Corporate Taxation and Productivity Catch‐Up: Evidence from European Firms

• Author: José F. Sanz‐Sanz,Richard Kneller,Danny McGowan,Norman Gemmell,Ismael Sanz
• Date: 01 April 2018
• DOI: http://doi.org/10.1111/sjoe.12212
• Published date: 01 April 2018

©The editors of The Scandinavian Journal of Economics 2016.

Scand. J. of Economics 120(2), 372–399, 2018

DOI: 10.1111/sjoe.12212

Corporate Taxation and Productivity

Catch-Up: Evidence from European Firms*

Norman Gemmell

Victoria University of Wellington, Wellington 6140, New Zealand

norman.gemmell@vuw.ac.nz

Richard Kneller

University of Nottingham, Nottingham NG7 2RD, UK

richard.kneller@nottingham.ac.uk

Danny McGowan

University of Nottingham, Nottingham NG8 1BB, UK

danny.mcgowan@nottingham.ac.uk

Ismael Sanz

King Juan Carlos University, 28032 Madrid, Spain

ismael.sanz@urjc.es

Jos´e F. Sanz-Sanz

Complutense University of Madrid, 28223 Madrid, Spain

jfelizs@ccee.ucm.es

Abstract

In this paper, we explore whether higher corporate tax rates, because they lower the

after-tax returns to productivity-enhancing investments, reduce the speed with which small

firms converge to the productivity frontier. Using data for 11 European countries, we

find evidence that their productivity catch-up is slower when the statutory corporate tax

rates are higher. In contrast, we find that large firms are instead affected by effective

marginal rates. Using the reduced-form model of productivity convergence of Griffith

et al. (2009, Journal of Regional Science 49, 689–720), our results are robust to a

host of robustness checks and a natural experiment that exploits the 2001 German tax

reforms.

Keywords: Convergence; firms; productivity; taxation

JEL classification:D24; H25; L11; O31

*We are very grateful to three anonymous referees for excellent comments and suggestions.

We thank seminar participants from the University of Exeter, ZEW (Mannheim) and the

UK HMRC. R. Kneller and D. McGowan gratefully acknowledge financial support from the

ESRC under project no. RES-194-23-0003. J. F. Sanz-Sanz acknowledges support from project

ECO2012-35572.

N. Gemmell et al. 373

I. Introduction

The large differences in the level of productivity that exist between firms

within the same industry have stimulated what is now a significant body

of research into the drivers of productivity change, and in particular the

factors that encourage firms to catch up with those on the productivity

frontier. Common themes within this research have included whether non-

frontier firms invest to improve their productivity either in response to

the presence of foreign multinational firms (see G¨org and Greenaway,

2004, for a review), or in response to intra-market (Foster et al., 2001)

and import competition (Nicoletti and Scarpetta, 2005; Schmitz, 2005).

We contribute to this body of literature by testing whether aspects of the

domestic policy environment affect the productivity catch-up of firms.

Whilst convergence of productivity levels from below is a feature

present in our cross-country firm-level data, and has been found in other

micro datasets by Bartelsman et al. (2008), Griffith et al. (2009), and

others, there is also evidence that the rate of catch-up differs significantly

across firms. This suggests the presence of features of the economic

environment that constrain the ability of some firms to make productivity-

enhancing investments (PEIs). In this paper, we investigate the role played

by corporate taxation. The question we consider is therefore the following.

Does higher corporate taxation reduce the expected returns to PEIs,

diminishing the ex ante incentive for firms to invest, and thereby slowing

their rate of productivity convergence?1

In his summary of the firm productivity literature, Syverson (2011) has

argued that differences in productivity across firms arise from differences

in the creation of new technologies through R&D, as well as the quality of

human and physical capital inputs, but also from “soft technologies” such

as management and organization (Bloom and Van Reenen, 2007; Bloom

et al., 2014). Traditionally, research on the effects of taxation at the micro

level has concentrated on its effects on firms’ R&D and tangible capital

investments. The relationship between tax policy (mostly R&D tax credits)

and the volume, or the location, of R&D across countries/US states is

reviewed in Hall and van Reenen (2000), while Auerbach (2002), Hasset

and Hubbard (2002), and Hines (2005) examine the relationship between

taxation and capital investment. The conclusion from this body of literature

has been that high statutory corporate tax rates reduce investment in

physical capital by increasing the user cost of capital (Hasset and Hubbard,

1This builds on the idea, known since Arrow (1962), that restrictions on the ability to

appropriate the returns to innovations slow the rate of technological progress.

©The editors of The Scandinavian Journal of Economics 2016.