Corporate Tax Policy, Entrepreneurship and Incorporation in the EU

In Europe, declining corporate tax rates have come along with rising tax-to-GDP ratios. This paper explores to what extent income shifting from the personal to the corporate tax base can explain these diverging developments. We exploit a panel of European data on firm births and legal form of business to analyze income shifting via increased entrepreneurship and incorporation. The results suggest that lower corporate taxes exert an ambiguous effect on entrepreneurship. The effect on incorporation is significant and large. It implies that the revenue effects of lower corporate tax rates – possibly induced by tax competition -- partly show up in lower personal tax revenues rather than lower corporate tax revenues. Simulations suggest that between 10% and 17% of corporate tax revenue can be attributed to income shifting. Income shifting is found to have raised the corporate tax-to-GDP ratio by some 0.2%-points since the early 1990s.