Economy and Public Finance
- No Gains without Reforms II -
Government of Japan
The Tax System Reform for Vitalizing the Economy
Section 2 Burden of Corporate Income Tax
There are some 2.54 million companies in Japan. They are
subject to several kinds of taxes. Among them, core taxes are the so-called
"three corporate taxes" consisting of 1) Corporation Tax (national tax),
2) Corporation Enterprise Tax (local tax), and 3) Corporation Inhabitants
Tax based on Corporation Tax (local tax)(See Figure
Corporate income tax is more responsive to business fluctuations than individual income tax and other tax items and is more susceptible to changes in corporate earnings. Corporation Tax revenues decreased sharply after hitting a peak of 19.0 trillion yen in the bubble economy era of FY1989 and came to 10.3 trillion yen in FY2001, nearly half that in the peak year. As a result, and due also to repeated tax rate cuts, the ratio of Corporation Tax revenues to total general account tax revenues fell from 34.6% in FY1989 to 21.4% in FY2001 (See Figure 2-2-2). As to local tax, Corporation Enterprise Tax revenues decreased from 6.5 trillion yen in FY1991 to 3.9 trillion yen in FY2000, and Corporation Inhabitants Tax based on Corporation Tax decreased from 4.2 trillion yen in FY1989 to 2.4 trillion yen in FY2000, also affected by repeated tax rate cuts. As a result, the ratio of the revenues of Corporation Enterprise Tax and Corporation Inhabitants Tax based on Corporation Tax combined with local tax revenues dropped from 33% in FY1989 to 18% in FY2000. In this section, we will examine the actual state of the burden of corporate income tax.
Figure 2-2-1 Kind of Corporate Taxation
Figure 2-2-2 Changes in Corporate Tax Revenues
1. Trend of Corporate Income Tax in Major Countries
A general survey of corporate income tax trends in major
countries since the 1980s shows that most countries have broadened their
tax bases and lowered effective tax rates, inspired by the Thatcher tax
system reform of 1984 (See Figure
Figure 2-2-3 Trends of Effective Corporate Tax Rate in Major Countries
The effective rate of corporate tax in the United States, which stood at slightly above 50% before Ronald Reagan came to appear, now stands at slightly above 40% as a result of the broadening of the tax base through the reviews of various forms of preferential treatment and tax rate cuts.
In the United Kingdom, the tax base was expanded and tax rates were lowered gradually with the aim of enhancing corporate earnings by reviewing special taxation measures and lessening the tax burden. As a result, the effective corporate tax rate, which stood at the 50% level in the first half of the 1980s, has been the lowest among major countries since the 1990s.
In Germany, where the effective corporate tax rate had consistently been the highest among major countries in the 1980s, corporate tax rates were lowered in 1994 with the aim of ensuring the competitiveness of corporations, promoting investment, securing employment, and promoting the reconstruction of former East Germany following the unification of Europe. Tax rates were lowered again in 2001 to 38.47% from 48.55% in 2000.
In France, the effective corporate tax rate, which stood at 50% in 1980, fell to 30% in the 1990s due to repeated rate cuts. Although the rate rose temporarily due to a sharp increase in corporate tax surcharge, it dropped again following a cut in surcharge.
Japan also carried out drastic reductions of the tax rate twice--in FY1998 and FY1999--and the effective corporate tax rate now stands at 40.87%.
According to an annual survey (involving 68 countries) conducted by a major accounting firm(25), from the latter half of the 1990s there was a tendency to lower the corporate income tax rate as part of attempts to encourage economic activity and to review the overall corporation tax system, against the background of changes in economic structure. The average effective rate of corporate income tax among OECD and EU countries stood at 31% in December 2001 and 33% in January 2002(26) (See Figure 2-2-4). In the last year, as many as 16 countries lowered their effective corporate tax rates with Asian countries, who are major competitors for Japanese corporations, leading this trend of lowering corporate income tax rates in recent years. While the effective corporate income tax rates in the U.K. and France are around 30-34%, in Japan it is 40.87%, almost at the same level as that in the United States. The rates in major Asian countries are around 25-30% (See Figure 2-2-5). Incidentally, when making an international comparison of tax rates, we have to take into account such factors as the differences in the size and economic/social structure of the countries and the contents and level of public services provided to corporations. In addition, we have to pay attention to the fact that there are franchise and enterprise taxes (local tax) that are not based on corporate income.
Figure 2-2-4 Trends of Average Effective Rate of Corporate Tax in Advanced Countries
Figure 2-2-5 International Comparison of the Effective Rate of Corporate Income Tax
Nominal Tax Rate and "Effective Tax Rate"
Corporate income tax is a tax imposed on corporate profit (income) and consists of Corporation Tax, which is a national tax, Corporation Enterprise Tax and Corporation Inhabitants Tax based on Corporation Tax that are local taxes. The tax rate of the national tax (Corporation Tax) is 30% and that of the local tax (Corporation Enterprise Tax + Corporation Inhabitants Tax based on Corporation Tax) is 14.79%. However, the corporate income tax rate that we usually discuss is not the rate of the two tax rates (nominal tax rate) put together (44.79% at present). This is because, when calculating the income of Corporation Tax and Corporation Enterprise Tax, the amount of Corporation Enterprise Tax in the preceding business year is deducted. Therefore, the rate that we often use when discussing corporate tax burden is the "effective tax rate" that is adjusted for such deductions. The rate now stands at 40.87% (Note).
The statutory effective tax rate is one of the indicators to express the weight of corporate tax burden. However, when we use it for international comparison, we have to pay attention to its "tax base" and "tax rate." It is for this reason that discussion on corporate income tax burden becomes complicated.
We will present several measures to cope with this in 3 Current State of the Burden of Corporate Income Tax.
The specific method of calculating the "effective tax rate" is as follows.
Effective tax rate = (Corporation Tax rate x (1 + Inhabitants Tax rate) / (1 + Enterprise Tax rate)
Introduction of Taxation by the Size of Business for Corporation Inhabitants Tax
Introducing taxation by the size of business for businesses is now being considered as a policy option. So, let' s briefly discuss this problem.
In taxation, the method that should be used as the tax base to calculate the amount of tax is important. In corporate taxation, there are generally two methods; one is to use income as the tax base and the other is to use something other than income as the tax base (for example, capital or employee numbers). The latter is called "taxation by the size of business." At present, Japanese corporate tax and corporate enterprise tax are in principle based on income.
The Corporation Enterprise Tax is a tax imposed on the business of corporations and is based on the idea that corporations, since they receive various administrative services of local public bodies in their business activities, should bear part of the necessary expenses. Discussion on taxation by the size of business has a long history (1). The Shoup Report recommended that the tax base for the enterprise tax should be "the amount of the value added by the corporation to the value of goods, such as materials, that had been purchased from other businesses." In other words, it is proposed that "values added" should be the tax base. The argument on taxation by the size of business has long history. The Government Tax Commission reviewed specific proposals for taxation by the size of business and concluded that the following four are desirable tax bases; (1) business activity value (value added), (ii) total wage, (iii) a combination of physical and personal bases, and (iv) amount of capital, etc.
The business activity value (value added), which is said to be "theoretically the best" among the four pro forma tax bases, is an income-based added value that adds together profits, total compensation, interest paid and rental of a corporation in one business year. There are several ways to grasp the value added, as is shown in Figure 1 (2).
The introduction of taxation by the size of business is an important reform for stabilizing the main local tax that supports decentralization, clarifying the characteristics of tax as a benefit-based taxation, ensuring fair distribution of the tax burden, easing the income tax burden, promoting business activities for greater profits, vitalizing the Japanese economy, and promoting economic structural reforms.
On the other hand, among the major problems pointed out as being involved in the introduction of the system are tax burden fluctuations, treatment of small and medium-sized enterprises, and employment considerations.
In the "Structural Reform and Medium-Term Economic and Fiscal Perspectives" adopted by the Cabinet in January 2002, the government says with regard to pro forma standard taxation that it will "continue discussions on the matter by hearing opinions from people in various fields and, after obtaining a specific plan, will decide to introduce it possibly in time for FY2005 after taking into account economic conditions, etc."
Lastly, let' s take a look at taxation by the size of business systems in other countries (Figure 2).
Figure 1 Basic Concept of Added Value
(1) The corporate enterprise tax has a long history that goes back to 1878, when a franchise tax was created. It was initially introduced as a fixed-amount tax that differs according to industry, but came to be assessed on the basis of capital, etc. in 1896, when it was transferred from local to national control. In 1926, the franchise tax was abolished and instead a business profit tax based on net profits was introduced. After the war, a value-added tax was established along with the enactment of the Local Tax Law in 1950 on recommendation by the Shoup Report, but was not implemented. In 1954 it was abolished due to social and economic conditions and public opinion trends prevalent at the time.
(2) The current Corporation Enterprise Tax on the electricity supply industry, the gas supply industry, life insurance industry, and non-life insurance industry is based on the amount of total receipts not on income. The Local Tax Law stipulates that a tax base other than income can be used for other industries. The "taxation by the size of business on the banking industry" that the Tokyo Metropolitan Government introduced in 2000 is based on this provision.
Figure 2 Examples of Taxation by the Size of Business in Local Governments Abroad
2. Current State of the Burden of Corporate Income Tax as Seen from Companies
Discussion on corporate income taxation always raises the
question of "whether the burden of corporate income tax is heavy or light."
Therefore, we investigated the extent of income tax burden on corporations
from various angles under the current situation where the burden of corporate
income tax has been considerably reduced thanks to repeated tax system
Rates of tax burden of corporate income after the application of the tax effect accounting
It is very difficult to understand the extent of the burden of corporate income tax as seen from companies. Here, we took note of "rates of corporate tax burden after the application of the tax effect accounting" which corresponds to the tax payable by pretax income(27).
Since the "amount of tax to be paid" by corporations every business year is the "amount of tax payment" that is calculated by multiplying the "amount of taxable income," which is to be calculated pursuant to the Corporate Tax Law, etc., by the "statutory effective tax rate," it includes "tax costs" that should not be payable by the "net profit before tax" for the year in question. Therefore, it was pointed out that after tax profit, which is the difference between net profit before tax and corporate taxes, is not an appropriate figure by which to express the performance of corporations under the traditional accounting system.
The tax-effect accounting, which was recently introduced in response to such arguments, is an accounting method to adjust the difference in perception of "accounting profit/loss" and "tax benefit/expense" and is a global standard in line with international accounting standards(28). Figure 2-2-6 shows the relationship of net profit before tax, corporate tax, etc., corporate tax, etc. adjustments, corporate tax, etc. after the application of the tax effect accounting, net profit after tax, and taxable income. In the tax effect accounting, the portion of corporate tax, etc. that is paid in advance is to be recorded as "deferred tax asset" and the portion that is paid later as "deferred tax liability." Corporations can figure out the tax costs for current net profit before taxes only after calculating corporate tax, etc. after the application of the tax effect accounting (See Figure 2-2-6).
Figure 2-2-6 Relationship of Corporate Taxes and the Corporate Taxes After the Application of the Tax Effect Accounting
According to a Ministry of Finance survey (2002), the number of corporations that had adopted the tax effect accounting by FY2000 stood at 77,631, accounting for 3.0% of the total. By capital, the tax effect account has already been adopted by 98.0% (5,361) of the corporations capitalized at 1 billion yen or more and by 60.8% of the corporations capitalized at 100 million~1 billion yen. As of the end of FY2000, the deferred tax assets (taxes paid in advance) stood at 19,408.6 billion yen and the deferred tax liabilities (taxes to be paid later) stood at 3,899.1 billion yen. As a result, "the tax burden after the application of the tax effect accounting," which corresponds to the tax payable by pretax profit, comes to 12.3 trillion yen, or 15.5 trillion yen smaller than the tax to be paid in FY2000 (27.8 trillion yen). Conversely, the current net profit after tax increases by 15.5 trillion yen.
Here, we will study the extent of corporate income burden as seen from companies by compiling "rates of tax burden after the application of the tax effect accounting," or corporate tax, etc. after the application of the tax effect accounting divided by current net profit before tax(29),(30). Figure 2-2-7 shows the differentials between "rate of tax burden after the application of the tax effect accounting (A)" and "effective statutory tax rate (B)." It shows that there are considerable differences in the rate of tax burden as measured by "rates of tax burden after the application of the tax effect accounting." Of the 286 companies covered, the number of companies whose "rate of tax burden after the application of the tax effect accounting" exceeded the "effective statutory tax rate" came to 78 (about 30% of the total) and the number of companies whose "rate of tax burden after the application of the tax effect accounting" was smaller than the "effective statutory tax rate" came to 65 (slightly more than 20% of the total). Moreover, 49 companies posted losses and 11 companies saw their "rate of tax burden after the application of the tax effect accounting" post a negative growth. Although the distribution shape is close to a normal distribution, the number of companies with a deviation of plus or minus 15% or over came to 49, or more than one-sixth of the total. In many of the companies with a large plus deviation, a large amount of items that are not permanently deductible, such as entertainment expenses, and reserves in excess of allowable limits were accounted for. On the other hand, in many of the companies with a large minus deviation, a large amount of items that are not permanently included as revenue, such as dividend income, and foreign tax credits were accounted for (See Figure 2-2-7).
Figure 2-2-8 shows the differentials by type of industry. It reveals on the whole that the actual rate of tax burden is relatively high in the fisheries, mining and construction industries (16 of the 33 companies) and the rate is low in the machinery and electric equipment industries (16 of the 45 companies). Incidentally, due to tax amount adjustment by the tax effect accounting, the actual rates of tax burden of 15 companies were in minus territory.
As just described, although the corporate income tax rates in Japan are in principle the same, there are considerable differences in the "rates of tax burden after the application of the tax effect accounting" by companies.
Figure 2-2-7 Deviation between the "Rate of Tax Burden after the Application of the Tax-Effect-Accounting" and the "Effective Statutory Tax Rate"
Figure 2-2-8 Industry-by-Industry Differentials Between the Effective Statutory Tax Rate and the Rates of Tax Burden after the Application of the Tax Effect Accounting
3. Current state of the Burden of Corporate Income Tax (International Comparison)
(1) Burden of corporate income tax as seen from macroeconomic data
We have already described that the real tax burden of a corporation cannot be measured by the effective tax rate alone(31). This is because there are tax credits and tax-base adjustment for the calculated tax amount (See Figure 2-2-9). Therefore, in order to take a look at the real rate of tax burden, we calculated the "rate of tax burden of corporate income tax" (hereinafter to be called "tax burden rate" ) by using macroeconomic tax statistics (such as "Results of the Corporation Sample Survey" ) and made an international comparison and corporate size-by-size comparison(32).
Figure 2-2-9 Calculation Structure of Taxable Income for Corporate Tax
International comparison of tax burden rate
Let' s take a look at changes in the tax burden rate of Japanese corporations (See Figure2-2-10). The figure shows that the tax burden rate moved 3~5% above the effective statutory tax rate during the 1980s but the difference narrowed to 0~2% in the 1990s.
Next, let' s compare the rate of tax burden on corporate income in Japan with those in other advanced countries (See Figure 2-2-11). The figure shows that the tax burden rate has been on a downward trend in every country since the 1980s. However, the tax burden rate as seen from macroeconomic data in Japan (about 45%) remains higher than those in major western countries (40% or lower)(33).
Figure 2-2-10 Changes in the Tax Burden Rate of Japanese Corporate Income and "Effective Statutory Tax Rate"
Figure 2-2-11 International Comparison of the Burden Rate of Corporate Income Tax
Comparison of the rates of corporate income tax burden by size of capital
We have calculated the rates of corporate income tax burden by size of capital and compared them with those in the United States(34) (See Figure 2-2-12). The figure shows that the disparity in the tax burden rate by size of capital is wider in the United States than in Japan. The tax burden rate of Japanese corporations of any size of capital comes within a range of about 25% to 33% but, in the United States, the tax burden rate rises gradually from about 19% for less capitalized corporations to the level for corporations capitalized at 1~5 million(35).
Figure 2-2-12 International Comparison of Tax Burden (National Tax) by Class of Capital
Bias in Burden of Corporate Income Tax as Seen from Macroeconomic Data
Since the object of taxation of corporate tax is income of corporations, loss-making corporations (loss corporations) are not subject to taxation (Note).
The ratio of loss corporations to total business corporations in Japan was more than 50% even when the economy was booming in the second half of the 1980s and 30% of big corporations with a capitalization of 100 million yen or more were not paying corporate tax. Moreover, the number of loss corporations increased sharply in the 1990s and it now accounts for about 70% of total business corporations (2.5 million) (See Figure 1).
As a result, the burden of corporate income tax is concentrated in a limited number of corporations. For example, corporations with a capitalization of 100 million or more (about 19,000 companies), which account for only 0.8% of the total, are shouldering some 70% of corporate tax burden. In particular, corporations capitalized at 10 billion yen or more, which number only 741, are shouldering about 30% of the burden (See Figure 2).
Note: There are special measures for loss-making corporations, such as carryover of losses and tax refund from the loss carry-back.
Figure 1 Changes in the Ratio of Loss Corporations by Capital Class
Figure 2 Corporate Tax by Capital Class
(2) Burden of corporate income tax as seen from microeconomic data
Now, let' s make a comparative study of corporate income tax burden in various countries by using microeconomic data that reflect the actual state of individual companies(36). Here we calculated how much corporate tax a company would have to pay, if the company conducted the same business activities as in Japan. The tax amount calculated is the total of the national and local taxes levied on corporate income(37).
Specific method for estimation
First of all, we set up a model corporation in the following way.
We selected the five top-selling companies in each of the five industrial sectors--electronics, steel, automobile, information services and retail. From the manufacturing industry, we selected the automobile industry as a representative industry; from the steel industry we selected the smokestack industry, and the electronics industry as one with an emphasis on research and development. From the service industry, we selected the retail industry as a representative industry and the from the information service industry we selected an advanced technology industry. Then, we calculated the financial statements of the five top-selling companies by taking the simple average of their financial statements and business reports for FY1999 and FY2000(38).
Then, estimates of the corporate income tax burden were made for cases where the model company was assumed to conduct business activities in the United States, the United Kingdom, and France, with the same business content and the same financial statements, by making a number of assumptions(39)(40).
Since the tax burden varies depending on preconditions, we have to interpret the results of the calculation with some latitude.
Tax burden rate of corporate income tax
Let' s take a look at the tax burden rate of corporate income tax in each country calculated by industry type (See Figure 2-2-13). The tax burden rate here means the ratio of "tax amount (after adjustment for tax credits, etc.)" to "taxable income" (41). Therefore, the tax burden rate of corporate income tax is based on the "effective tax rate (40.87% in Japan), not on the nominal tax rate (44.79% in Japan).
Figure 2-2-13 International Comparison of Estimated Tax Burden Rate of Corporate Income in Each Industry
The figure shows the rate of corporate income tax burden for the model companies was higher in Japan in all sectors. In the case of the electronics industry, for example, while the rate is 29% in Japan, it is 6% in the U.S., 14% in the U.K., and 21% in France. In other industries, the burden rate in Japan is close to that in the U.S., but it is still 5~25% higher than that in the U.K. and France.
International comparison of tax amount
We have compared the tax burden rate by using the ratio of tax amount to taxable income, but this does not reveal the differences in corporate taxation, including the scope of taxable income. Therefore, in order to compare the tax burden including tax base, let' s take a look at the ratio of tax amount to pretax profits. Since our estimates are based on the assumption that each company is placed under a different country' s tax system and earns the same amount of profits, this comparison can be made by simply comparing the tax amount.
Figure 2-2-14 shows the tax burden amount in each country, with that in Japan being 100. In the electronics industry, for example, the amount comes to 19 in the U.S., 49 in the U.K., and 31 in France. In the automobile industry, though the difference in tax amount is relatively small, the amount in Japan is larger than in the U.S. (88), the U.K. (73), and France (78). This shows that even in a comparison after adjusting the tax base to the fullest extent possible, the model company' s tax burden in Japan is large.
These estimates show that the corporate income tax burden in Japan differs from those in the U.S. and European countries to a greater extent than the difference revealed by the "effective tax rate." The main factor affecting the results of the estimation was the setting of profits and losses in the process of assessing taxable income, and the adjustments, such as tax credits and additions, after the assessment of the amount of tax.
Figure 2-2-14 International Comparison of Estimated Tax Burden of Corporate Income in Each Industry
Japan-U.S. Comparison of Corporate Income Tax (National Tax) Burden as Seen from Tax Statistics by Type of Industry
Let' s compare the average corporate tax (national tax) burden industry by industry in Japan and the United States by using tax statistics of the two countries. The corporate tax burden here refers to the ratio of the "actual amount of corporate tax" to "taxable income" by type of industry (1). The tax rate used for the calculation is that of the national tax (corporate tax rate) levied on corporate income.
The rates of corporate tax burden calculated industry by industry show that the rate in Japan on the whole is smaller than in the U.S., reflecting the difference in the basic tax rate on corporate income between the two countries (Japan: 30%, U.S.: 35%). To be more specific, the rate is 30.2% on average in Japan and 33.0% in the U.S. Incidentally, the industry-by-industry differential in the corporate burden rate is larger in the U.S. than in Japan(2).
(1) The specific calculation method for "corporate tax burden rate" is as follows;
Corporate tax burden rate = Corporate tax amount (before foreign tax credits and income tax credits) / taxable income
Corporate tax amount (before foreign tax credits and income tax credits) is "corporate tax amount" in the two countries' statistics plus the foreign/income tax credits added back. The classification of industries is based on the Standard Industrial Classification (Major division) of the two countries.
(2) The coefficient of variation for the industry-by-industry differential in the corporate tax burden rate is 0.032 for Japan and 0.053 for the U.S.
Estimated Corporate Tax (national tax) Burden by type of Industry in Japan and U.S.
Discussion on Tax Base
The tax base of corporate income tax is calculated by deducting total costs (losses) of a given business year from the total earnings (profits) of the business year. What characterized the Japanese tax base was the existence of provisions and reserves (in FY2000, the three provisions of allowance for bad debts, allowance for bonus payable, and allowance for employee retirement benefits totaled 36.5 trillion yen). The proportion of corporations utilizing provisions and reserves is high among large capitalization companies and varies widely according to the type of industry, causing disparities in the effective tax burden among industries and companies. Such provisions and reserves prompted Japanese companies to build up internal funds and use them for business investment during the years of high economic growth. However, the role of the provisions and reserves decreased, as fund raising became easy in the second half of the 1980s, and instead it has become increasingly necessary for companies to secure profits through tax cuts by way of lower tax rates and to enhance their international competitiveness. In the FY1998 Tax Reform, the tax base was revised drastically and the basic tax rate was lowered and it was decided to abolish or reduce various provisions. The "Basic Policies 2002" also calls for lowering the effective tax rate and expanding the tax base.
In discussions on the tax base, what is particularly called for is reviewing various special taxation measures. Special taxation measures, unlike cuts in the corporate tax rate that apply to all tax-paying companies, have an advantage in that they intensively provide preferential treatment to the tax-paying companies that are deemed to contribute to the achievement of specific policy objectives. At the same time, however, they reduce corporate tax revenues, distort an efficient allocation of resources through the market, and may impair the neutrality of taxation. Therefore, efforts to consolidate and review company-related special taxation measures have been made. As a result, the tax revenue loss caused by such measures decreased to 434 billion yen in FY2002 from a peak of 630 billion yen in FY1991 and the ratio of such a tax revenue loss to corporate tax revenues has decreased gradually.
For the reasons described above, some people argue that when taking special taxation measures, they should be focused and concentrated in the fields of research and development that are really effective in creating new industries and technological innovation.
4. Simulation of the impact of corporate income tax using an applied general-equilibrium model
Corporate income taxation causes not only changes in the
relative price of production factors of production but also mobility of
factors of production among industry sectors and changes in production
volume in each sector. Research made so far has revealed that corporate
income taxation will have an impact not only on the companies subject to
taxation but also on the overall economy through the impact on resource
allocation. Therefore, in order to get a complete picture of corporate
income taxation change, it is necessary to evaluate its macroeconomic impacts.
Here, we will conduct simulation analyses of the impact of capital cost changes due to changes in corporate income taxation under a certain hypothesis by using an applied general-equilibrium model(42).
Model use for analyses
The analysis of an applied general equilibrium model is a numerical simulation that takes into account the general equilibrium structure of the economy. The model presumes that households and corporations conduct transactions on the market based on the principle of utility maximization and of profit maximization (cost minimization) and that supply/demand adjustments of goods/services and factors of production (capital, labor, land) are made in each market through price fluctuations and therefore market equilibrium of more than one market exists (Walras' law). Since the model analysis structurally sees the activities of the economic units, such as households and corporations that are playing important roles in the real economy, it allows us to analyze and evaluate the impact of changes in economic policy on resource allocation, economic welfare, etc. It also allows us to explore changes in industrial and economic structure. For this reason, the applied general equilibrium analysis method has been used frequently in the United States and other countries to analyze the impact of taxation reform on the macro economy.
Here, we will simulate the impact of changes in capital cost due to changes in corporate income taxation by using the GTAP model, one of the applied general equilibrium models (for GTAP model, see Appended Note 2-4).
Based on the results of previous research, we simulated (i) the impact on only resource allocation with the total amount of capital fixed (Case 1), and (ii) the impact of capital accumulation(43), in addition to the impact on resource allocation (Case 2).
When interpreting the results of the simulation, however, we have to take notice of the fact that the model assumes optimizing behavior of economic units under perfect competition and perfect information and that the results of the simulation are not future prospects for the reasons (i) that the simulation is nothing but a comparison between the original equilibrium point and a new equilibrium point and therefore does not depict the transition processes of changes in industrial structure, job mobility, and capital accumulation, (ii) that the changes in industrial structure, job mobility, and capital accumulation takes time, (iii) that the structure of the world economy in 1997, the base year for the simulation, was likely to have been greatly different from what it is now, and (iv) that the government sector is seen only from the aspect of consumers as in the case of households and therefore the impact of the government sector on fiscal balance is not taken into account.
In addition, we have to note that since the GTAP model used for the analysis does not incorporate corporate income taxation as a variable, a direct simulation of the impact of corporate income tax cuts cannot be made.
Impact of changes in capital cost due to changes in corporate income taxation
We estimated the impact of changes in capital cost due to changes in corporate income taxation in the case where the corporate income tax was cut by 10 percentage points.
Changes in corporate income taxation cause a change in capital cost. Here, we estimated changes in capital cost outside of the GTAP model (See Figure 2-2-15)(44).
Figure 2-2-15 Magnitude of Changes in Capital Cost Caused by a Cut in Corporate Income Tax
Generally speaking, industries with a larger decline in capital cost can take greater advantage of corporate income taxation change. Calculation results show that the impact varies according to industrial sector. The decreasing rate in the transportation industry is 1% and that in the electricity, gas & water, telecommunication, and electrically machinery industries is about 2% , while that in the textile & clothing industry is relatively large at around 3.5% . The rate in other industries is around 3%. The margin of decline in capital cost differs according to industry because (i) the useful lives of depreciable equipment differ according to industry and (ii) interest rates on borrowed money differ according to industry. As to (i), since the present value of depreciation is high in the industries with shorter useful lives of depreciable equipment, such as the transportation and electric machinery industries, the decline in capital cost is smaller than in other industries. As to (ii), the decline in capital cost in the industries with high borrowing costs, such as transportation and electricity and gas & water, is smaller than in other industries.
Incorporation of changes in capital cost into GTAP model
We applied to the GTAP model the industry-by-industry changes in capital cost thus obtained. Specifically, we conducted simulation on the assumption that the factor price of capital on the GTAP declined by the same percentage as the decline in capital cost(45).
However, we have to take notice that incorporating the impact of changes in capital cost into the model in this way may lack consistency due to the facts that (i) the rate of change in capital cost calculated outside of the model cannot be equated with the rate of change in the factor cost of capital on the GTAP, and that (ii) the data used for calculating capital cost does not correspond to the data used for the model.
We conducted a simulation of industry-by-industry changes in production volume and the rate of change in real GDP of the macro economy in Case 1 and Case 2.
Impact on only resource allocation: Case 1
In Case 1, where only the impact on resource allocation is simulated, the total volume of capital and other production factors are assumed to be constant. Therefore, when the factor price of capital changes the input of capital changes, but when the input of capital increase in one industry, it inevitably reduces the input of capital in other industries.
Based on this assumption, it can be said that a decline in the factor price of capital affects the macro economy in the following two ways. First, since a decline in the factor price of capital makes capital input relatively advantageous, it increases input through the substitution effect. Second, since the total volume of capital is constant, the advantages of production increases in capital-intensive industries, leading to an increase in the input of capital, but the input of capital decreases in labor-intensive industries as the advantages of production decreases. Such changes in resource allocation change the production volume of each industry. The change from the original equilibrium point can be considered as the "effect of resource allocation."
Simulation results show that a decline in the factor price of capital changes the industry-by-industry input of capital and labor, but the extent of the change differs according to industry (See Figure 2-2-16). The margin of industry-by-industry changes in production volume is about plus/minus 0.3%. In this sense, it can be said that the resource allocation impact of a change in the factor price of capital on production volume is limited (See Figure 2-2-17).
As to the impact on industry-by-industry goods prices, they decline in almost all industrial sectors. In particular, the margin of decline is large in the other services and textile/clothing industries. This is because the relatively large decline in the factor price of capital led to a decline in sales prices of products (See Figure 2-2-18).
As to the impact on the pattern of trade, the trade balance has deteriorated mainly in the industries whose production volume decreased (other equipment machinery and transportation machinery industries) due to a decrease in exports and an increase in imports. On the other hand, the trade balance has improved in the industries whose production volume increased (other services and textile/clothing industries) due to an increase in exports and a decrease in imports (See Figure 2-2-19).
Lastly, let' s take a look at the impact on economic growth and economic welfare. Compared with the original equilibrium point, the real GDP remains almost unchanged (See Figure 2-2-20). This is because the total volume of production factors including capital is constant and therefore an increase in production volume in one industry is offset by decrease in production volume in other industries. The level of economic welfare also remains almost unchanged(46).
Figure 2-2-16 Impacts of a Decline in the Factor Price of Capital on Capital & Labor Input (Simulation)
Figure 2-2-17 Changes in Production Volume Caused by a Decline in the Factor Price of Capital (Simulation)
Figure 2-2-18 Changes in Goods Prices Caused by a Decline in the Factor Price of Capital (Simulation)
Figure 2-2-19 Impact of a Decline in the Factor Price of Capital on the Pattern of Trade (Simulation)
Figure 2-2-20 Impact of a Decline in the Factor Price of Capital on Real GDP and Economic Welfare (Simulation)
Case where the impact on capital accumulation is taken into account: Case 2-A
Since the total volume of each production factor such as capital is fixed in Case 1, only the impact of reallocation of such factors among industries is analyzed. It does not take into account changes in total volume of production factors. In the actual economic society, however, capital is being accumulated through investment activities.
Case 2 looks at the case where capital is accumulated. Capital accumulation is made by an increase in savings and one of the sources of savings is domestic savings. In a country like Japan where capital flow has been liberalized, foreign savings are also sources of capital accumulation. Therefore, we conducted simulation with regard to two sub cases of Case 2. Case 2-A is the case where domestic savings increase in response to changes in return on capital in Japan, leading to capital accumulation. Case 2-B is the case where foreign savings flow into Japan in response to changes in international return on capital.
First, let' s take a look at the characteristics of the Case 2-A simulation results by comparing them with the results of Case 1. A study of the industrial structure impact shows that production volume increased drastically in all industries, as capital accumulation was taken into account (See Figure 2-2-17). In particular, production volume increased drastically in such industries as construction, metal, and electric machinery. This reflects that demand, mainly for investment goods, has increased in line with capital accumulation.
The impact on industry-by-industry prices of goods, in all industries except the mining industry and the government sector, goods prices declined as in the case of Case 1. The decreasing rate of goods prices was larger than in the case of Case 1 (See Figure 2-2-18).
As for the impact on trade patterns, both exports and imports increased in most of the industries, including the transport machinery and electrical machinery industries. As a result, the trade balance improved in the transport machinery industry but deteriorated in such industries as mining and other manufacturing (See Figure 2-2-10).
Finally the impact on real GDP, compared with the initial equilibrium point, real GDP increased 2.8% in response to an increase in production volume. The level of economic welfare also improved (See Figure 2-2-20).
Incidentally, the growth rate of real GDP represents the deviation margin of real GDP from the initial equilibrium point to the new equilibrium point, not the year-by-year growth rate of real GDP. It takes a considerable period of time for changes in industrial structure, job mobility, and capital accumulation to reach a new equilibrium point from the old equilibrium point. Moreover, since the model does not take into account the fiscal balance of the government section, it is necessary to note that the economic impact of the expansion of fiscal deficits caused by changes in corporate income taxation is not taken into account.
Case where the impact on capital accumulation is taken into account: Case 2-B
Next, let' s take a look at Case 2-B where foreign savings move in response to changes in international return on capital. Production volume increased in all industries except for the transport machinery industry, but the growth rate was smaller than in the case of Case 2-A. As to industry-by-industry prices of goods, they decreased in the other services, electricity, gas & water, and chemical/petroleum industries but increased in other industries. In terms of trade, exports decreased and imports increased in almost all industries, resulting in trade balance deterioration. Since the trade balance deteriorates in the case of an inflow of foreign savings in order to maintain the equilibrium, the growth of production volume is smaller than in the case of Case 2-A.
Lastly, real GDP increased 2.1% compared with the old equilibrium point and the level of economic welfare also improved. Although the increase and the improvement were smaller than in the case of Case 2-A, they indicate that the effect of capital accumulation was large.
The results of the simulation are summarized as follows.
First, changes in capital cost due to changes in corporate income taxation will have an impact on the overall economy through impact on resource allocation, etc.
Second, if the amount of capital stays the same, the changes will only promote reallocation resources between industries and will have hardly any impact on the overall production volume.
Third, if the capital accumulation mechanism is considered, the changes will promote not only reallocation of resources but also an increase in income, savings and investment, and capital stock as a result, and the impact on the overall production volume and real GDP will be much larger. However, the impact on the trade balance is different between Case 2-A and Case 2-B as their capital accumulation mechanism differs in that only domestic savings increase in the former and capital flows into Japan from abroad in the latter.