Table Of ContentTaxes and Exchange Rates in the EU
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Taxes and Exchange Rates in
the EU
By John Lorié
© John Lorié 2006
Softcover reprint of the hardcover 1st edition 2006 978-0-230-00475-7
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accordance with the Copyright, Designs and Patents Act 1988.
First published 2006 by
PALGRAVE MACMILLAN
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PALGRAVE MACMILLAN is the global academic imprint of the Palgrave
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ISBN 978-1-349-28143-5 ISBN 978-0-230-62570-9 (eBook)
DOI 10.1057/9780230625709
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A catalogue record for this book is available from the British Library.
Library of Congress Cataloging-in-Publication Data
Lorié, John, 1960-
Taxes and exchange rates in the EU/John Lorié.
p. cm.
Includes bibliographical references and index.
1. Taxation--European Union countries. 2. Foreign exchange rates--
European Union countries. I. Title.
HJ2599.5.L67 2006
336.2094--dc22
2006047487
10 9 8 7 6 5 4 3 2 1
15 14 13 12 11 10 09 08 07 06
Contents
List of Tables xiv
List of Figures xvii
Acknowledgements xviii
Chapter 1 Introduction 1
1.1 Background 1
1.2 Aim and principal questions 2
1.3 A literature survey 4
1.3.1 Theory 4
1.3.2 Empirical analysis 6
1.3.3 The broader research task 10
1.4 Limitations and objective 10
1.5 Overview of the study 12
1.5.1 Main themes 12
1.5.2 Structure 14
1.5.3 Brief description of the chapters 15
Notes 18
Chapter 2 The Basic Model 21
2.1 Introduction 21
2.2 The classical model 22
2.2.1 The classical model of international capital flows 22
2.2.2 Application to financial capital liberalisation 24
2.3 The model of Grossman and Razin 25
2.4 Interpretation of the GR model 27
2.4.1 The foundation of a financial market 27
2.4.2 Calling payments on shares issued 29
2.4.3 Underlying assumptions 34
v
vi Contents
2.4.4 Taking out a bank loan 40
2.4.5 Calling on shares versus taking out a bank loan 42
2.4.6 Further remarks on Grossman and Razin 42
2.5 A micro-foundation with a financial market 44
2.5.1 Overview 44
2.5.2 Equilibrium of the segmented market 44
2.5.3 Adjustment towards equilibrium 46
2.5.4 Alternative objectives of the firm 50
2.5.5 Non-linearity in the production function 53
2.5.6 Monopoly 54
2.5.7 A multi-period extension 55
2.5.8 Welfare measurement 58
2.5.9 Equilibrium after international liberalisation 58
2.5.10 Equilibrium and welfare: Graphical representation 59
2.6 Differences in time preferences 61
2.6.1 Preliminary remarks 61
2.6.2 Basic model 62
2.6.3 Extension 64
2.7 Retained earnings 64
2.7.1 Assumptions 64
2.7.2 Financial markets 66
2.7.3 Factor markets 68
2.7.4 Two-country situation 68
2.8 Summary 69
Notes 70
Chapter 3 A Formal Elaboration of the Basic Model 77
3.1 Introduction 77
3.2 The micro-founded model with a financial market 77
3.2.1 Overview 77
3.2.2 The supply side 77
Contents vii
3.2.3 The demand side 82
3.2.4 Free trade equilibrium 85
3.2.5 Welfare creation 87
3.3 Deepening and widening of the model 90
3.3.1 Overview 90
3.3.2 Market value maximisation 90
3.3.3 Profit maximisation 92
3.3.4 Multi-period approach 94
3.4 Differences in time preferences 97
3.4.1 Overview 97
3.4.2 Basic model 97
3.4.3 Extension 98
3.5 Retained earnings 100
3.5.1 Overview 100
3.5.2 Share prices 100
3.5.3 Prices for shares and bonds 103
3.5.4 Factor remuneration 105
3.5.5 Two-country situation 107
3.5.6 Deepening of the model with earnings retention 108
3.6 Summary 112
Notes 116
4 Tax Distortions: One Financial Asset 119
4.1 Introduction 119
4.2 Taxation of income from shares in the EU 122
4.2.1 Introduction 122
4.2.2 Company taxation 122
4.2.3 Investor taxation 124
4.2.4 Structure of taxes in the EU-15 125
4.2.5 Classification 125
viii Contents
4.3 Classical analysis 126
4.3.1 Description 126
4.3.2 Extension of the classical analysis: welfare distribution 128
4.3.3 Evaluation of the limitations of the model 132
4.4 The basic model extended with tax distortions 134
4.4.1 Introduction 134
4.4.2 Incorporation of a government 134
4.4.3 The approach of FRS 136
4.4.4 An adjusted approach 136
4.4.5 ‘Source’ taxes: segmented market 139
4.4.6 Free trade: equilibrium and welfare 140
4.4.7 Welfare distribution 141
4.4.8 Different ‘residence’ taxes: income tax on dividend
and capital gains 144
4.4.9 Residence taxes and different company taxes 145
4.4.10 Relief of double taxation 146
4.5 Elaboration of tax distortions in a two-country model 148
4.5.1 Introduction 148
4.5.2 Investors: the approach of FRS 148
4.5.3 The adjusted utility function 150
4.5.4 Firms 152
4.5.5 Equilibrium 153
4.5.6 Welfare aspects: preliminaries 154
4.5.7 Aggregate welfare 155
4.5.8 Welfare distribution: home country 156
4.5.9 Foreign country welfare 158
4.5.10 Discussion 158
4.5.11 Tax levy at investor level 160
4.5.12 Tax levy at investor level and firm level combined 162
4.5.13 Evaluation formal analysis 164
Contents ix
4.6 Taxation on income from shares in the EU revisited 166
4.6.1 Taxation at company level and investor level combined 166
4.6.2 Dividend pay-out ratios 168
4.7 Summary 170
Appendix I: Incorporation of a government production function 173
Appendix II: Welfare neutrality at micro-level 174
Notes 175
5 Tax Distortions: Shares and Bonds 179
5.1 Introduction 179
5.2 Tax on income from bonds in the Eu: the facts 182
5.3 The incorporation of bonds 184
5.3.1 Introduction 184
5.3.2 Financial asset prices and finance behaviour 185
5.3.3 Free trade in financial assets: bonds only and shares only 188
5.3.4 Shares and bonds: financial market 191
5.3.5 Shares and bonds: the real side 194
5.3.6 Shares and bonds: the alternative tax configuration 196
5.3.7 Incorporation of bonds: finance and physical capital flows 198
5.3.8 Welfare consequences 199
5.3.9 Dividend tax and capital gains tax: segmented market 201
5.3.10 Dividend tax and capital gains tax: free trade
in financial assets 204
5.4 International tax arbitrage 210
5.4.1 The mechanism of international tax arbitrage 210
5.4.2 Effect on financial market equilibrium 215
5.4.3 Implications for integrated financial market equilibria of
international tax arbitrage 216
5.5 Relevance of the theoretical analysis for the EU 218
5.6 Formalisation in a two-country model 221
5.6.1 Introduction 221
5.6.2 Investors 221
