Business Responses to Corporate Income Tax Changes: Estimates From Aggregate and Firm-level Data

This paper examines the economic effects of corporate income tax (CIT) reforms in the European Union between 2000 and 2016. The novelty of our approach hinges on the availability and use of real-time estimates of discretionary fiscal adjustments. In particular, exploiting a unique database covering anticipated and unanticipated income tax changes, we provide the first panel estimates of output, investment and employment multipliers for CIT changes in Europe. Furthermore, we do so using both macro and micro data, complementing traditional macroeconometric estimates with rich firm-level estimates. First, following earlier studies’ narrative identification of shocks to total revenues, we estimate response functions to CIT changes using a panel VAR model, controlling for contemporaneous and anticipated income and consumption tax reforms. Next, we confirm these aggregate responses employing a detailed, harmonized panel of non-consolidated Europe-based firms’ balance sheets and profit-and-loss accounts. We estimate the firms’ responses using dynamic panel regression models for capital investment, employment and (after tax) profits, controlling for coinciding tax reforms as well as country, sector, ownership structure and time fixed effects. The models are estimated on a yearly basis using Least Squares and Generalized Method of Moments estimators. Our results suggest that medium-term CIT-based output multipliers are well above unity for unanticipated tax changes, and comparatively larger for their anticipated counterparts. Preannounced changes, moreover, trigger larger investment responses and temporarily impact economic activity inversely upon announcement. Finally, we are able to identify clear differences across business sectors.