Corporate Tax Model

CORTAX is a macro-economic model designed to evaluate the economic implications of unilateral and multilateral corporate tax policies as well as the harmonization of these policies. It includes 27 countries of the European Union, plus the UK, the US and Japan. Countries are linked to each other via trade in goods markets, international capital markets and multinational firms.

It is a computable general equilibrium (CGE) model that captures the behaviour of households, firms and the government sector. All countries have the same functional form structure in terms of consumption, savings, production and public finances, but the data are country-specific. Firms are divided into three categories: domestic firms, multinationals headquarters and multinational subsidiaries. Multinationals and domestic firms differ to the extent that the former optimise profits globally and are engaged in profit shifting activities across borders. However, domestic firms pay their corporate taxes in their country of residence according to the revenues generated in that particular country. The effects of reforms can be expressed as changes in GDP, household consumption, business investment and fiscal revenue. It is coded in GAMS software. The model was originally built at CPB Netherlands, and was inspired by the OECDTAX model (Sørensen).

CORTAX has been used for policy formulation for corporate tax policies, in particular the Impact Assessment for the Common Corporate Tax Base (CCCTB) and the Common Consolidated Corporate Tax Base (CCCTB).

The CORTAX model is a multi-country computable general equilibrium model designed for the EU-27 to evaluate the economic effects of corporate tax reforms. The general equilibrium framework captures the optimal behaviour of all agents in the economy, specifically households, firms and government; and offers an economy-wide analysis of policy proposals. In the model, each country is assumed to have the same theoretical setting in terms of consumption, savings, production and public finances, although data accommodate country-specific features of the economy and the tax system. Besides the EU, the model includes the U.K., U.S., Japan and a tax haven. Countries are linked to each other via international trade in goods markets, international goods markets and investment by multinationals.

CORTAX features three categories of firms: multinationals headquarters, their subsidiaries located abroad and domestic firms. Each country has one representative domestic firm, one multinational headquarter and several subsidiaries, which are owned by headquarters in every other country. Each firm maximizes its value, equal to the net present value of all future cash flows, subject to the possibilities of the production function and accumulation constraints on physical capital and fiscal depreciation. The production function is a Cobb Douglas combination of the fixed factor and the value added, which, in turn, is a CES aggregate of labour and capital. Labour is immobile across borders and wages are determined on national labour markets. Capital is assumed to be perfectly mobile internationally so that the return to capital (after corporate taxes) is given for each country on the world capital market. The fixed factor is location-specific (e.g. land) and supplied inelastically. The income from the fixed factor reflects an economic rent.

Multinationals and domestic firms differ to the extent that the former optimise profits globally and are engaged in profit shifting activities across borders, via transfer pricing. Domestic firms only produce and pay their corporate taxes in their country of residence according to the revenues generated in the country only. Both domestic and multinational firms shift profits to tax haven to reduce their tax burden. Multinationals decide about the location of investment across subsidiaries. The size of the subsidiary in each country is determined by data on bilateral foreign direct investment (FDI) stocks.

The model allows the parent company to charge a transfer price for intra-firm deliveries of a homogenous good to the foreign subsidiaries that deviates from the equivalent price that would be charged if it had been an inter-firm transaction (the ‘arms-length’ price). Specifically, there is an incentive in place to set an artificially low (high) transfer price for supplies to subsidiaries in countries that feature a lower (higher) statutory corporate tax rate. In this way, the multinational shifts profits from high- to low-tax countries, thereby reducing its overall tax liability. The benefits from profit shifting thus rise linearly in the tax difference between countries. In order to ensure an interior solution, a convex cost function is specified to describe the organisational costs associated with the manipulation of transfer prices and that make profit shifting increasingly costly at the margin.

For domestic firms, practices of profit shifting are captured through the inclusion of a tax haven. The tax haven is modelled by setting an artificially low CIT rate and profit shifting depends on the difference between the statutory CIT rate in the country and the artificial rate. Also multinationals engage in this practise. The extent to which profit shifting to tax haven occurs is parameterised in line with the literature, in particular the elasticity estimates of a meta-regression study (Heckemeyer & Overesch, 2013). Multinational firms are considerably more able to take advantage of tax haven than domestic firms. Therefore firms in the model know that not all of their CIT tax base will be subject to statutory tax rate, meaning that their effective statutory tax rate is reduced.

Households are modelled in a two-generations overlapping framework with young and old. Households maximise their intra-temporal utility function subject to a budget constraint, where net savings from young workers (wages, current transfers and negative consumption) are equal to negative value of net savings from old households. Households' savings are allocated to bonds and stocks, which are imperfect substitutes and have different rates of return. The returns to assets are determined on world markets and are assumed to be the same irrespective of the residence of their owner. Total bond and stock holdings are derived from the maximisation of total assets CES combination of bonds and equities subject to their total value. The effects on welfare are calculated using the compensating variation, computed as the difference in transfers received by young households required to compensate the change in utility.

Government keeps the budget balanced with consumption and public debt as fixed shares of GDP. Tax revenues and/or transfer payments adjust to keep a constant public budget. The taxes included in CORTAX are indirect taxes consumption and direct taxes on income from corporate and labour, dividends, capital gains and interest. The expenditure side features government consumption, interest payments on public debt and lump-sum transfers.

Extracts from many databases are required:

• FDI, employment (Eurostat)
• National accounts, tax revenues (Ameco, OECD)
• Population and labour force (United Nations)
• Government debt (Ameco)
• Labour force statistics (Eurostat, OECD, World Input-Output Database)
• Purchasing power parity exchange rates (IMF)
• Implicit tax rates on consumption (Eurostat)
• Implicit tax rate on labour (calculated using EUROMOD)
• Statutory corporate tax rates (ZEW)
• Tax rates on dividends, interest and capital gains (ZEW)
• Firm-level balance sheet and ownership structure (Orbis from Bureau Van Dijk)
• Depreciation rules (ZEW)