Welfare effects of a corporate tax rate reduction in Norway

An increasing magnitude of multinational companies locates operations in countries with low tax. Moreover profits are transferred from countries with high tax rates to countries with low tax rates. This has led to tax competition which is consistent with reductions in tax rates in EU countries in recent decades, see Devereux et al (2008). Meanwhile, the Norwegian corporate tax rate has been kept at 28 percent until 2014, where it was lowered to 27 percent. This has led to a debate about whether the Norwegian corporate tax rate should be reduced.

This study analyzes the welfare effect of reducing the Norwegian corporate tax rate. The study uses the intertemporal, disaggregated general equilibrium model, MSG6 of the Norwegian economy to quantify welfare effect of reducing corporate and capital income tax rates from 28 to 25 percent. The public budget constraint is maintained by an increase in the taxation of personal income. Model simulations show that such a revenue-neutral tax reform generates a welfare gain when tax cuts that also accrue to foreign capital owners stimulate investment. Welfare effect is marginally negative in a more pessimistic scenario where such tax cuts do not stimulate investment. The main explanation is that reduced corporate and capital income taxation improves the allocation of savings forms as housing investments fall when interest deduction is reduced. The tax reduction also stimulates productivity, and thus welfare. Investments increases in cases where reduced corporate tax rate leads to a reduced rate of return requirement, This leads to increased capital per worker ratio, which in turn pushes up wages. This increases the supply of labor, which together with the increase in real capital generates an increase in GDP. This provides increased consumption possibilities and welfare. The disadvantage of the reform is that parts of the tax reduction accrue to foreign capital owners. Moreover, the increase in the income tax increases the tax wedge in the labor market, and in this way enhances the welfare cost associated with distortions in the supply of labor.

Many aspects of changes in corporate and capital taxation, such as distributional effects and tax evasion by reporting labor income as business income, are excluded in this analysis. This is also relevant welfare economic effects that will modify the conclusions of the model analysis, unless they can be counteracted by changing other taxes.