## _wp1228

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---

### Introduction and motivation
- Objective: study the evolution of corporate income tax (CIT) systems in emerging and developing economies since the mid-1990s until the global financial crisis in 2008.
- Motivating considerations:
  - Concerns about tax competition and advanced tax planning affecting revenues.
  - Theoretical literature: no clear consensus; accepted notion that "the revenue yield of a tax on mobile factors will depend on taxes in other jurisdictions."
  - Empirical gap: scant evidence for developing economies; most existing studies focus on advanced economies.
- Contribution:
  - Use a newly-constructed dataset of effective corporate tax rates in 50 emerging and developing economies over 1996-2007.
  - Integrate special regimes into measurement of effective tax rates.
  - Analyze impact of CIT developments on government revenues and investment.

### Definitions and methodological choices
- Measures computed:
  - Effective Average Tax Rate (EATR): ratio of the present value of taxes to the present value of profits for a discrete investment project; applicable to projects with positive ex ante economic rent.
  - Effective Marginal Tax Rate (EMTR): special case of the EATR for a project that just breaks even (post-tax economic rent = nil).
- Key methodological assumptions:
  - Manufactured investment in plant and machinery assumed.
  - Equity finance assumed.
  - For EATR calculations, a rate of return of 20 percent is assumed.
  - Both EMTR and EATR consistently reported.
  - Extension implemented to allow special regimes (reduced rates for a few years, tax holidays).
- Data sources and sample:
  - Primary sources: annual worldwide corporate tax guides by Price Waterhouse Coopers and Ernst and Young over 1995-2007.
  - Sample period: 1996-2007.
  - Sample: 50 emerging and developing economies across Africa, Asia, Europe, and Latin America.
  - Processed measures: statutory corporate tax rates (simple averages), PDV of depreciation allowances normalized by statutory tax rate, EATR and EMTR per Appendix I methodology with special-regime extension.

### Stylized facts and regional trends (1996-2007)
- Statutory corporate tax rates:
  - Declined in emerging and developing economies from about 31 percent to 26 percent (simple averages).
  - Europe: ended sample at 21 percent (lowest average).
- PDV of depreciation allowances (normalized by tax rate):
  - Stable in most regions; Africa experienced a move to narrower bases (implied by fall in normalized PDV).
- Effective tax rates:
  - EATR declined in every region following statutory tax rate declines.
  - EMTR declined overall; Africa experienced a major reduction due to narrower bases and lower rates.
- Special regimes:
  - EATR under the most generous regime more than halved from an already low level.
  - Europe: roll-back of generosity in special regimes observed.
  - Africa: effective average rates under most generous regimes fell further to zero.
- Tax revenues (1996-2007):
  - Total tax revenues: stable or rising trends across regions prior to 2008 crisis.
  - Corporate tax revenues rose more sharply than aggregate revenues.
  - CIT/total tax revenue ratio increased from 17 to 21 percent over the period.
  - Notes: Taxes exclude social security contributions and, where applicable, oil revenues (scaling to non-oil GDP).
- Investment and FDI:
  - Gross private capital formation: moderation in Asia and Latin America after late 1990s crises; Africa rose consistently from a low base; Europe rose notably after 2000.
  - Inward FDI: upward trend with a trough in early 2000s; gradual build-up to Africa since 2004.

### Episodes of large ETR/EMTR changes (1996-2007)
- Identification and counts:
  - Continuous increases or reductions in EATR/EMTR extracted; temporary one-year 1 percentage point reversals ignored.
  - EMTR: 44 episodes (16 large increases, 28 large decreases).
  - EATR: 46 episodes.
- Durations and magnitudes:
  - Two-thirds of episodes had duration < 3 years.
  - Median duration: decreases phased over 3 years; increases typically took 1 year.
  - Median magnitudes:
    - EATR increases: 6 percentage points.
    - EATR decreases: 9 percentage points.
    - EMTR increases: 14 percentage points.
    - EMTR decreases: 18 percentage points.
- Associations with statutory rates and special regimes:
  - About half of ETR increases accompanied by tightening of most generous regime.
  - Two-thirds of EATR declines accompanied by relaxation of most generous regime.
  - 47 ETR declines coincided with statutory tax rate reductions.
- Initial conditions around episodes (average of year t-1 and year t-2 mean values over episodes):
  - For EATR increases vs. decreases (percent of GDP):
    - Total tax revenue: 14.1 (EATR increases); 17.2 (EATR decreases).
    - Corporate tax revenue: 2.4 (EATR increases); 2.8 (EATR decreases).
    - Gross private investment: 16.0 (EATR increases); 15.6 (EATR decreases).
    - Inward FDI: 3.2 (EATR increases); 2.9 (EATR decreases).
  - Interpretation:
    - Large EATR increases tend to occur with low tax revenues and relatively high investment.
    - Large EATR decreases tend to occur with higher prior revenues and lower investment.
- Episode outcomes (scatter evidence):
  - Relationship reported between changes in EATR and corporate tax revenue: slope y = 0.0158x + 0.1984; a 10 percentage point increase in EATR coincides with a 0.2 percent of GDP increase in corporate tax revenue.
  - Relationship between large EMTR changes and domestic investment: weak; slope reported y = -0.0195x + 1.0007.
  - EATR changes and FDI: negative association in some specifications (slope reported y = -0.0283x + 0.014); some FDI gains in EATR-reducing countries may reflect market share shifts within the region rather than net new FDI.

### Econometric estimates — Revenues
- Regression setup:
  - Dependent variable: corporate income tax revenue as share of GDP.
  - Regressors include: statutory tax rate (τ), tax base proxy (PDV of true economic depreciation to statutory depreciation), gross operating surplus (profits proxy), τ squared, special-regime dummy, region interactions, country fixed effects, year effects.
- Key results (Table 4 highlights):
  - Tax rate coefficient: positive and significant in most specifications; reported coefficients include 0.046***, 0.046***, 0.116*, 0.064***, 0.061*** across columns.
  - Tax rate squared: generally not significant.
  - Tax rate * special regime interaction: when special regimes are offered, the impact of an increase in the tax rate is reduced by about half.
  - Africa interaction: in Africa, increasing tax rates appears to have no impact on revenues (statistically different coefficient).
  - Broad tax base proxy: often not significant in fixed-effect specifications (likely captured by country fixed effects); significant in simple OLS.

### Econometric estimates — Investment and FDI
- Regression setup:
  - Dependent variable: private investment (or FDI) as share of GDP.
  - Regressors: lagged dependent variable, effective tax rate (EATR or EMTR), EATR for special regime, controls (inflation, financial openness, growth, USD GDP), country fixed effects, year dummies.
  - Estimators: within-groups (WG) fixed effects and Blundell-Bond system GMM; specification tests (AR(2), Hansen) reported and passed.
- Private investment (Table 5 highlights):
  - Lagged private investment: highly significant (examples: 0.631***, 0.660***, 0.629***, 0.663***, 0.443***, 0.511** across models).
  - EMTR: insignificant (coefficients e.g., -0.027, -0.015, not significant).
  - EATR: negative and in some specifications significant (e.g., -0.076**, -0.099*), indicating rent-earning investments respond to tax changes.
  - EATR for special regime: often insignificant; presence of special regimes tends to make standard EATR effect on investment insignificant.
  - Controls: financial openness, growth, USD GDP (trillions) show mixed significance; inflation often insignificant except in some specifications.
- FDI (Table 6 highlights):
  - Lagged FDI: highly significant (examples: 0.561***, 0.733***).
  - EMTR: insignificant negative coefficients (e.g., -0.020, -0.012).
  - EATR: negative and significant in some WG specifications (e.g., -0.062**).
  - GMM finds negative impact primarily for EATR applicable to special regimes (EATR for special regime coefficient -0.190* in one GMM model).
  - Inflation: negatively associated with FDI in some specifications (e.g., -0.730***).

### Interpretation of econometric evidence
- Revenues:
  - Corporate tax revenues are positively related to statutory tax rates outside Africa; relationship weakens with special regimes.
  - In Africa, no significant short-term revenue response to statutory tax rate increases; possible explanations include pervasiveness of special regimes, profit shifting, and sensitive investment responses.
- Investment and FDI:
  - Standard EMTR does not have a discernible impact on aggregate investment.
  - EATR (average tax on rent-earning projects) has a negative effect on private investment.
  - Presence of special regimes undermines the relationship between standard tax rates and investment: tax-sensitive investment may be concentrated under special regimes, making standard EATR irrelevant.
  - FDI responds negatively to higher EATR in some specifications; evidence that FDI reacts to special regimes is suggestive but sample-limited.

### Key findings and policy-relevant conclusions
- Broad findings:
  - Standard tax systems in emerging and developing economies evolved similarly to advanced economies: statutory and effective rates fell while bases were kept stable or broadened in many regions.
  - Sub-Saharan Africa stands out: tax bases on average narrowed; special regimes drove EATRs to near zero in many countries.
  - Despite rate cuts, tax revenues held up and corporate tax revenues rose as a share of total taxes (CIT/total tax revenue ratio rose from 17 to 21 percent over 1996-2007).
- Episodes and motivations:
  - Large ETR increases tend to follow low revenues and comfortable FDI levels; large ETR decreases tend to follow low domestic investment.
  - Statutory rate reductions account for most ETR and EMTR declines; increases often implemented by tightening allowances and depreciation.
- Policy implications:
  - Revenues remain a positive function of tax rates (except in Africa), but the presence of special regimes substantially weakens this relationship.
  - High tax rates on rent-earning investments reduce investment; special regimes can neutralize this effect by shifting tax-sensitive activity into preferential regimes.
  - Evidence does not support an across-the-board "race to the bottom" for standard tax systems; rather, a "partial race to the bottom" where competition concentrates on special regimes and mobile capital.
- Research gaps and future work:
  - Open questions:
    - What proportion of investment qualifies for special regimes, and how does this vary across countries?
    - Do special regimes successfully target mobile investment or merely shift investment that would occur anyway into incentives?
    - What are short- and long-term revenue implications of special regimes, and how do these interact with competing countries’ policies?
  - Main challenge: obtaining detailed data on the implementation and utilization of special regimes to complement statutory measures.

### Appendix I — Derivation of effective tax rates (framework and implementation)
- EATR definition adapted from Devereux and Griffith (2003):
  - EATR* = (R* - R) / (p + r), and for infinite (permanent) investment horizon adapted to EATR* = (R* - R) / (p + r + δ), where δ is true economic depreciation.
- EMTR: special case of EATR when post-tax economic rent R = 0.
- Present discounted value of economic rent and firm value:
  - R = sum_{s=0}^{∞} dD_{t+s} / (1+\rho)^{s+1} = dV, with γ = (1 - m_d) / (1 - mz) and ρ = (1 - m_i) / (1 + i) - 1.
- Tax-free PDV R* and taxed PDV R derived under permanent investment with explicit expressions (equations provided in source).
- Decomposition of taxed R:
  1. First sum: tax-dependent PDV profits accounting for special regime lasting Y years at tax rate τ' (program accommodates up to three sequential changes).
  2. Second sum: sum_{s=0}^{∞} dI_{t+s} / (1 + ρ)^{s+1} = 1 / (1 + ρ).
  3. Third sum: present discounted value of depreciation allowances, A, depends on official depreciation rules.
- Financing effects F:
  - Funds needed to finance investment reduced by τϕ in year of investment.
  - Financing effect F decomposed into new equity and debt components; NE component F_{NE} = sum_{s=0}^{∞} γ_{t+s} dN_{t+s} / (1 + ρ)^{s+1}.
  - Program accounts for debt repayment assumptions and detailed debt-related terms (full expressions in source).
- Depreciation allowance A:
  - Program calculates A for declining balance and straight-line depreciation; accommodates up to three rate and method changes.
- EMTR computation:
  - Solve equation (8) for pre-tax net profit p̃ setting R = 0 (explicit formula in equation (11)).
  - EMTR = (p̃ - pr) / p̃ (equation (12)); equivalently compute R* for p̃ and substitute into EATR definition.
- Implementation notes:
  - Framework adapts one-period perturbation to a permanent unit increase in capital stock disinvested over time via δ.
  - Program capabilities:
    - Accommodates up to three sequential changes in special regimes (τ' changes).
    - Accounts for up to three rate and method changes in depreciation rules.
    - Calculates A and F per chosen depreciation method and financing assumptions.

*Source: _wp1228 - 1. Sample of Emerging and Developing Economies; Appendix I. Derivation of Effective Tax Rates (excerpt).*

### 1. Sample of Emerging and Developing Economies .................................................................6

### 1. Sample of Emerging and Developing Economies

### Introduction and motivation
- Corporate income tax (CIT) developments have been widely studied, with concerns about tax competition and advanced tax planning affecting revenues.
- Theoretical literature has no clear consensus on the net effects of tax competition; however, "the revenue yield of a tax on mobile factors will depend on taxes in other jurisdictions" is generally accepted.
- Empirical evidence on CIT developments in developing economies is scant; most existing studies focus on advanced economies.
- This paper aims to fill that void by studying the evolution of CIT systems in emerging and developing economies since the mid-1990s until the global financial crisis in 2008.

### Key differences between emerging/developing economies and advanced economies (as motivating factors)
- Typical emerging markets are smaller, face a more elastic supply of international capital, and have a smaller base of local investors, implying stronger pressures to cut tax rates (e.g., Bucovetsky, 1991).
- Tax administration and enforcement capacity is often more limited, increasing the threat to revenues from aggressive tax planning.
- Economic structure: many small producers operate outside the formal sector or are officially exempt on size grounds, leading to high dependence on a few large businesses; CIT often makes up a larger share of total tax receipts.
- Higher reliance on generous special regimes and holidays to attract foreign investors wary of inefficient or corrupt tax administrations.

### Literature context and gaps
- Devereux, Griffith and Klemm (2002) for advanced economies (1960-99) report stylized facts: (i) statutory tax rates have fallen; (ii) tax bases have been broadened; (iii) effective tax rates have fallen, especially for investments with high rates of profitability; (iv) tax revenues have remained stable as a share of GDP; (v) tax revenues have fallen as a share of total tax revenue since the 1960s, but have stabilized since the 1980s.
- Few comparable studies document such stylized facts in developing economies or analyze the impact of CIT developments on government revenues and investment.
- Keen and Simone (2004) collect data on tax incentives in 40 developing economies over 1990-2002 and find that unlike advanced economies—which have tended to broaden tax bases and cut tax rates while maintaining revenues—developing economies have cut rates, introduced special regimes and lost revenues.
- Keen and Mansour (2010) examine Sub-Saharan Africa and find bases have narrowed—especially through tax holidays and special zones—but "surprisingly, tax revenues have held up in this region." Their paper counts the number of special regimes but does not track generosity or calculate impacts on effective tax rates.
- There is no comprehensive study integrating special regimes into a general analysis of CIT developments in emerging economies.

### Data and methodological approach (sample and measures)
- The paper uses a newly-constructed dataset of effective corporate tax rates in 50 emerging and developing economies over 1996-2007.
- Effective (marginal and average) tax rates summarize all tax laws, including rate, base, and any special regime.
- Effective tax rate computations are based on an extension of Devereux and Griffith (2003), allowing calculation of tax law-based measures for rent-earning investments and including the effective marginal tax rate as a special case.

### Objectives and contributions
- Document developments in CIT systems in emerging and developing economies over 1996-2007.
- Integrate special regimes into the measurement of effective tax rates to assess their generosity and impact.
- Analyze the impact of CIT developments on government revenues and investment in emerging and developing economies.

*Source: _wp1228 - 1. Sample of Emerging and Developing Economies (excerpt).*

### Appendix I for detailed derivation). Briefly, the rates are obtained by constructing a forward-

### _wp1228 - Appendix I for detailed derivation). Briefly, the rates are obtained by constructing a forward-

### Definitions and methodology
- Effective Average Tax Rate (EATR)
  - Ratio of the present value of taxes to the present value of profits for a discrete investment project.
  - Applicable to projects where a positive economic rent is expected ex ante (example: multinational with a patent).
- Effective Marginal Tax Rate (EMTR)
  - Special case of the EATR for a project that just breaks even (post-tax economic rent = nil).
  - Relevant for companies operating at the margin; incremental investment decisions.
- Methodological choices used throughout the paper
  - Manufactured investment in plant and machinery assumed.
  - Equity finance assumed.
  - For EATR calculations, a rate of return of 20 percent is assumed.
  - Common assumptions across time and space to ensure differences reflect tax systems only.
  - Both EMTR and EATR are consistently reported.
  - Extension to allow special regimes (reduced rates for a few years, tax holidays) is implemented.

### Data and sample
- Primary data sources: annual worldwide corporate tax guides published by Price Waterhouse Coopers and Ernst and Young over 1995-2007.
- Sample period: 1996-2007.
- Sample of emerging and developing economies includes countries across Africa, Asia, Europe, and Latin America (list present in source).
- Key processed measures:
  - Statutory corporate tax rates (simple averages across countries).
  - Present discounted value (PDV) of depreciation allowances normalized by statutory tax rate.
  - EATR and EMTR computed using methodology in Appendix I and special-regime extension.

### Stylized facts and regional trends (1996-2007)
- Statutory corporate tax rates
  - Declined in emerging and developing economies from about 31 percent to 26 percent (simple averages).
  - Europe: most pronounced reductions; ended sample at 21 percent (lowest average).
  - Africa and Asia: moderate reductions; Latin America: slight edge downwards.
- PDV of depreciation allowances (normalized by tax rate)
  - Stable in most regions; Africa experienced a move to narrower bases (implied by fall in normalized PDV).
- Effective tax rates
  - EATR declined in every region following statutory tax rate declines.
  - EMTR declined overall; Africa experienced a major reduction due to combination of narrower bases and lower rates.
- Special regimes
  - EATR under the most generous regime more than halved from an already low level.
  - Europe: roll-back of generosity in special regimes observed.
  - Africa: effective average rates under most generous regimes fell further to zero.
- Tax revenues (1996-2007)
  - Total tax revenues: stable or rising trends across regions prior to 2008 crisis.
  - Corporate tax revenues rose more sharply than aggregate revenues.
  - CIT/total tax revenue ratio increased from 17 to 21 percent over the period.
  - Notes: Taxes exclude social security contributions and, where applicable, oil revenues (scaling to non-oil GDP).
- Investment and FDI
  - Gross private capital formation: moderation in Asia and Latin America after late 1990s crises; Africa rose consistently from a low base; Europe rose notably after 2000.
  - Inward FDI: upward trend over period with a trough in early 2000s; gradual build-up to Africa since 2004.

### Episodes of large ETR/EMTR changes (1996-2007)
- Episode identification
  - Continuous increases or reductions in EATR/EMTR extracted; temporary one-year 1 percentage point reversals not considered to interrupt episodes.
- Counts and durations
  - EMTR: 44 episodes (16 large increases, 28 large decreases); EATR: 46 episodes.
  - Two-thirds of episodes had duration < 3 years.
  - Median duration: decreases phased over 3 years; increases typically took 1 year.
  - Median magnitudes: EATR increases 6 percentage points, EATR decreases 9 percentage points; EMTR increases 14 percentage points, EMTR decreases 18 percentage points.
- Special regimes and statutory rates during episodes (Table 2 summary)
  - About half of ETR increases accompanied by tightening of most generous regime; two-thirds of EATR declines accompanied by relaxation of most generous regime.
  - 47 ETR declines coincided with statutory tax rate reductions.
- Initial conditions around episodes (Table 3 summary; “Average of year t-1 and year t-2 mean values over episodes”)
  - For EATR increases vs. decreases (percent of GDP):
    - Total tax revenue: EATR increases 14.1; EATR decreases 17.2
    - Corporate tax revenue: EATR increases 2.4; EATR decreases 2.8
    - Gross private investment: EATR increases 16.0; EATR decreases 15.6
    - Inward FDI: EATR increases 3.2; EATR decreases 2.9
  - Interpretation:
    - Large EATR increases tend to occur with low tax revenues and relatively high investment.
    - Large EATR decreases tend to occur with higher prior revenues and lower investment.
- Episode outcomes (scatter evidence, Figure 11)
  - A 10 percentage point increase in EATR coincides with a 0.2 percent of GDP increase in corporate tax revenue (slope reported: y = 0.0158x + 0.1984 in scatter).
  - Relationship between large EMTR changes and domestic investment is weak; estimated slope reported: y = -0.0195x + 1.0007.
  - EATR changes and FDI: negative association in some specifications (slope reported: y = -0.0283x + 0.014); some FDI gains in EATR-reducing countries appear to come from market share shifts within the region rather than net new FDI to the region.

### Econometric estimates — Revenues
- Revenue regression specification
  - Dependent variable: corporate income tax revenue as share of GDP.
  - Regressors include statutory tax rate (τ), tax base proxy (PDV of true economic depreciation to statutory depreciation), profits proxy (gross operating surplus), τ squared, special-regime dummy, region interactions, country fixed effects, year effects.
- Key regression results (Table 4 highlights)
  - Tax rate coefficient positive and significant in most specifications:
    - Examples: Tax rate coefficients reported as 0.046***, 0.046***, 0.116*, 0.064***, 0.061*** across columns (standard errors reported parenthetically in table).
  - Tax rate squared generally not significant for this sample.
  - Tax rate * special regime interaction: when special regimes are offered, the impact of an increase in the tax rate is reduced by about half.
  - Africa interaction: in Africa, increasing tax rates appears to have no impact on revenues (statistically different coefficient).
  - Broad tax base proxy often not significant in fixed-effect specifications (likely captured by country fixed effects); in simple OLS it is significant.

### Econometric estimates — Investment and FDI
- Investment regression specification
  - Dependent variable: private investment (or FDI) as share of GDP.
  - Regressors: lagged dependent variable, effective tax rate (EATR or EMTR), EATR for special regime, controls (inflation, financial openness, growth, USD GDP), country fixed effects, year dummies.
  - Estimators used: within-groups (WG) fixed effects and Blundell-Bond system GMM (to address lagged dependent variable bias); specification tests (AR(2), Hansen) reported and passed.
- Private investment (Table 5 highlights)
  - Lagged private investment highly significant (e.g., 0.631***, 0.660***, 0.629***, 0.663***, 0.443***, 0.511** across models).
  - EMTR: insignificant (coefficients reported: -0.027, -0.015, not significant).
  - EATR: negative and in some specifications significant (e.g., -0.076**, -0.099* in WG and GMM respectively); indicates rent-earning investments respond to tax changes.
  - EATR for special regime: often insignificant; in presence of special regimes, standard EATR effect on investment becomes insignificant.
  - Controls: financial openness, growth, USD GDP (trillions) show mixed significance; Inflation often insignificant except in some specifications with large standard errors.
- FDI (Table 6 highlights)
  - Lagged FDI highly significant (e.g., 0.561***, 0.733***, etc.).
  - EMTR: insignificant negative coefficients (e.g., -0.020, -0.012).
  - EATR: negative and significant in some WG specifications (e.g., -0.062**); GMM finds negative impact primarily for EATR applicable to special regimes (EATR for special regime coefficient -0.190* in one GMM model).
  - Inflation negatively associated with FDI in some specifications (e.g., -0.730***).

### Interpretation of econometric evidence
- Revenues
  - Corporate tax revenues are positively related to statutory tax rates outside Africa; relationship weakens with special regimes.
  - In Africa, no significant short-term revenue response to statutory tax rate increases (possible explanations: pervasiveness of special regimes; profit shifting; sensitive investment responses).
- Investment and FDI
  - Standard EMTR does not have a discernible impact on aggregate investment; EATR (average tax on rent-earning projects) has a negative effect on private investment.
  - Presence of special regimes undermines the relationship between standard tax rates and investment: tax-sensitive investment may be concentrated under special regimes, making standard EATR irrelevant.
  - FDI responds negatively to higher EATR in some specifications; evidence that FDI reacts to special regimes (GMM result) is suggestive but sample-limited.

### Key findings and policy-relevant conclusions
- Broad findings
  - Standard tax systems in emerging and developing economies evolved similarly to advanced economies: statutory and effective rates fell while bases were kept stable or broadened in many regions.
  - Sub-Saharan Africa stands out: tax bases on average narrowed; special regimes drove EATRs to near zero in many countries.
  - Despite rate cuts, tax revenues held up and corporate tax revenues rose as a share of total taxes (CIT/total tax revenue ratio rose from 17 to 21 percent over 1996-2007).
- Episodes and motivations
  - Large ETR increases tend to follow low revenues and comfortable FDI levels; large ETR decreases tend to follow low domestic investment.
  - Statutory rate reductions account for most ETR and EMTR declines; increases often implemented by tightening allowances and depreciation.
- Policy implications
  - Revenues remain a positive function of tax rates (except in Africa), but the presence of special regimes substantially weakens this relationship.
  - High tax rates on rent-earning investments reduce investment; however, special regimes can neutralize this effect by shifting tax-sensitive activity into preferential regimes.
  - Evidence does not support an across-the-board “race to the bottom” for standard tax systems; rather, a “partial race to the bottom” where competition concentrates on special regimes and mobile capital.
- Research gaps and future work
  - Key open questions:
    - What proportion of investment qualifies for special regimes, and how does this vary across countries?
    - Do special regimes successfully target mobile investment or merely shift investment that would occur anyway into incentives?
    - What are short- and long-term revenue implications of special regimes, and how do these interact with competing countries’ policies?
  - Main challenge: obtaining detailed data on the implementation and utilization of special regimes to complement statutory measures.

*Source: Authors’ calculation based on dataset described in Appendix II (content unit: _wp1228 - Appendix I for detailed derivation). Briefly, the rates are obtained by constructing a forward-).*

### APPENDIX I. DERIVATION OF EFFECTIVE TAX RATES

### APPENDIX I. DERIVATION OF EFFECTIVE TAX RATES

### Definition and framework
- The Devereux and Griffith (2003) measure of the effective average tax (EATR) is defined as EATR* = (R* - R) / (p + r), where:
  - R* is the present discounted value of economic rent in the absence of taxation,
  - R is the present discounted value of economic rent in the presence of taxation,
  - p is the pre-tax profit (net of depreciation),
  - r is the real interest rate.
- For the infinite (permanent) investment horizon used here, the EATR is adapted to:
  - EATR* = (R* - R) / (p + r + δ), where δ is true economic depreciation.
- The EMTR (effective marginal tax rate) is included as a special case of the EATR when post-tax economic rent equals zero.

### Present discounted value of economic rent and firm value
- The present discounted value of economic rent equals the change in firm value V:
  - sum_{s=0}^{∞} dD_{t+s} / (1+\rho)^{s+1} = R = dV,
  - with D dividends, γ = (1 - m_d) / (1 - mz) (factor for difference in treatment of new equity and distributions; m_d personal tax on dividends; z tax on capital gains),
  - ρ = (1 - m_i) / (1 + i) - 1 (investor’s discount rate; m_i personal tax rate on interest; i nominal interest rate).
- Dividends follow the flow of funds equation (equation (3) in source), where K_t is capital stock, τ is corporate tax rate, I is investment, B new debt, ϕ official depreciation allowance, and K_T tax-written-down value of capital.

### Tax-free present discounted value R* (permanent investment)
- Under permanent investment (I_{t+s} = 1 for all s ≥ 0) and all taxes set to zero, the tax-free present discounted value of profits R* is derived as (equation (4)):
  - R* = p * [ (1 + πδ) / (1 + i)(1 + r)(1 + δ) ... ]  (presented in the source as an infinite sum collapsed into the shown expression),
  - The source presents R* in the explicit expanded fraction form shown in equation (4).

### Presence of taxation: structure and decomposition
- For the taxed case, assume investment financed by retained earnings (B = N = 0) in initial derivation (equation (5)).
- Equation (5) decomposes into three principal sums:
  1. First sum: tax-dependent present discounted profits accounting for a special regime lasting Y years with tax rate τ' (which can be zero for tax holidays). The full expanded form is given in equation (7) and the program accommodates up to three sequential changes in the special regime.
  2. Second sum: simplest and independent of special regimes:
     - sum_{s=0}^{∞} dI_{t+s} / (1 + ρ)^{s+1} = 1 / (1 + ρ).  (equation (6))
  3. Third sum: present discounted value of depreciation allowances, labeled A; its calculation depends on official depreciation rules.

- Aggregated taxed present discounted rent R (equation (8)) is expressed as:
  - R = p * [complicated fraction capturing pre-tax profit p, tax rates τ and τ', duration Y, δ, π, ρ, γ] + A + F,
  - where A is depreciation allowance present value and F captures additional financial effects not yet included in the earlier sums.

### Financial effects (F) and financing assumptions
- Amount of funds needed to finance the investment is (1 - τϕ) due to depreciation allowance in the year of investment; tax rate in the year of raising funds matters (τ' if special regime in place; equals 1 when τ' = 0 for a tax holiday).
- Financing assumptions:
  - Increase in new equity is assumed permanent,
  - Debt is repaid equivalent to nominal depreciation so debt-asset ratio remains stable.
- Financing effect F is decomposed into contributions from new equity (NE) and debt; the NE component is given by (equation (9)):
  - F_{NE} = sum_{s=0}^{∞} γ_{t+s} dN_{t+s} / (1 + ρ)^{s+1},
  - Debt component and full F are provided in the extensive expression of equation (10) (the source provides the full expanded series for the debt-related terms).
- The program allows up to three rate and method changes when calculating A (depreciation allowances). Specific formulae:
  - For declining balance depreciation: A = expression given in source (declining-balance formula).
  - For straight-line depreciation: A = expression given in source (straight-line formula with case φ < 1 noted).
  - If methods or rates change, formulae become more complicated; program accounts for up to three changes.

### EMTR calculation
- EMTR is obtained by setting post-tax economic rent R = 0 in equation (8), solving for the required level of pre-tax net profit p̃:
  - p̃ = [ FA + A + (terms involving δ, ρ, π, τ, τ', Y, γ) ] / (1 + ... )  (the source provides the explicit formula in equation (11)).
- The EMTR can then be calculated by:
  - EMTR = (p̃ - pr) / p̃  (equation (12)), equivalently by computing R* for p̃ and substituting into the EATR definition.

### Implementation notes and program capabilities
- The framework adapts Devereux and Griffith from a one-period perturbation to a permanent unit increase in capital stock, disinvested over time via true economic depreciation.
- The program used to calculate effective tax rates:
  - Accommodates up to three sequential changes in special regimes (tax rate τ' changes),
  - Accounts for up to three rate and method changes in depreciation rules,
  - Calculates A and F according to the chosen depreciation method (declining balance or straight-line) and financing assumptions.

*Source: APPENDIX I. DERIVATION OF EFFECTIVE TAX RATES (from the provided PDF content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp1228.pdf_