Corporate Taxation of Heterogeneous Firms and the Welfare Effects of Labour Unions

• Published date: 01 April 2017
• Author: Andrea Schneider
• DOI: http://doi.org/10.1111/twec.12380
• Date: 01 April 2017

Corporate Taxation of Heterogeneous

Firms and the Welfare Effects of Labour

Unions

Andrea Schneider

Institute of Public Economics, University of M€

unster, M€

unster, Germany

1. INTRODUCTION

IN discussions on the role of labour unions in the context of internationally mobile firms,

powerful labour unions are often presented in a bad light. The reason, as outlined by Fuest

and Huber (2000), is that labour unions increase wage costs and might therefore drive some

firms out of the domestic market, leading to an increase in unemployment. Moreover, there

are arguments that an increase in the bargaining power of labour unions reduces foreign direct

investment (FDI) (Naylor and Santoni, 2003) or leads to inefficiently high FDI if firms use

this to strengthen their domestic bargaining position (Lommerud et al., 2003). This paper,

however, provides an argument in favour of powerful labour unions. If the government levies

a uniform tax rate but firms are heterogeneous, a welfare loss arises that can be reduced by

powerful labour unions. In addition, if the government’s tax policy is restricted to a uniform

tax rate, some firms might move abroad. I show that the likelihood of such migration can be

reduced if labour unions are powerful.

A uniform tax rate is the most widely used tax regime in the OECD (in 23 of 34 coun-

tries).

1

Thus, in most OECD countries corporate tax rates do not (directly) depend on firm

productivity.

2

Moreover, most countries in the OECD are characterised by a high degree of

labour market unionisation, especially in continental and northern Europe. For example, in

2012 the average labour union density in the OECD was 17.1 per cent with countries like

Belgium (55.0 per cent), Finland (68.6 per cent) or Sweden (67.5 per cent) facing labour

union densities far above this average.

3

Motivated by these observations, I restrict the government’s tax policy to a uniform tax

rate and assume, in line with Fuest and Huber (2000) and Krautheim and Schmidt-Eisenlohr

(2012), firm heterogeneity. Using these two assumptions, I show that restriction of the govern-

ment’s tax policy leads to a welfare loss, benefits the low-productivity firm and might foster

the high-productivity firm to move abroad. I then provide conditions under which an increase

in the bargaining power of the low-productivity firm’s labour union decreases the welfare

1

These countries are Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia,

Finland, Germany, Iceland, Ireland, Italy, Luxembourg, Mexico, New Zealand, Norway, Poland, Slova-

kia, Slovenia, Sweden, Switzerland and Turkey. Note that in Belgium, Canada and Germany, there are

some differences in corporate tax rates depending on ownership or location but tax rates do not directly

depend on productivity.

2

The present model focuses on statutory tax rates. There is evidence that effective tax rates differ

between national and multinational firms and therefore with firm productivity (Egger et al., 2010). If

current efforts made by the EU to reduce profit-shifting activities will be successful, the difference

between statutory and effective tax rates will be reduced fostering uniform taxation also with respect to

effective tax rates.

3

Data taken from https://stats.oecd.org; indicator ‘trade union density’.

©2016 John Wiley & Sons Ltd 703

The World Economy (2017)

doi: 10.1111/twec.12380

The World Economy