Effective Green Taxation: Method and application to firm-level data

EU climate policies advocate a shift towards green taxation. We address this issue in the context of tax on companies, focusing on the consequences for the cost of capital, the effective marginal tax rate and the effective average tax rate.We develop an indicator of effective green taxation extending the method proposed by Devereux and Griffith (1999, 2003) to include environmental taxation, namely taxes on energy use and greenhouse gas emissions. The basic approach is to consider a hypothetical incremental investment undertaken by a given firm considering a post-tax real rate of return required by the firm’s shareholder and using the tax code to compute the implied required real pre-tax rate of return. We calculate a cost of capital indicator and corresponding effective marginal and average tax rates including green taxes, effective statutory profit taxes and asset-specific tax allowances for building and machinery.This approach brings two novel contributions to the existing literature on green taxation: (i) it considers explicitly the possibility for green taxes to interact with existing tax codes and, more specifically, to quantify their influence on overall corporate tax burden and asset-specific taxation, (ii) the method provides the basis to simulate the expected impact of green tax reforms and to investigate their impact on the cost of capital invested taking into account country-specific tax specific features. We provide some econometric tests illustrating the influence of our effective green taxation indicator on firms’ investment and employment based on a panel of EU firms between 2005 and 2010.