A new working paper from the International Monetary Fund (IMF) by economists Serhan Cevik and Fedor Miryugin shows that taxes have an economically important effect on whether firms survive in the marketplace.
Amid concern by policymakers and scholars over the fall in business dynamism in the United States, the authors examine whether taxation influences how long firms stay open for business. TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy is an important determinant of business success, especially as business formation rates have fallen.
Using a dataset of over four million financial firms from 21 countries between 1995 and 2015, the authors find that higher effective marginal tax rates (EMTR) on firms are associated with a lower likelihood of firms surviving over time. Tax rates become especially harmful at high levels, which is something that policymakers should take into account when considering proposals that would raise tax rates to high levels.
Older firms are more heavily affected by tax burdens than young firms are. A 1 percent increase in the marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. for old firms is associated with a 6.5 percent decrease in survival, vs. a 1.4 percent decrease in survival for younger firms experiencing a similar tax increase. While younger firms may struggle with high tax burdens early on, this research shows that firms are also sensitive to taxes as they mature.
These results show that the structure and burden of business taxation affects whether firms are successful in the marketplace. Tax policy affects firms differently depending on what industry and country they operate in. Firms in capital-intensive industries, like manufacturing and information technology, experience a greater burden from higher effective marginal tax rates.
The structure of tax policy also matters for firm survival, as the authors argue that “tax systems can be designed to improve efficiency and boost investment that foster[s] innovation and job creation.” To do so, policymakers must “level the playing field for all firms by rationalizing differentiated tax treatments across sectors, capital asset types and sources of financing.”
The authors calculate the effective marginal tax rate for each of the four million firms they observe in the study, which captures the share of net profits subject to tax. The EMTR accounts for differences in tax rules across countries, such as how a country’s tax code treats depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. .
To make sure that the tax system is not a barrier for a firm’s success, the tax code ideally would treat firms across industries and with different financing methods neutrally. At present, America’s tax code distorts the economic decision-making of firms, such as the favorable treatment of debt financing over equity. This study adds to this argument while providing motivation for policymakers to focus on how reforms to tax policy can increase American entrepreneurship.
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