy originates in the neutrality aspects of the ACE, which we briefly discuss in this section in the Belgian context. Debt bias occurs if only interest is deductible for the CIT, but not the normal return on equity. It provides an incentive for companies to excessively finance their investments by debt, rather than equity—with important implications for welfare and financial stability.
The NID aims to alleviate this financial distortion by neutralizing the treatment of debt and equity. Indeed, by granting a deduction for the normal return on equity, the debt bias induced by the ordinary CIT system is removed. Empirical evaluations show that the Belgium NID has been effective in lowering corporate leverage ratios, both in financial and non-financial firms.
Thus, it has contributed to the resilience of the Belgian economy by mitigating instability risks Burggraeve et al. These analyses have been conducted for only non-financial companies. To assess the implications for the banking sector, we present new estimates based on the synthetic control method. The challenge of assessing the impact of the NID on bank leverage is that the counterfactual is not observable, that is, what would have happened to bank debt had Belgium not introduced the NID in ?
The weights are determined optimally by minimizing the distance between the average Belgian bank debt ratio and a synthetic debt ratio predicted using the predicting variables that are typically used in the literature. These predictors are at the country-year-level and include, for example, the statutory CIT rate, the interest rate, and profitability. Having constructed a variable mimicking the Belgian debt ratio before the reform i. Figure 5 shows that the actual Belgian average debt in the banking sector considerably diverged from the counterfactual debt after , suggesting that the NID has been highly successful in reducing bank leverage, with a magnitude reaching Similar findings are reported by Schepens As the NID charges no tax on projects whose return equals the cost of capital, the effective marginal tax rate is reduced to zero.
This offers a powerful stimulus for investment compared to a system without such a provision. Employment would also rise under both scenarios, while GDP expands by, respectively, 2 and 1 percent. The NID has therefore recently received increased attention from countries and, for instance, was the main motivation for its introduction in Italy and its inclusion in the Common Consolidated Corporate Tax Base in the EU.
However, the empirical evidence on investment effects of the ACE is scarce, and the outcomes of the available empirical studies are mixed see, e. A concern with the Belgian NID is that it is widely used for international tax planning. To see how the mechanism works, consider an MNC that resides in country 1 and that wants to invest in a subsidiary in country 2. Instead of directly funding this investment, the MNC can finance a Belgian special purpose vehicle SPV with equity; subsequently, the SPV transfers these funds to the subsidiary in country 2 in the form of a loan.
At the same time, any dividend repatriation to the parent will be typically exempt in country 1, while the interest paid by the subsidiary is generally deductible in country 2. While the Belgian government neither suffers nor benefits from this SPV, other countries lose from its use. When that capital enters Belgium, it often takes the form of equity, for tax reasons: when it leaves Belgium, it does so in the form of an intra - group loan.
Given the negative spillovers to the tax base of other countries, the question is whether this generates any benefit for the Belgian economy. There are several remedies against tax planning, which both Belgium and other countries can adopt. Suggestions for reforms in Belgium are discussed in, for example, Zangari For other countries, it is important to note that the international tax planning induced by the ACE is reminiscent to classical debt shifting.
Indeed, international differences in CIT rates also induce firms to shift debt into high-tax countries and equity into low-tax countries. Countries have increasingly started to protect their tax base against this debt shifting through the adoption of thin capitalization rules and earnings-stripping rules. These anti-avoidance measures could also be effective against tax planning through the NID. Estimating the fiscal costs of the NID is complex, especially in light of important behavioral responses.
However, this figure does not adequately represent the overall fiscal cost of the NID for at least two reasons. They are present in Belgium only because of the existence of the NID and it is likely that they would disappear if the regime were repealed. Moreover, these NID provisions are exactly offset by an equivalent addition to the tax base due to taxable foreign interest income. This implies that 40 percent of the gross fiscal cost of the NID should be subtracted from the number above.
Conversely, the stock of debt and associated interest deductions is noticeably smaller. Thus, using the current equity stock in computing the revenue impact of the NID significantly overestimates the true revenue loss, since the fiscal benefits from lower interest deductions should also be accounted for. IMF a estimates that this element leads to an overstatement of the revenue loss by 50 percent. Recent international initiatives have significant implications for the Belgian CIT design. Under the BEPS initiative, concluded in November , countries have agreed on a non-binding set of common guidelines and minimum standards to limit opportunities for international tax avoidance by MNCs.
Belgium is committed to adopt at least the four minimum standards. The initiative has already led to amendments in the design of the Belgian innovation box. Another important element of BEPS is the multilateral instrument, which modifies the bilateral tax treaties along the lines of a common framework. This has been signed in June and Belgium has proposed 98 of its tax treaties for revision.
A general anti-treaty abuse rule will be added to every treaty covered by the multilateral instrument. EU state aid rules have targeted various special regimes across Europe, including prominent cases in Ireland, Luxembourg and the Netherlands. In Belgium, it has required the government to abolish the so-called excess profit tax ruling regime. Additionally, the CFC rule which would require the non-distributed income of a controlled foreign subsidiary or permanent establishment to be included in the tax base of the parent company in Belgium and the exit tax which would impose Belgian tax on unrealized capital gains when an asset is transferred abroad provide potential for further base broadening in Belgium.
Each country could then apply its own CIT rate to the apportioned base. It would also curb aggressive tax planning and remove the need for transfer pricing within the EU. Yet, the CCCTB would also involve new challenges, not least due to a significant re-allocation of tax bases across countries.
Moreover, as tax will effectively be levied based on the formula factors, new distortions will arise in the location of these factors—and tax competition for attracting those factors with a low tax rate will remain. Yet, two specific elements in the CCTB are worth mentioning. However, the AGI is applied to incremental equity relative to a base year and granted only for a year period. 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. We left out of the estimation sample those individuals whose prevailing economic activity in the income reference period could not be defined. We first focus on the definition of economic activity that serves as a dependent variable in the probit model. Economically active people encompass those who declared themselves as employed or unemployed in terms of the ILO definition of economic activity ; the category of inactive people consists of children, pensioners, and those who are otherwise inactive.
However, those pensioners and students who have declared a positive labour income are considered in our model to be employed, and their influence on labour force participation probability is controlled by using dummy variables. Income variables are necessary to generate gains to work; those which are collected on the individual level are listed in gross terms on a yearly basis in SK-SILC. The only exception is the net profit loss from self-employment. Information on disposable income, income taxes, and social security contributions are only available in the SK-SILC database as an aggregate at the household level.
Therefore, all income variables are used in gross terms and the net income is simulated. Actually, we distinguish between three different types of income: labour income, non-labour income, and transfers from the government. Labour income includes gross wages from a main and second job, income from self-employment, income from company shares, and income from agreement contracts temporary employment contracts. Information on fringe benefits, severance and termination payments, and a company car is also available. Non-labour income covers income from the rental of property or land, interest, dividends, and profit from capital investments.
Transfers involve pensions old age and disability , means-tested benefits such as the material needs benefit , contributory benefits unemployment and maternity , and family-related benefits. In short, we describe the tax and benefit system valid in Slovakia. As the system is highly complex, we focus on substantial parts and discuss its major attributes. In addition, we present a newly developed microsimulation tax and benefit module. The Slovak tax and benefit system is largely unified, and all important components are set at the central level.
Individuals are subject to personal income tax PIT , and the joint taxation of couples is not permitted. Tax is levied on gross income from different sources including wages from employment, self-employment income, fringe benefits, capital income dividends excluded , rental income, and interest income.
Social and health insurance contributions are exempt from the tax base, which is given as the gross earnings net of paid social and health insurance contributions. The tax law allows for deductions from the tax base, and these include a basic tax allowance, spouse tax allowance, employee tax credit, and child tax credit. Every individual can apply for the basic tax allowance—the amount is based on the legally defined minimum subsistence level, and a progressive reduction in its amount applies when earnings exceed the threshold value.
If the earnings of a spouse are under a certain level, the taxpayer may be entitled to a spouse tax allowance. An employee tax credit is targeted at low-income groups who pay health and social insurance contributions. One spouse may claim a child tax credit, which is an allowance for every child in the household.
12222 Effective Tax Burden In Europe Current Situation Past Developments And Simulations Of Reforms
Income tax is calculated by applying the appropriate tax rate schedule to the tax base. Social and health insurance payments are split between employers and employees. From , the assessment bases for the social and health insurance contributions of employees were unified; before then, they differed based on the type of insurance and employment contract. The assessment base for contributions differs from the base for the computation of the PIT and has a maximum level i.
Social insurance payments by employers and employees consist of unemployment, sickness, disability, and old-age insurance, but the two categories pay different percentages from the social insurance assessment base.
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Besides this, employers contribute to a reserve solidarity fund, accident insurance, and guarantee insurance. The Slovak benefits system comprises three components, and every component consists of several programmes. Contributory benefits cover various pensions e. The social assistance programme includes the material needs benefit, which is a means-tested transfer provided to families to provide them with a basic living standard if their income is below the minimum subsistence level.
The third component is the state social support programme, which includes several family-related benefits e. Eligibility for these transfers does not depend on the contribution history and is not means-tested. The SIMTASK microsimulation model is a tool that can simulate individual tax liabilities and benefit entitlements according to policy rules.
The development of the model and validation tests of the simulations are comprehensively documented in a related paper by Siebertova et al. Simulations cover direct taxes namely labour and capital income taxes and health and social insurance contributions paid by employees, employers, and the self-employed. Selected transfers—the unemployment benefit, material needs benefit, and family-related transfers the child-birth grant, child benefit, and parental allowance —are also simulated. In this section, we present the labour force participation elasticities estimated for the small and open Slovak economy.
The results are shown for different educational, age, and income groups as well as for the full sample. On top of that, we make use of the estimated models to carry out simulations of two tax reform scenarios. Equipped with the vectors of gains to work logGTW and non-labour income logNY that are constructed using a microsimulation model, we estimate the probit model of labour force participation decision given by Eq. The model is estimated separately for males and females. The point estimates and the goodness-of-fit measure pseudo R 2 are listed in Table 9 in the Appendix.
Reported standard errors are bootstrapped replications. In general, the estimates of parameters are in line with the usual findings; the significance and direction of dependencies is similar to those described for the selection equation of the Heckman model that we have used for the prediction of gross wages. Having a higher education and living with an economically active partner increases the probability of economic activity. However, being the father of a small child of an arbitrary age significantly increases activity.
Reporting chronic illness, being a student, or being a pensioner proved to have a significant negative effect on the probability of activity. Since our income measures of gains to work and non-labour income are given in natural logarithms, note that in fact we are evaluating semi-elasticities. Looking at both specifications, the computed results are statistically significant and have the expected sign; in other words, an increase in gains to work increases the probability of participation both for males and females, while the opposite is true for non-labour income.
The key estimate of interest—the income semi-elasticity of a labour force participation decision—is significantly larger for females than for males. This effect is more pronounced for net wages see Eq. Our results show that the own-wage semi-elasticity of the probability of participation yields 0. Corresponding income elasticities Footnote 9 can be obtained by dividing the semi-elasticities by the average predicted probability of activity—these estimates yield 0. Next, we focused on selected subgroups of individuals and explored how estimated semi-elasticities vary in magnitude.
The estimated semi-elasticities are substantially different in terms of educational subgroups: the highest responsiveness was observed in the low-educated group with an elementary education these individuals are often highly transfer dependent. Our results suggest that participation semi-elasticities substantially decrease with the educational level for both genders. When comparing males and females, the responsiveness of females in higher educated groups is two times higher compared to that of males.
Note that in agreement with previous studies, the prime-age subgroup of higher educated males exhibits a low responsiveness overall. Overall, the responsiveness of females is again higher than that of males. On the contrary, females with small children are the group with the highest responsiveness, being ten times higher than that of males in the same category. Overall, the presented results suggest that policies that make work pay would lead to an increase in participation. The low-skilled and females are the groups that are more responsive to changes in taxes and transfers.
This implies that labour market policies, namely tax and transfer system reforms that are aimed at boosting economic activity, should be primarily targeted at low-educated individuals and women. It appears that the magnitudes of Slovak estimates are lower compared to those for Hungary or the Czech Republic Benczur et al. On the other hand, Bicakova et al. Estimates lie in the rather wide range of already published labour supply elasticities. However, this comparison should only be taken as indicative due to the differences in the methodologies used.
Using the SIMTASK microsimulation model and the model of labour force participation decision estimated above, we conducted a policy analysis of static and behavioural effects of two tax system reforms. As a baseline, the tax and transfer system valid in in Slovakia was taken. We performed a microsimulation of two scenarios. Firstly, we simulated the effects of adopting the legislation valid since January , which includes a marginal departure from the flat tax and results in higher revenues.
Secondly, we estimate the impact of a hypothetical abolition of the flat-tax regime with the same simulated fiscal impact as in the first scenario. Although revenue-neutral scenarios are usually analysed in the academic literature, in our setup, we preferred to simulate the reform with the same first-round fiscal effect that is directly comparable with the first scenario.
The national setting
Moreover, this scenario includes a significant increase in the maximum assessment base for social security and health care contributions as well as an increase in the burden for income from agreement contracts. To solely assess the effects of changes in PIT legislation, government transfers and other system parameters that enter the computations in SIMTASK for example, the minimum subsistence level and the minimum wage were fixed to the level valid in As this elementary setup of tax rate regime would result in a decline in tax revenues, a further hypothetical measure needed to be applied to make the fiscal effect of the reform comparable to the scenario.
Specifically, the basic tax allowance is reduced by two thirds. The behavioural aspect was analysed afterwards using the estimates of the probit model of the labour force participation decision. It can be clearly seen that simulated changes affect individuals across the whole income distribution in positive as well as negative ways.
The variability arises mainly from various combinations of incomes labour and non-labour and the fact that the individual income components might be considered differently in tax liability computations in particular, the entitlement to apply different tax allowances. In the scenario, the individuals in the upper tail of the distribution face a positive change in their marginal as well as their average effective tax rates.
This is mainly the result of an increase in the maximum assessment base for social security and health care contributions. Individuals with income exceeding the pre-reform values of the maximum assessment base pay higher contributions, which at the same time decreases their tax liability. After the threshold of the new maximum assessment base is reached, both effective tax rates are solely influenced by the newly introduced second tax rate.
For most of the earners in the lower part of income distribution, the marginal and average effective tax rates stay unaffected in the scenario. Effective tax rates increased for those with income from agreement contracts, whose burden was affected by legislation. While before the reform the incomes from agreement contracts Footnote 10 were only subject to a 1. Additionally, due to tightened eligibility conditions for spousal tax allowance valid from , an increase in the tax burden could be observed for affected individuals. On the other hand, a decrease in the tax burden was identified for three small groups affected by the specific change in legislation.
In the hypothetical scenario, the individuals in the upper tail of the distribution face a positive change in their marginal and average effective tax rates, which is expected as the tax rates for incomes in the second to fifth tax brackets increased while the decline in the tax allowance additionally led to an increase in their burden. However, those with earnings below the new basic tax allowance would have no tax liability after the deduction of the tax allowance, similarly as in the baseline scenario.
For those with earnings above the new basic tax allowance, the effect of the lowered allowance prevails over the effect of the lower tax rate, thus leading to an increase in the tax burden. The burden would decrease mainly in those cases when the income is not eligible for a tax allowance deduction, e. These results can be contrasted to the findings of Krajcir and Odor , who analysed the Slovak flat-tax reform. They showed that an increase in the non-taxable allowance was an important factor that allowed the tax system to remain moderately progressive and made the reform revenue-neutral, leading to a modest net income decrease for certain groups of workers with below average earnings.
Following this, the impact of legislative changes on labour supply behaviour was analysed. Using the SIMTASK microsimulation model, key income variables gains to work and non-labour income were computed for the tax and transfers system setup valid in the baseline and in the two scenarios. The individual responses to analysed tax regime changes, i. Individuals with a higher labour income are less responsive to changes in the tax and welfare system despite the fact that they face an increase both in the METR and AETR.
In line with the literature as well as our model estimates, suggesting that extensive margin decisions are taken at the lower end of income distribution, Fig. Our approach allows us to compare the impact on participation probabilities for arbitrarily defined population subgroups, thus allowing us to assess to what extent they are affected by the reform. It turns out that the average probability of participation decreases only negligibly by 0.
The detailed results suggest that the probability of participation would decrease for almost all of the selected subgroups. Low earners the first income quintile and individuals with a lower education responded with the highest magnitudes. This can be explained by pointing out that these individuals often have income from agreement contracts which after the reform were burdened more and in the same way as income from employment or no labour income at all.
Individuals with either a low or no labour income but with a partner that faced a drop in disposable income could as a family become recipients of the material needs benefit or could have their material needs benefit increased. As a result, this translates into a decrease in participation probability in the behavioural model. Both of these groups are specific; individuals frequently do not have a labour income being students and mothers on parental leave and their own disposable income did not substantially change due to the simulated reform.
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In the behavioural model, the average participation probability in these groups increased mainly due to the lower disposable income of other working family members. In the hypothetical scenario, the average probability of labour market participation would decrease by 0. Similarly to the previous scenario, the detailed results show no special pattern among particular subgroups.
This is influenced by the fact that old-age pensioners would not be worse off by a lowered tax allowance but would benefit from a significant decrease in the tax rate. On the other hand, young individuals would decrease their labour participation by 0. The same applies for the level of income earned. Low earners with high values of estimated participation elasticities are more responsive to changes to the tax system than those people with higher earnings.
The individuals belonging to the third and fourth quintile would not change their participation decision under the simulated tax system. For policymakers, it is of crucial importance to assess the distributional impacts of every proposed tax change. The fundamental question that may arise here is which subgroups of the population would benefit and which would lose after the reform. For both scenarios, the changes in the disposable income of households are simulated, and as a result, the income inequality measures can be compared in two states before and after the reform.
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The impacts of the simulated scenarios differ in terms of income inequality. The Gini coefficient, which is the most commonly used measure of inequality, suggests a slight increase in inequality in the scenario. The reason is that this tax change would increase the tax wedge for agreement contracts, which are located in the lower deciles of the income distribution and among couples with a lower income. On the other hand, the implementation of the hypothetical scenario would decrease income inequality.
This would result from a combination of new tax rates and a substantial decrease in tax allowances. Having in mind a slight increase in the Gini coefficient, we would have expected the opposite effect. Table of Content Executive Summary. Write a review. Company Taxation. Effective Tax Burden. European Union EU. Sensitivity Analysis. More articles from. No social media integration components are displayed.
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