Effective profit taxation and the elasticity of the corporate income tax base- Evidence from German corporate tax return data

We estimate the elasticity of corporate taxable income with respect to the effectivecorporate tax rate on the basis of a pseudo-panel constructed from corporate tax return microdata for the period 1998-2001, a period which saw the introduction of a major corporate taxreform in Germany. Endogeneity of the effective tax rate is controlled for by an instrumentalvariable approach. Our instrument for the observed effective corporate tax rate is thecounterfactual effective tax rate a corporation would face in a particular period had there beno endogenous change of corporate profits. This counterfactual is obtained from a detailedmicrosimulation model of the corporate sector based on tax return micro data. We find astatistically significant and relatively large point estimate of the average tax base elasticity,which implies that a reduction of the statutory corporate tax rate would reduce corporate taxreceipts less tha n proportionally due to income shifting activities. We also find somestatistically weak evidence for the hypothesis that the tax base elasticity is higher forcorporations that may benefit from various forms of tax shields.