Essays on Tax Policy and its Effect on Firm Behaviour

Abstract

This dissertation consists of three self-contained essays and contributes to find optimal tax policies by analysing different tax policy instruments and taxpayers' behavioural responses to them. Moreover, it also provides new evidence on how German firms react to administrative interventions and taxes and how tax enforcement is designed in the German sub-national states. A large part of this dissertation relies on a self-collected data set which contains information about tax enforcement in the German states. This data set is unique since information about tax enforcement at the German state level has not yet been collected or released. Chapter 2 of this dissertation contributes to a better understanding of how German firms react to different size-dependent tax administrative thresholds which aim to foster Small and Medium Enterprises (SMEs) and increase the efficiency of taxation. The German tax administration has size-dependent thresholds in place to partition firms into different tax-related categories in order to economise on administrative costs. Using data from the statistics about the Business Tax for several years, the results show that frictions in tax administrative regulations cause behavioural responses of firms. Additionally, the study shows that tax administrations can prevent behavioural firm responses by designing more complex thresholds which are regularly adjusted. Chapter 3 analyses tax enforcement in the German sub-national states and examines whether there are any structural differences in their tax enforcement activities. Tax enforcement is one of the most important tax policy instruments to guarantee equity of taxation amongst taxpayers. The analyses show that audit cycles differ significantly between the German states which might indicate that some states use low audit ratios as a strategic tool for tax competition. Moreover, no evidence is found that the German fiscal equalisation scheme causes a significant difference between states' tax enforcement activities and there is no consistent evidence that there are differences in rightwing and leftwing governments' tax enforcement efforts. Most importantly, the study illustrates that smaller firms are less tax compliant than larger firms which raises doubts as to whether the current tax enforcement strategy in Germany fulfills its legal mandate. Chapter 4 focuses on one of the most intensely discussed questions in public finance - how taxes affect investments and entrepreneurship. We exploit a tax reform in Sections 8c/8d German Corporate Income Tax Act which improves firms' possibilities to carry forward losses and deduct these losses from future profits. Before this tax reform, the possibility to carry forward and deduct losses was very restricted in case a certain amount of a company's shares was sold. Since startups, due to a lack of monetary resources, usually sell large parts of their shares in their early lives, they have been particularly affected by this strict loss deductibility rule. Data from startups' investment rounds is used to analyse whether this tax reform had a significant impact on startup investments in Germany. While we do not find a significant increase in investments for all startups, we can show that especially early-stage startups with their first investment rounds benefit from this tax reform. We contribute by showing that tax policies, which aim to improve the economic principle of investment neutrality, can influence investment behaviour and firms' economic conditions.