IMF Research Shows Higher Business Taxes Reduce Likelihood of Firm Survival

April 21, 2019 by Dan Mitchell @ International Liberty

 

The International Monetary Fund is one of my least favorite international bureaucracies because the political types who run the organization routinely support bad policies such as bailouts and tax increases.

But there are professional economists at the IMF who do good work.

While writing about the mess in Argentina yesterday, for instance, I cited some very sensible research from one of the IMF’s economists.

Today, I’m going to cite two other IMF scholars. Serhan Cevik and Fedor Miryugin have produced some new research looking at the relationship between firm survival and business taxation. Here’s the basic methodology of their study.

While creative destruction—through firm entry and exit—is essential for economic progress, establishing a conducive ecosystem for firm survival is also necessary for sustainable private sector development… While corporate income taxes are expected to lower firms’ capital investment and productivity by raising the user cost of capital, distorting factor prices and reducing after-tax return on investment, taxation also provides resources for public infrastructure investments and the proper functioning of government institutions, which are key to a firm’s success. …the overall impact of taxation on firm performance depends on the relative weight of these two opposing effects, which can vary with the composition and efficiency of taxation and government spending. … In this paper, we focus on how taxation affects the survival prospects of nonfinancial firms, using hazard models and a comprehensive dataset covering over 4 million nonfinancial firms from 21 countries with a total of 21.5 million firm-year observations over the period 1995–2015. …we control for a plethora of firm characteristics, such as age, size, profitability, capital intensity, leverage and total factor productivity (TFP), as well as systematic differences across sectors and countries.

By the way, I agree that there are some core public goods that help an economy flourish. That being said, things like courts and national defense can easily be financed without any income tax.

And even with a very broad definition of public goods (i.e., to include infrastructure, education, etc), it’s possible to finance government with very low tax burdens.

But I’m digressing.

Let’s focus on the study. As you can see, the authors grabbed a lot of data from various European nations.

And they specifically measured the impact of the effective marginal tax rate on firm survival.

Unsurprisingly, higher tax burdens have a negative effect.

We find that the tax burden—measured by the firm-specific EMTR—exerts an adverse effect on companies’ survival prospects. In other words, a lower level of EMTR increases the survival probability among firms in our sample. This finding is not only statistically but also economically important and remains robust when we partition the sample into country subgroups. …digging deeper into the tax sensitivity of firm survival, we uncover a nonlinear relationship between the firm-specific EMTR and the probability of corporate failure, which implies that taxation becomes a detriment to firm survival at higher levels. With regards to the impact of other firm characteristics, we obtain results that are in line with previous research and see that survival probability differs depending on firm age and size, with older and larger firms experiencing a lower risk of failure.

For those that like statistics, here are the specific results.

Here are the real-world implications.

Reforms in tax policy and revenue administration should therefore be designed to cut the costs of compliance, facilitate entrepreneurship and innovation, and encourage alternative sources of financing by particularly addressing the corporate debt bias. In this context, the EMTR holds a special key by influencing firms’ investment decisions and the probability of survival over time, especially in capital intensive sectors of the economy. Importantly, the challenge for policymakers is not simply reducing the statutory CIT rate, but to level the playing field for all firms by rationalizing differentiated tax treatments across sectors, capital asset types and sources of financing.

There are some obvious takeaways from this research.

• First, it’s a very good idea to lower corporate tax rates.
• Second, it’s a good idea to treat all businesses the same.
• Third, it’s a good idea to treat debt and equity alike.

For what it’s worth, this IMF study basically embraces the sensible principles of business taxation that you find in a flat tax.

Too bad we can’t convince the political types who run the IMF to push the policies supported by IMF economists!