Master Thesis: German Tax Reforms and the Value of German Corporations

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1 Maser Thesis: German Tax Reforms and he Value of German Corporaions Liu, Xiaofeng Maser of Economics and Managemen Science Wirschafswissenschafliche Fakulä Humbodl Universiä zu Berlin Marikel Nr.: Adviser: Prof. Harald Uhlig, Ph.D. Dae:

2 Acknowledgmens I am hankful o my wife, Zhao Dandan for her srong suppors, highly valuable commens, and suggesions and Sefan Ried for giving me quie helpful advices in Toolki programming and model analyzing.

3 Absrac Growh model is widely used as a ool of macroeconomics and public finance. In he hesis, a sandard neoclassical growh model wih four exogenous permanen ax shocks is buil o analyze he relaionships beween ax raes and corporae evaluaions. By using Toolki, he model simulaes he impulse responses of price of shares and oher economic behavior variables o he ax shocks (corporaion income ax, personal income ax, consumpion ax, and dividend income ax). The oucome shows ha price of shares has posiive relaionships wih all four ax raes. The changes in ax policy do affec economic behaviors of he households and he firms, such as consumpion, oupu, wage, labor, deb, new invesmen and dividend paymen. Key words: Tax Reforms, Growh Model, Corporae Evaluaions, Toolki

4 Conens Inroducion... 2 German Tax Reforms Reducion of Personal Income Tax Reducion of Corporaion Income Tax The Changes in he Sysem of Taxing Shareholders Tax Reform has no End The Growh Model Model Represenaion The Equilibrium Calibraion and Parameerizaion Applicaion o Germany Tax Reform Reducion in Corporaion Income Tax rae Reducion in Personal Income Tax Reducion in Dividend Income Tax Consumpion Tax Tax Reform Reducion in Corporaion Income Tax Reducion in Dividend Income Tax Conclusion and Remarks References Appendix...32 A. Firs-Order Condiions Household Problem...32

5 2. Firm Problem...32 B. Seady Saes Equaions Seady Saes Equaions Solving Seady Saes...34 C. Log-Linearizaion...35 D. Toolki Code...36

6 Inroducion Since he unificaion of easern and wesern Germany, he value of German sock marke relaive o gross domesic produc (GDP) has varied and varied a lo (see Figure ). Boh GDP and capial sock experience increase every year. Bu apparenly he speed of he increase in capial sock is slower han ha in GDP. Thus, he raio of capial sock relaive o GDP in Germany decreases from 3.35 in 99 o 2.93 in Figure : Value of German Corporaions, Daa source: European Commission, AMECO However, based on he sudy of McGraan and Presco (2005), he raio of capial sock relaive o GDP in he Unie Saes is quie differen from ha in Germany (see Figure 2). A firs, he raio in he Unied Saes ( ) is much smaller han ha in Germany ( ). Secondly, corporae valuaions (relaive o GDP) rose from abou 0.50 in he mid-980 s o 2.00 in he mid-990 s in he Unied Saes. While corporae valuaions kep decreasing since he mid-990 s. The raio decreased from abou 2.00 o almos.50 in Of course, many facors have impacs on corporae valuaions, such as economic environmen, poliical environmen, confidence of he shareholders, developmen of echnology, and so on. McGraan and Presco (2005) poin ou ha one facor affecs srongly corporae valuaions. I is a counry s ax and regulaory sysem. Their opinion is ha he American axaion sysem has changed a lo since 960. So did

7 he corporae valuaions. Therefore, here mus be a relaionship beween he axaion sysem and corporae valuaions. Figure 2: Value of U.S. corporaions, Resource: McGraan and Presco (2005) Similar o he American axaion sysem, German axaion sysem has varied a lo, especially since he ax reform I is necessary o analyze wheher here is a relaionship beween German axaion sysem and German corporae valuaions. In my hesis, I follow he primary idea of McGraan and Presco he axaion sysem does affec he corporae valuaions and sudy how German ax reforms impac German corporae valuaions and how agens reflec o he ax reforms: he economic behaviors of individuals and corporaions. There is large lieraure on he effecs of ax reform on German economy and on he effecs of fiscal policy wihin growh model. Afer he German ax reform is implemened, many researches focus on he German ax reform or German ax sysem. Bach, Seidel and Teichmann (2000) firs predic he impacs of he ax reform Their conclusion is ha a posiive macroeconomic effec is o be expeced from he ax reform as a whole. Bu hey also poin ou ha if he ax reform is implemened, pressure could arise in he longer run o apply he new lower raes of ax no only o reained profis bu also o disribued profis and oher capial income. There is a very real danger ha he ax reform 2000 marks he firs sep down he road owards a dual income ax sysem. 2

8 Keen (2002) describes and evaluaes he ax reform The paper assesses he likely impacs on invesmen and labor supply, and focuses paricularly on key srucural reform: he end of impuaion, and he aboliion of ax on corporae holdings in oher corporaions. They believe ha he ax reform 2000 is essenially a radiional rae-cuing, base-broadening reform. I marks a radical and consrucive shif in German ax policy. There may be lile effec on levels of real invesmen and on labor supply a all, bu he highes incomes. Germany will be a more aracive place for inernaional invesors, he allocaion of invesmen will be improved, he cu in he op rae will help reain and moivae skilled workers and enrepreneurs, and he reducion in average raes of personal income axes is likely o feed helpfully ino paricipaion decisions and employmen bargaining. Based on a general equilibrium model of OECD economy, Sorensen (2002) shows ha ax reform 2000 will raise domesic economic aciviy and welfare and produce a non-negligible gain in economic efficiency. The efficiency gain will come mainly from lower corporaion and personal income ax raes, whereas he much dispued dividend ax reform seems o be slighly welfare-reducing, because i parly reinsaes he double axaion of dividends. However, he impac will be limied. Haan and Seiner (2004) employ microsimulaion echniques o esimae behavioral effecs of he ax reform using a discree choice labor supply model. They find ha he oal effec of he ax reform on he ne household s income amouns on average o 850, which implies a relaive increase of 3.29%. Cash gains of he ax reform are sricly increasing in he level of axable income implying an increase in income inequaliy as a consequence of he ax reform. Regarding o he fiscal effecs of he reform, hey esimae he ax reform induces a oal loss in personal income ax revenue by abou 33 billion. As he labor supply esimaion indicaes, addiional paricipaion and hours of work reduce he revenue loss by approximaely 2 billion. All in all, so many researches focus on he impacs of he German ax reform. Bu quaniaive research is quie few. On he oher hand, growh heory is widely used in quaniaive sudies on macroeconomics and public finance. Baxer and King (993) sudy four classic fiscal-policy experimens wihin a quaniaively resriced neoclassical model. They find 3

9 ha permanen changes in governmen purchases have imporan effecs on macroeconomic aciviy when hese are financed by lump-sum axaion, can lead o shor-run and long-run oupu mulipliers ha exceed, and induce larger effecs han emporary changes; he financing decision is quaniaively much more imporan han he direc resource cos of changes in governmen purchases; and public invesmen has dramaic effecs on privae oupu and invesmen. Presco (2004) also uses growh heory o analyze he effecs of labor axes on labor supply for he Unied Saes and European counries. He finds ha Europeans work much less han Americans because labor axes in European counries have raised more. Traband and Uhlig (2006) examine he shape of he Laffer curve quaniaively in a simple neoclassical growh model for he Unied Saes and EU-5 economy. They find ha since 975 he EU-5 area has moved closer o he peaks of heir Laffer curves. The slope of he Laffer curve in he EU-5 economy is much flaer han in he Unied Saes. Alhough many researches are relaed wih he German ax reform, and growh heory is widely used in research area in macroeconomics and public finance, hese researches do no connec he reform wih economic behaviors of individuals and corporaions. Furhermore, he sudy on he relaionship beween ax and regulaory sysem and he corporae valuaions is much less. McGraan and Presco (2005) find ha he changes in he ax and regulaory sysem significanly affec he corporae valuaions based on growh heory. The resuls of he Unied Saes and Unied Kingdom approve heir idea. From he growh model, hey derive he relaionships beween ax raes and corporae valuaions. The corporae valuaions are negaively relaed wih he ax raes on disribuion and corporaion income and subsidy rae on angible invesmen. v = ( τ )[( τ ) k + ( τ ) k ] dis subs m, + corp u, + where v, k m, + and k u, + denoe he price per share, angible asses, and inangible asses. τ dis and τ corp denoe he ax raes on disribuion and corporaion income, whileτ subs denoes subsidy rae on angible invesmen. The hesis is in line wih McGraan and Presco s findings ha corporae valuaions have relaionships wih he ax raes. Therefore, he iniial assumpion is ha he changes in ax raes do affec he corporae valuaions. How he changes in ax raes affec he 4

10 corporae valuaions, and how he agens (he households and he firms) reflec wih hese changes are sudied. The srucure of he hesis is organized as follows. The firs secion is he inroducion, which reviews briefly former researches abou German ax reform and growh heory ha is used in he analysis. In he second secion he German ax reforms are shorly reviewed, especially ax reform The hird secion is model seings and analysis. I se up he model and deal wih i o ge equilibrium condiion. The resuls are analyzed in he fourh secion. The las secion is conclusion and remarks. 5

11 2 German Tax Reforms In his secion I primarily focus on he main ax reforms afer he unificaion ha have been implemened (he ax reform 2000 and consumpion ax reform 2007) and will be implemened soon (he ax reform 2008). On 6h July, 2000, he Bundesag passed he Tax Reducion Ac. On 4h July, i was approved by he Bundesra. The Tax Reform 2000 became realiy. The law enered ino force on s January, 200 and was fully implemened on s January, The ax reform 2000 has brough fundamenal changes o he German ax sysem. Haan and Seiner (2004) poin ou ha he ax reform 2000 will reduce he ax burden in oal by abou 57 billion, of which abou 32 billion is due o he reducion of personal income axes, and he res o reducion in he axaion of corporaions. Families, wage and salary earners and small and medium-sized businesses are he main beneficiaries of he reform. 2. Reducion of Personal Income Tax The main changes in he personal income ax (PIT) were he sequenced cu in marginal ax raes, he increase in he basic allowance, and he reducion in he level a which he highes marginal rae and he enry-level rae applied (see Figure 3). The goal of he reform was o send a powerful growh signal o consumers and invesors which, in urn, boosed domesic growh in paricular, promoed job creaion and increased he incenives o ake up legal employmen. Tax reform 2000 has significanly lowered he raes of he income ax in several sages. The enry-level ax rae was reduced from 25.9% in 998 o 22.9% in 2002, and finally 5.0% in The op marginal rae was cu, also sep by sep, from 53.0% in 998 o 5.0% in 2002, and finally 42.0% in Over he same period, he basic personal allowance was increased from 6,322 in 998 o 7,235 in 2002, and finally 7,664 in Since 2005, he op rae was applied only o axable income in excess of 52,52. Maerial abou ax reform 2000 comes from Federal Minisry of Finance and Keen (2002). 6

12 Figure 3: Developmen of ax raes and basic allowance, Source: Federal Minisry of Finance Figure 4 illusraes he changes in marginal ax raes beween 998, prior o he sar of he reform, and 2005, a he end of he reform. A he wo exremes of his disribuion, he cus in he marginal raes are large ( ; ). However, a inermediae income levels in which many axpayers are likely o be locaed he cus are less significan. The rae cus reduced he ax charge on all payers of income ax, affording he greaes relief o employees and families wih low and medium incomes as well as small and medium-sized unincorporaed businesses. 7

13 Figure 4: Marginal income ax raes. Source: Keen (2002) 2.2 Reducion of Corporaion Income Tax The deepes srucural reform was he corporaion income ax (CIT). Before 200 German corporaion income axes were calculaed according o a spli rae sysem 40.0% on reained profis and 30.0% on disribued profis. This mehod has been replaced by a single ax rae. The corporaion income ax rae was cu from he above menioned raes of 40.0% and 30.0% o a uniform rae of 25.0% since 200. In 2003, he federal governmen decided o raise he corporaion income ax rae by.5% o 26.5% agains he background of he flood caasrophe. The corporaion income ax rae reurned o 25.0% since The Changes in he Sysem of Taxing Shareholders Regarding o he axaion of dividends, he full impuaion sysem he corporaion income ax paid on disribued profis being reaed as a prepaymen of he shareholder s liabiliy o personal income ax on hose dividends was replaced by he so-called half-income sysem, o make cross-border invesmen wihin Europe more aracive. Under his sysem, only half of he disribued profis of a corporaion were included in he shareholder s personal income ax base. This provision enered ino force in Tax Reform has no End From s January, 2007 value added ax rae (VAT, or consumpion ax rae) increased from 6.0% o 9.0%. On 25h May, 2007 he Bundesag passed he German Tax Reform 2008 bill. The new rules will become effecive on s January, The main change in he ax reform 2008 is a significan cu in ax raes for corporae axpayers. Today, he average combined corporaion income ax and rade ax rae for corporae axpayers is around 39.0%. As rade ax raes are se by municipaliies, he exac rae depends on he municipaliy where he business is locaed. Afer he ax reform 2008, he combined average corporaion income ax and rade ax will be reduced o 8

14 around 29.0%. Whereas rade ax raes will say more or less unchanged, he corporaion income ax will be reduced from oday s rae of 25.0% o 5.0% in Surcharge of 5.5% on corporaion income ax will keep unchanged. Therefore, effecive corporaion income ax will decrease o 5.825% (from currenly %). Curren calculaions show ha he planned corporaion ax reform will appreciably relieve he German economy. By improving is saus as a fiscal locaion, Germany will make a big leap forward by inernaional comparison. All he small and medium-sized enerprises will be he big winners, because he rae cus will have heir effec for enerprises of his size, while essenial elemens of he couner-financing will no affec hem, since hey will be exemped due o allowable deducions and ax-free amouns. Anoher dramaic change is axaion of privae capial invesmen income. Privae invesors capial invesmen income (effecive on s January, 2009) will no longer be subjec o heir progressive individual income ax rae, bu will insead be subjec o a 25% fla ax rae (plus surcharge and church ax). The half-income axaion sysem on dividends will be abolished. Capial invesmen income is defined as ineres and dividend income as well as capial gains (excep from real esae). 9

15 3 The Growh Model A sandard neoclassical growh model wih preferences, echnology, and budge consrains for he households, he firms, and he governmen is used. There are hree secors in he model: ) he households, who consume he final goods, provide labor, buy shares of he firms, receive wage and dividend paymen from he firms, and borrow money from he governmen; 2) he firms, which hire labor, produce he final goods, issue he socks o ge capial, pay wage o he households, and disribue dividends o he shareholders; and 3) he governmen, which pays governmen ransfer o he households, collecs axes from he households (VAT, PIT ec.) and he firms (CIT ec.), and lends money o he households. To simplify he model, I combine financial insiuions wih he governmen. I means ha he households can only borrow money from he governmen. In addiion, Germany is simply assumed as a closed economy. There is no inernaional rade and invesmen. Time is discree and infinie, = 0,,...,. The households, he firms, and he governmen would exis for ever. Finally, here is no uncerainy. 3. Model Represenaion The households have preferences over sequences of consumpion and labor, and maximize heir lifeime uiliy by deciding consumpion, labor, number of shares and deb subjec o heir budge consrain. Here he simples naural-logarihm uiliy funcion is used. The uiliy depends posiively on privaely provided consumpion and leisure of he households. In he hesis, he iniial assumpion is ha he sum of labor and leisure is equal o. Thus, he uiliy funcion is as follows. where indexes ime, c Sincel + n =, I subsiue l as n uc (, l) = logc+ logl () l + n = (2), l and n denoe consumpion, leisure and labor supply. ha depends on consumpion and labor as follows. ino he uiliy funcion and ge uiliy funcion 0

16 c, n, s, b β uc n = β c+ n = 0 = 0 max (, ) (log log( )) s.. (3) ( + τ ) c + v ( s s ) + Rb = ( τ ) d s + ( τ ) wn + ψ + b (4) c d n This consrain says ha he expendiures mus be equal o afer-ax income. Expendiures of he households are consumpion c, purchases of shares in socks, v( s s ), and gross paymen of he loans, Rb, where v is price of shares, s denoes he number of he shares ha he households are holding a ime period, R is gross ineres rae, and b is deb ha he households borrow from he governmen. Here s is a decimal fracion from 0 o. Receips of he households are wage, dividend paymen from he firms, and governmen ransfer. w, d, andψ denoe he wage rae, dividend paymen, and lump-sum governmen ransfer. The households have o pay axes on consumpion a a rae equal oτ, on personal income a a rae equal oτ n, and on c dividend income a a rae equal oτ. I is assumed ha iniial value of deb is equal o zero, and when he ime goes o infiniy, lim pb = 0. d The firms have capial and hire labor o produce final goods wih a consan reurns-o-scale Cobb-Douglas producion funcion, y = zk n θ θ where z denoes echnology shock a ime period, and k denoes asses of he firms a he end of ime period -, which will be used a ime period. A each ime period, dividend paymen o he households is equal o wha he firms have afer hey pay wage, axes, and make new invesmen. I means ha he firms disribue all he afer-ax profis afer making new invesmen. There is no profi reenion. The firms pay axes on corporaion income a rae is given by τ i b. The dividend paymen

17 d = ( y wn δk )( τ ) + δk x (5) i where x denoes new invesmen.δ denoes deprecaion rae. The firms pay corporaion i income ax a a rae ofτ. I is assumed ha iniial value of asses k is equal o zero. The firms choose capial and labor o maximize he presen value of dividend paymen ne of axes paid by he households on dividend income: d k, x pd τ = 0 max ( ) (6) s.. k = ( δ ) k + x (7) The governmen budge consrain says ha governmen expendiures mus be equal o governmen income. The governmen collecs axes from he households (consumpion ax, personal income ax and dividend income ax) and he firms (corporaion income ax), receives ineres and deb paymen from he households. The governmen pays governmen ransfer and provides loans o he households. ψ + b = τ c + τ d s + ( y wn δk ) τ + τ wn + Rb (8) c d i n 3.2 The Equilibrium In equilibrium, he households choose consumpion, labor, number of shares and deb o maximize heir preferences, he firms maximize he presen value of disribuions afer he households pay axes on dividend paymen, and he governmen ses ax policies o saisfy is budge consrain. And marke-clearing in equilibrium requires ha labor marke clears (In equilibrium, labor supply should be equal o labor demand. This condiion has been used in he model seings, because he same noaions for labor supply and labor demand are used.); he equiy marke clears; and he goods marke clears: s = (9) x + c = y (0) The echnical Appendix A shorly summarizes he process how he seady saes are derived. I assume ha he seady saes of labor n and governmen ransferψ are given. 2

18 The ax sysem is also given. And he ax raes (corporaion income ax rae, personal income ax rae, dividend income ax rae, and consumpion ax rae) are looked as exogenous permanen shocks. Here average personal income ax rae is calculaed by he model. Average personal income ax is used insead of marginal ax rae based according o he argumens of Uhlig (999). The Appendix B shows all he equaions ha describe he saionary equilibrium. For he dynamic analysis, I log-linearize he equaions around he seady saes (see Uhlig, 999 and Appendix C). 3.3 Calibraion and Parameerizaion I calibrae he model using daa of Germany from 997 o All he daa comes from AMECO daabase of he European Commission. Because a solidariy surcharge of 5.5 % is levied on he corporaion income ax, effecive corporaion income ax should equal o original corporaion income ax rae muliplied by (+5.5%). Here, he auocorrelaion of echnology shock is se o be Since all he ax shocks will las permanenly, he auocorrelaions of he ax shocks is equal o. All he sandard deviaions of he shocks are he same (0.%). For normalizaion, z is equal o. The seady sae of labor n is 0.22, and capial shareθ is Boh of hem come from Traband and Uhlig (2006). The seings are summarized in Table. Table : he Parameer Seings in he Model Parameer Value Descripion ρ z 0.95 Auocorrelaion of echnology shock ρ Auocorrelaion of ax shock on dividend income d ρ Auocorrelaion of ax shock on consumpion c ρ Auocorrelaion of ax shock on corporaion income i ρ Auocorrelaion of ax shock on personal income n σ 0. Sandard deviaion of echnology shock (%) z 3

19 σ 0. Sandard deviaion of ax shock on dividend income (%) d σ 0. Sandard deviaion of ax shock on consumpion (%) c σ 0. Sandard deviaion of ax shock on corporaion income (%) i σ 0. Sandard deviaion of ax shock on personal income (%) n z Normalizaion n 0.22 Seady sae of labor θ 0.36 Capial share in producion 4

20 4 Applicaion o Germany The following secion discusses he oucome of he model. The model reas he changes in ax raes as exogenous permanen shocks. There are four ax shocks (consumpion ax shockτ, corporaion income ax shockτ, dividend income ax c shockτ and personal income ax shockτ ) and one echnology shock zˆ in he model. d n The impulse responses show how ax reforms affec he corporae equiy values, and how he households and he firms respond o he differen shocks. I concenrae on he reducion of corporaion income ax, personal income ax and dividend income ax in he ax reform 2000, he increase in consumpion ax in 2007 and reducion of corporaion income ax and dividend income ax in he ax reform Here, Toolki developed by Prof. Uhlig s group is used. Toolki can analyze he growh model by showing he impulse response o a shock. The impulse response shows how he variables respond o he shock when he model ges a posiive exogenous shock. The verical axis shows how much he oher variables deviae from heir seady saes if he shock increases by.0%. The horizon axis means ime periods. One can see how he response changes during differen ime periods. 4. Tax Reform 2000 i To analyze he effecs of reducion of corporaion income ax, personal income ax and dividend income ax in he ax reform 2000, I value all he parameers dependen on he siuaion in 2000, since he ax reform 2000 was implemened on s January, 200. The seady sae of governmen ransfer relaive o GDPψ is The seady sae of gross i ineres rae R in 999 is The seady sae of corporaion income ax raeτ is 40.0%. Surcharge is sill 5.5%. Thus he effecive corporaion income ax rae should be 42.2%. Since he full impuaion sysem sill works in 2000, he seady sae of ax rae on dividend income τ ax τ c d should be equal o corporaion income ax rae. Consumpion is sill unchanged (6.0%). The depreciaion raeδ should be 0.04 in Oher 5

21 parameers follow he seings in secion 3.3. Table 2 summarizes he seings. Table 2: Parameer Seings for Tax Reform 2000 Parameer Value Descripion R.0526 Gross ineres rae in 2000 ψ Governmen ransfer relaive o GDP i τ 42.2% Seady sae of effecive ax rae on corporaion income d τ 40.0% Seady sae of ax rae on dividend income c τ δ 6.0% Seady sae of ax rae on consumpion 0.04 Depreciaion rae Afer he ax reform 2000 corporaion income ax rae decreases from 40.0% o 25.0%, ax rae on dividend income also declines from 40.0% o half of personal income ax rae, and he basic and op raes of personal income ax also decrease. Finally, i led o reducion of average personal income ax. The impulse responses show how consumpion, labor, oupu, wage, deb, and price of shares respond o he changes in corporaion income ax, personal income ax, and dividend income ax. 4.. Reducion in Corporaion Income Tax rae Figure 5 and 6 illusrae he impulse responses of consumpion, oupu, wage, labor, deb, price of shares, dividend paymen, capial, and new invesmen o a corporaion income ax shock. From Figure 5 and 6, we know ha wage, price of shares, and dividend paymen have posiive relaionships wih corporaion income ax rae. Consumpion, oupu, labor, deb, capial, and new invesmen have negaive relaionships wih corporaion income ax rae. Since corporaion income ax rae decreases afer he ax reform 2000, he firms pay less ax on corporaion income. Therefore, he firms increase oupu o ge more profis. The increase in oupu leads o he rise in labor, which resuls in he fall in wage. Meanwhile, he increase in oupu also leads o he increase in consumpion. The households consume more, bu ge lower wage. I is he reason why deb grows sharply. 6

22 The ax cu in corporaion income resuls in he decrease in price of shares. The impulse response shows he relaionship beween corporaion income ax rae and corporaion valuaions opposie o he conclusion of McGraan and Presco (2005). The oucome shows ha price of shares is posiively relaed wih he corporaion income ax, while McGraan and Presco (2005) ge a negaive relaionship. The impulse responses of dividend paymen, capial, and new invesmen answer why price of shares has a posiive relaionship wih corporaion income ax. When corporaion income ax rae decreases, dividend paymen also decreases, bu new invesmen and capial increase. We know ha oupu grows. The firms need more inpu o produce more final goods. So he increases in new invesmen and capial are reasonable. I also leads o he fall in dividend paymen. This is he reason why price of shares decreases. Normally, dividend paymen is a signal of siuaion of he firms. If he firms declare ha hey will decrease dividend paymen. I may affec he shareholders confidence in he firms. I may lead o he decrease in price of shares. Figure 5: he impulse responses o a shock in corporaion income ax 7

23 Figure 6: he impulse responses o a shock in corporaion income ax 4..2 Reducion in Personal Income Tax Figure 7 and 8 ell us ha he decrease in personal income ax rae leads o he decrease in wage, price of shares, dividend paymen, capial, and new invesmen and he increase in consumpion, oupu, labor, and deb. Because of reducion of personal income ax rae, he households have more money o deal wih if he income is unchanged. Thus, consumpion grows. The firms need o increase oupu o saisfy he increased demands. To produce more final goods, he firms need more workers. Therefore, labor increases. The rise in labor makes wage lower. The households consume more, bu receive less. So hey have o borrow more money. Keen (2002) also ges similar conclusion ha he decline in average personal income ax rae brough abou by he ax reform 2000 will end o generaes subsiuion effecs ha poin o an increased labor supply. Figure 8 displays he effec of a shock in personal income ax on price of shares. Because he average personal income ax decreases afer he ax reform 2000, price of shares falls. As we know, oupu grows. I means ha he firms performance well. I should lead o increase in price of shares. The impulse responses of dividend paymen, capial, and new invesmen do no give us meaningful explanaion (see Figure 8). As personal income ax rae decreases, 8

24 dividend paymen, capial and new invesmen decrease oo. Meanwhile, oupu increases. How do he firms finance heir oupu booming? In he model, he firms disribue all he ne profi afer making new invesmen. Therefore, he decrease in new invesmen should resul in he rise in dividend paymen. Since he impulse response shows ha dividend paymen would decrease oo, he only possible explanaion is ha he firms reain some of heir profis o increase heir oupu. The reason why price of shares decreases is ha he firms performance well, bu hey decrease dividend paymen on conrary. The firms, which performance well, decrease dividend paymen, capial and new invesmen o ge more profi reenion. I migh lead o he decrease in price of shares. Figure 7: he impulse responses o a shock in personal income ax 9

25 Figure 8: he impulse responses o a shock in personal income ax 4..3 Reducion in Dividend Income Tax From he ax reform 2000, we also know ha he half-income ax sysem replace he full impuaion sysem. Indeed, i leads o he decrease in dividend income ax rae. Figure 9 and 0 show ha dividend income ax rae has posiive relaionship wih wage, price of shares, and dividend paymen and negaive relaionships wih consumpion, oupu, labor, deb, capial and new invesmen. Due o reducion of dividend income ax rae, he shareholders ge more afer-ax dividends relaively. The households ge more money a heir disposal. Therefore, consumpion increases. I leads o he rise in oupu, which resuls in he increase in labor. Wage falls, as labor increases. The decline in wage resuls in he increase in deb. Since he dividend income ax rae has a posiive relaionship wih price of shares, he decrease in dividend income ax rae leads o he fall in price of shares. Here, we ge similar resuls wih corporaion income ax shock and personal income ax shock. Oupu increases, bu price of shares decreases. Figure 0 ells us why price of shares decreases. The increase in oupu leads o he increases in new invesmen and capial, which lead o he decrease in dividend paymen. Thus, he decrease in dividend paymen is he only explanaion of he decrease in price of 20

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