Everyone hates higher taxes…unless... : why the confessions of Dutch company owners can lead us to a new understanding of the rationales of corporate tax payers

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Master thesis of:

Daniel Peter, 11148594

MSc Human Geography – track Economic Geography

University of Amsterdam

20 June 2016

Word count: 20,547

Everyone Hates Higher Taxes…unless...

Why the Confessions of Dutch Company Owners Can Lead us to a New

Understanding of the Rationales of Corporate Tax Payers

Abstract

This thesis has investigated how company owners in The Netherlands would

respond to a corporate tax increase. Through in-depth interviews, it has been

found that there is a great acceptance amongst company owners for potentially

higher corporate taxes. Yes, exactly. However, this acceptance does not come

without strings attached. Furthermore, it has been found that a tax hike would

have no impact on the capacity of companies to conduct investment spending.

The rationales given by the interviewees for these rather counter-intuitive

findings challenge predominant assumptions of the literature and stress the need

for further research on the relationship between taxpayers and policymakers.

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Today’s economy is characterised by a high degree of global integration and international competition. This competition shows its effects not only concerning the price of labour, the locations of manufacturing sites or the availability of financial services, but also expresses itself with regard to national corporate tax regimes. Corporate tax levels in the Western world have significantly decreased over the past 30 years and a convergence to fairly similar levels has taken place (Swank 2013: 1). Companies are frequently able to move their locations to another country for tax reasons. Therefore, alongside the costs of labour, potential state subsidies, good-quality infrastructure and a myriad of other factors, the corporate tax rate of a country has become one of many criteria that will determine how competitive the country appears for both the businesses already located there as well as any future ones. In this context, The Netherlands praises itself to have a very competitive corporate tax regime (Lejour et al. 2013). Apart from some big loop holes that enable companies to pay even less in corporate taxes than the standard tax rate, the Dutch corporate tax rate already ranks within the lower spectrum of its peers in the Western world (Lejour et al. 2013 & stats.oecd.org 2016: “corporate income tax rate”). The standard corporate tax rate in The Netherlands is 25% (PwC 2015: 18). To visualise this for the reader, table 1 below shows the corporate tax rates for the BeNeLux countries as well as the 8 biggest Western economies in alphabetical order.

Table 1: Comparative overview of corporate tax rates amongst selected OECD countries

Country (in alphabetical order) Standard Corporate Tax Rate

Australia 30.00% Belgium 33.99% Canada 26.70% France 34.43% Germany 30.18% Italy 27.50% Luxembourg 29.22% Netherlands 25.00%

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Spain 25.00%

United Kingdom 20.00%

United States 38.92%

source: stats.oecd.org

Apart from the fact that the Dutch corporate tax rate is amongst the lowest in the developed world, table 1 also shows that, as pointed out already, there is few discrepancy amongst the corporate tax levels. However, that the Dutch corporate tax is particularly low has received much criticism both from trading partners and domestic political activists (FT.com 2013). Despite this criticism, the reality of a globalised and highly competitive world economy means that any move to raise corporate tax levels should be carefully calibrated. The public and political discussion regarding corporate taxes takes into account these international pressures. However, it is being largely ignored which economic policies could offset the negative repercussions of a corporate tax increase. The OECD states that tax policy is only one factor in making a country a competitive location for companies (OECD, 2011:5-8). Amongst a myriad of other factors, the OECD highlights the importance of a flexible and efficient labour market, the availability of a skilled workforce, the quality of infrastructure (especially for export) and the regulatory regime. The OECD argues that if these and other pillars of the economy are strong, then a country “is generally more able to impose corporate income tax without discouraging investment” (OECD, 2011, 7). Hence, the debate on whether a certain corporate tax rate is reasonable compared to other countries should not just focus on comparing the tax level, but also on how the country compares with regard to the pillars just mentioned and many others. This thesis therefore aims to broaden the debate in this regard. Improving these pillars could significantly reduce a company’s inclination to leave a country as a result of an increase in corporate tax levels. In fact, a tax increase that would be used to improve the above mentioned pillars and other variables might even gain the support of those affected by the tax themselves. For example, a company may not want to relocate in the face of a corporate tax increase if that money is (at least party) spend on research and development efforts or export facilities or higher education. Hence, the opinion of the people affected by the tax increase should be heard on that issue. This approach could be applied not only to the corporate environment, but likewise to income tax, consumption taxes, etc. For example, in times of persistent terrorist threats, it is imaginable that tax payers would

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approve of an increase in their income tax in order to better fund the police and intelligence services. The same could potentially hold true for the willingness of company owners to accept higher corporate taxes. Different from the earlier referenced OECD report, this example also shows that a tax increase does not even have to be related to directly improving the business climate. Whereas this was a fictional example and we do not know how taxpayers would actually respond to a tax increase for the purpose of the security services, it shows the possibility that those who are affected by a tax increase could be persuaded to be supportive of it. Given the mobile nature of today’s goods and capital markets, this realisation is of even greater importance with regard to corporate taxation than probably any other. It would also go beyond the research scope of this master thesis to investigate the entire realm of government taxes and levies. If it holds true for company owners as well that there are circumstances under which they might at least not disapprove of tax increases, then the negative repercussions of companies leaving The Netherlands would be avoided. Taking this angle has not been in the public debate yet and this thesis hence seeks to contribute to opening up this debate in order to offer a way to increase tax revenues without alienating those who generate the jobs in this country. As mentioned, the same approach of purpose-specific taxes could also be applied in other areas.

Concerning which type of businesses should be the focus of this thesis, owner-run businesses account for over 50% of both the total GDP and total employment of The Netherlands (Flören et al. 2011: 67-68). Consequently, they are the single biggest type of businesses in the country and form the backbone of the Dutch economy. This measure of 50%, however, includes all companies that are owner-run, regardless of their size or their wider economic impact. In the context of researching the corporate tax regime, it may be more useful to narrow down the research scope to companies within this 50% that are sizeable enough to have the option of leaving The Netherlands in the event of an unfavourable tax change; some of them might already have production sites and offices abroad. Therefore, this research will focus on medium and large-sized enterprises.

Even though owner-run businesses account for half of the Dutch economy alone, the reader may wonder why the research scope of this thesis is not on publicly-listed companies, which are frequently mentioned in the media as taking advantage of national differences in corporate tax levels and for whom it might be easier to relocate offices. The reason not to focus on this group of companies is threefold. Firstly, the directors of a publicly-listed company are not

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the owners. They are managers who have a fiduciary duty towards their shareholders, who are the owners of the company. This fiduciary duty is a legal obligation the directors have to solely act in the interests of the shareholders. Of course, this sole focus on the shareholders can be limited by law. For example, a law can require the company to consider environmental concerns. Furthermore, the company can also consider environmental concerns without being required by law as long as it deems this to be in the shareholders’ interest; such as contributing to good PR. In that case, the company would still comply with its fiduciary duty. The primary duty of the directors is to manage the shareholders’ money well and achieve the highest return on their investments. By definition, a tax increase would limit that return. Hence, focusing this thesis on publicly-listed companies will likely result in a fairly predictable outcomes. To make matters even more complicated, the shareholders are frequently insurance companies and asset managers. These likewise have a fiduciary duty towards their own clients to attain the highest return on investment. Often, this is underscored by laws requiring insurance companies to achieve a certain minimum return every year, which is especially the case with pension insurances. To be able to get an understanding of the degree of acceptance of tax increases amongst publicly-listed companies, it is therefore not sufficient to interview the CEOs of these companies. They are by no means the ultimate decision makers and therefore the research would have to encompass the CEOs, managers of pension funds, other investors, etc. This undertaking will lie vastly outside the scope of a master’s thesis. More importantly, the just mentioned fiduciary duty sets strong limitations to the degree to which publicly-listed companies will be accepting tax increases as opposed to net profit generation. This dilemma does not exist for owner-run companies, which also –as pointed out- exceed any other type of business in The Netherlands in terms of employment generation and GDP contribution.

1.2 Motivation and Research Question

The motivation of this thesis is to deliver societally and academically relevant insights into the circumstances under which company owners would be willing to accept higher corporate tax levels. The theoretical framework will show that a large body of literature and empirical analysis exists on the subject of what affects individual taxpayers’ attitudes towards tax payments and their perceived fairness of tax rates. However, there is no empirical body focusing on the same

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question regarding company owners. Whereas there are plenty of theories in academia concerned with the effects corporate tax increases/reductions have on business activity, no field work has been undertaken on the question of whether company owners themselves would accept a tax increase anyway. One may assume that this question does not arise since company owners, as businesspersons, are presumed to be rational individuals to which economic theories of utility-maximisation always and everywhere apply. However, traditional economic theory assumes the same rationality about all individuals. Nonetheless, as the theoretical framework will show in-depth, there is plenty of empirical evidence to refute this assumption. None of the empirical research, however, has focused on company owners. Given the societal and economic centrality companies have in a market economy, this lack of empirical research must be rather surprising. This thesis therefore does not only aim to begin narrowing a gap in the academic and societal discussion on the question of which corporate tax levels are acceptable and which effect an increase might have, but also seeks to open up a debate as to the methods employed to research this issue. Out of this motivation derives the following research question:

Under which circumstances -if any- would owners of medium and large-sized businesses in The Netherlands be willing to accept higher levels of corporate taxes?

To further specify this research question, the following sub-questions will form part of this thesis:

Which societal and governmental factors shape the willingness of company owners to accept higher levels of corporate taxes?

How would corporate tax increases affect the companies’ capital stock build-ups and therefore their abilities to conduct future investment spending?

To what degree are company owners willing and able to relocate their companies in the event of a corporate tax increase they deem unacceptable?

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2. Societal Relevance

2.1 The Fiscal Necessity for Taxes

After 14 years of almost uninterrupted GDP growth, the Dutch economy was hit by the global financial crisis in 2008 (worldbank.org 2016: “GDP growth (annual %) Netherlands”). The crisis immediately led to a strongly pronounced recession in that year and especially in 2009. As it is the case in all recessions, the negative GDP growth affected both the income side as well as the expenditure side of the government budget: Tax revenues were decreasing due to a decline in private consumption and corporate profits whilst spending on social welfare went up due to higher unemployment rates and other factors. The Dutch government was faced with two option to address this dilemma. Option 1 was to further increase spending or at least not cut it in the hope that this would help the economy to recover quickly, which would automatically reverse the above mentioned trends. However, this strategy would lead to a higher budget deficit in the short term and, given future financial obligations to the creditors, also limit the government’s fiscal room for manoeuvre in the future. Option 2 was to cut spending and/or raise taxes in order to close the budget deficit. However, this strategy would both directly and indirectly withdraw demand from the economy and therefore contribute to a prolonged recession or at least a slower recovery. The decision for the Dutch government which of the two options to pursue was also impacted by the onset of the Eurozone crisis in 2010. Almost immediately succeeding the financial crisis, and being partly a result of it, was a sovereign debt crisis that hit in particular Southern European members of the Eurozone as well as Ireland, Slovenia and, temporarily, Belgium. These countries came under intense pressure to address their budget deficits in the face of sharply rising costs for refinancing their sovereign debt on the financial markets. The higher the budget deficit, the more risky it is for financial investors to buy debt (bonds) of a certain country. Hence, the risk premium a country has to pay for its bonds will rise. To avoid this scenario, even countries of the Eurozone not mentioned above faced scrutiny to address their budget deficits. In Europe’s largest economy, Germany, this led to the introduction of a balanced budget provision in the country’s constitution in 2009, taking effect from 2016 onwards (Grundgesetz für die Bundesrepublik Deutschland, Art. 109(3)). In light of the developments all across the Eurozone, the possibility of running a large budget deficit seemed to be a potentially very unpleasant path. The government opted for the second option: spending cuts. As pointed out

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above, this has most likely contributed to a significantly prolonged time the economy needed to recover. The question that arises from this dilemma therefore is how it would be possible to limit or even avoid spending cuts and instead raise taxes without hurting the economy. Indeed, the relevance of addressing this question has gained importance with the Eurozone crisis, but has not just emerged as a result of it. The dilemma of how to spend more without suppressing economic activity through tax hikes or accumulating large deficits has always been a problem for all finance ministers. Offering a possible path towards a solution to this age old dilemma will be one of the central objectives of this thesis and is therefore likewise central to its societal relevance. It is, of course, not easy to increase taxes without negative repercussions both politically and economically. The research of this thesis will therefore consider both of these parameters in great detail. With regard to the economic impact of tax increases, it is imperative to understand that different types of taxes affect macroeconomic activity differently. To gain an understanding of these dynamics, it is helpful to get an idea of an important macroeconomic concept: the velocity of money. This concept is what the following section will look into. After just having established that tax increases are necessary to prevent spending cuts or government debt accumulation, the following section will look into the next logical step: Who to tax? By doing so, the section will add further clarity on why it is relevant to focus this thesis on company owners in order to address the just discussed dilemma.

2.2 The Capacity to Pay Taxes and Their Economic Impact

In order to establish the relevance of selecting large, owner-run businesses as the unit of analysis for this thesis, we need to consider which income group has the capacity to absorb higher tax payments, but also what the economic effects of that increase could be. I would therefore like to draw the reader’s attention to the graph below. It displays the wealth distribution in The Netherlands by deciles of households. The graph shows that the bottom 60% of Dutch household have, in aggregate numbers, a net wealth of zero. The top 10% of households, however, account for 61% of the total wealth of the country. The reason why it is important to look at the graph displaying wealth distribution, as opposed to income distribution, has to do with the concept of velocity of money.

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Table 2: Distribution of household net wealth in The Netherlands over decile groups, 2013

source: van Bavel 2014: 83

Investopia defines velocity of money as follows: “The velocity of money is the rate at which money is exchanged from one transaction to another” (investopia.com, 2016: “velocity of money”). Hence, the velocity of money states how fast money circulates in the economy; in other words how fast one Euro (in the case of The Netherlands) of received income is spent again. If the savings ratio of an economy is high, then the velocity of money will be lower. As mentioned, the above graph shows that, in aggregate, 60% of Dutch households have no savings at all, with the lowest 10% even having net debt. Hence, the velocity of money of the bottom 60% group has, in aggregate, a factor of 1, meaning that all the money they earn, they spent. Therefore, increasing the tax rates on these households would, by definition of this factor of 1, reduce their ability to spend by the same amount by which the taxes have increased. As a result, a tax increase would negatively affect consumer spending. Consumer spending accounts for

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about 45% of total Dutch GDP, making it the single biggest contributor to the economy (worldbank.org 2016: “Household final consumption expenditure, etc. (% of GDP)”). This policy would therefore have a significant negative impact on the overall GDP of the country. To see if that scenario would be different when focusing the tax increase on another group of households, I would therefore like to draw the reader’s attention for now to the highest decile in the above graph.

On the upper end of the household scale the situation looks significantly different from the one described in the previous paragraph. The top decile owns 61% of the wealth of The Netherlands. What the graph does not show, however, is how this decile will react to a tax increase. This group has two option. The first one is to react by reducing their spending as a result of a lower net income. This would be the same reaction as the one just discussed group concerning the lower end of the household spectrum. Hence, this would likewise negatively affect consumer spending. However, different from the previous group, the top 10% of households also have the option to gradually reduce their savings (wealth) in order to be able to keep affording the same goods and services as before the tax increase. This would, by definition, have no impact on consumer spending. To clarify why, I would like to recall the basic macroeconomic equation below. It shows that the only other option apart from reducing consumption would be to reduce one’s savings.

household income – tax = disposable household income = consumption + savings

Investigating the question of which of these two options (decreasing consumption or decreasing savings) the actual response of the top 10% households would be must be central to any analysis on the economic effects of a tax increase. Consequently. this exact question will be an imperative focus of the field work. The relevance of this thesis to look at the top 10% group of households therefore emerges out of two factors. Firstly, this group is the most capable to deal with tax increases due to their much higher savings. Secondly, increasing tax rates on this group might not affect overall consumer spending as much as tax hikes on other households since the bottom households do not have the option to reduce their savings. It should be noted that the emphasis at this point is on the effect on consumer spending; regarding the effects on investment spending, please see the respective section in the theoretical framework.

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So far, we have only looked at households and their respective wealth. One might argue, however, that being amongst the 10% wealthiest households in the country does not necessarily mean that one is a company owner. However, in the vast majority of cases that is exactly what it means. Whereas detailed numbers for each individual household that falls into the top 10% are not publicly available, it can be said over 80% of the 500 richest people in The Netherlands accumulated their wealth by owning a company or having inherited one from their families (quotenet.nl 2016: “miljonairs”). Different from the UK or the US, only a negligible number of households in that group accumulated wealth through financial investments or as entertainers/sportsmen (quotenet.nl 2016: “miljonairs”). Apart from a selected few, investigating attitudes towards taxation of owners of large companies is therefore almost equivalent to investigating these attitudes of people in the top 10% wealth and income bracket. Furthermore, and at least equally important, a change in taxation on companies could have much wider macroeconomic implications than a change in private income taxes. The latter case would, in an extreme scenario, mean that highly paid sports stars or musicians seek residence outside The Netherlands, but the economic and socioeconomic effects themselves could be much more severe after tax hikes on corporations. To conclude the societal relevance of this thesis, the following aspects have been established:

1. In order to avoid government spending cuts and/or debt accumulation, it is relevant to research how taxes could be increased.

2. In order to prevent companies from leaving the country as a response to a tax increase, it is relevant to research if any measures can be taken to offset the effect of such an

increase.

3. Given the capacity to absorb tax increases and the limited impact of such on consumer spending, it is relevant to focus the research on the top 10% wealthiest households, the vast majority of which are company owners.

After having considered the societal angle on the issue of corporate taxation, we will now turn to embedding this topic into the academic literature.

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2. Theoretical Framework

2.1 The Willingness to Pay Taxes and their Perceived Fairness

Various scholars have argued that trust within a society is an important constituent in stimulating economic activity. In his book “TRUST”, Francis Fukuyama outlines how trust plays a significant role in shaping a country’s business landscape (Fukuyama 1996). Referring to Italy and southern France, he explains how trust in these cases rarely extends beyond family boundaries and therefore impedes the emergence of large corporations in those economies (Fukuyama 1996). He compares these cases with “high trust” societies like Germany and Japan, where great trust levels make it more common for companies to involve non-family business expertise into a company, consequently contributing to its growth (Fukuyama 1996). Similarly, he outlines how trust of investors into firms is high in Germany, making it easier for companies to gain access to financing and associated expertise (Fukuyama 1996). Whereas Fukuyama’s selection of countries surely is deliberate, his book’s findings should not be underestimated in showing the great importance trust has for the economic success of a country. Even though trust between the state and firms plays a role for Fukuyama in making his argument, he stops short of extending his theory to whether higher levels of trust in the government also result in a higher acceptance of firms to contribute to the government coffers with corporate taxes. Of course, one can make the case that taxes are compulsory levies and the trust of the taxpayers in the government, whether companies or individual citizens, is therefore irrelevant. However, such an angle would neglect that a lower willingness to pay taxes increases the incentive to find ways to avoid as well as evade them. This especially holds true for companies, which could their whole business or a part of it abroad. This would not only result in a loss of government tax revenues, but also in a loss of domestic employment.

This section of the theoretical framework will henceforth examine how the trust citizens have in the government to manage taxpayer’s money is affecting their willingness to pay taxes. In this context, it will be shown that the theorisation and empirical data on this issue remain weak concerning the issue of corporate taxes, which is precisely the gap this thesis seeks to narrow. The phenomenon of accepting current tax levels and adhering to the payments that come with them is described as tax compliance (Scholz and Lubell 1998: 398). Scholz and Pinney have theorised a relationship between tax compliance and the trust the taxpayers have in

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the government regarding the use of their taxes. In their political psychology analysis of 1995, they state that “citizens will meet obligations to the collective despite the temptation to free ride as long as they trust other citizens and political leaders to keep up their side of the social contract” (Scholz and Lubell 1998: 411). This is a critical concept, which the reader will later come across again. The authors refer to this phenomenon as the “duty heuristic” (Scholz and Lubell 1998: 411). Based on the theories by Scholz and Pinney, Scholz and Lubell conducted interviews on the topic of tax compliance in the state of New York amongst highly educated, above average earners. In 1-hour long interviews, the subjects were asked about their sense of duty to pay tax, their trust in the government and fellow citizens and their compliance with the tax code. These individuals were educated and wealthy enough to have the ability to optimise their tax payments should they opt to do so. Scholz and Lubell’s findings point with great consistency in the direction that “trust in government and trust in other citizens will increase [tax payment] compliance even after controlling for risks of punishment and perceived duty to obey the law.” (Scholz and Lubell 1998: 399). This point is further supported by Cummings et al., who argue that “reducing tax evasion is often not simply a matter of applying higher penalties and/or increasing the frequency of audits. Extreme penalties may backfire by creating a setting in which bribery and corruption are more prevalent with the end result being lower tax compliance and a general loss of trust in public institutions. Designing effective policies for reducing tax evasion requires understanding the behavioural aspects of the tax compliance decision.” (Cummings et al. 2009: 447). Even though taxes are involuntary levies and the subjects of the respective tax are henceforth obliged to pay them regardless of their willingness, their compliance with the law nonetheless seems critically influenced by the amount of trust they have in the government. This argument that Cummings et al. make underpins in theoretical terms what Scholz and Lubell, as referenced above, have proven with empirical research. However, their research was relatively narrow in scope and focused on a very specific group of participants within the state of New York.

A much wider research scope was set by Sofie Marien and Marc Hooghe in 2011. The pair from the University of Leuven investigated the relationship between political trust and law compliance in 32 European countries, with 41,135 participants (Marien et al. 2011: 267). For that study, the interviewees were asked how much confidence they have in the government on a scale from 1-10 and were also questioned about their attitudes towards abiding the law as well as

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their religious, national and ethnic affiliations (Marien et al. 2011: 274-275). Remarkably consistent with the above referenced study on the case of the state of New York, their results likewise show “that political trust levels have a negative effect on the likelihood of having permissive attitudes [towards the law]” (Marien et al. 2011: 279-280). Specifically, “the probability of having permissive attitudes is 43 per cent among highly distrusting citizens, while this probability is only 18 per cent among highly trusting citizens” (Sofie Marien et al. 2011: 281). The difference between these two figures varied between the 32 European countries studied, but in every single case a positive relationship could be found.

A further renown scholar in the field of government trust can be found in Benno Torgler, who investigated which factors influence tax compliance in Canada. His research is based on data from the World Values Survey and therefore does not only look into the effects government trust has on tax compliance, but also variables like age, income or employment status (Torgler 2003). Regarding the research scope of this thesis, it is interesting to point out that Torgler performed a statistical correlation analysis between tax morale as the dependent variable and government trust as the independent variable (Torgler 2003). His results are therefore clearly quantifiable. The correlation analysis shows that an “increase of trust by one unit raises the share of persons indicating the highest tax morale [on a 4-point scale] by 12.2%” (Torgler 2003: 297). His study therefore confirms the results of the ones cited above. However, Torgler has not only produced this particular study, but is one of the leading scholars in the field of how factors such as government trust impact tax compliance and tax morale. A study of particularly wide scope was conducted by him and professor Bird from the University of Toronto. In that study, the researchers compared government trust and its relation to tax payment moral amongst 25 high income countries, 20 of which in Europe (Bird et al. 2008). Their research approach, however, significantly differs from the one of the previously mentioned studies, which relied purely on field work. Bird et al. use macro-indicators like the economic structure of a country, governance criteria, political and economic openness and other variables as a proxy to test the citizens’ satisfaction with how the government spends taxpayers’ money (Bird et al. 2008). Despite their more removed research approach, they come to the same conclusion as the above referenced studies and state that: “A more legitimate and responsive state is likely an essential precondition for a more adequate level of tax effort in developing countries and also high income countries” (Bird et al. 2008: 68). Different from Torgler’s study

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on the case of Canada, this study goes further than pointing out a statistical correlation between government trust and tax compliance, but, crucially, offers a theoretical underpinning that evolved based on their research results: “If taxpayers perceive that their interests (preferences) are properly represented in political institutions having a meaningful ‘voice’ in influencing the state their willingness to contribute increases” (Bird et al. 2008: 58). This is a valuable theoretical addition to the earlier cited theory by Scholz and Pinney, who argued that citizens see tax payments as their side of the bargain between them and the government/society and are willing to comply with them as long as they trust the other side (the government) to also keep their part of the deal. Both of these theories are supported by the field work referenced so far.

In light of these theoretical and empirical underpinnings, it might be questioned how citizens are able to conceptualise a term like ‘trust’ in a far-removed, multi-layered and often impersonal institution like government. Russell Hardin offers a critical theoretical insight into this dilemma. He states that “in general, it appears to be difficult for citizens to judge their governments as trustworthy - at best they can judge that a government seems to be competent and that it produces apparently good outcomes” (Hardin 2013: 47). It is important to note that he does not say that citizens do generally not trust their government, but that it is difficult for them to make this judgement, due to the lack of direct contact and knowledge about the inner workings of government and the true intentions of the agents involved in it. He therefore comes to the conclusion that citizens trust their government based on observable outcomes, such as public infrastructure or, for example, the right decision to engage or not engage in military interventions. According to Hardin, a failure of the government to deliver the results desired by the citizens would lead them to conclude that the “government is either incompetent or badly motivated” (Hardin 2013: 47). Hence, he sees government trust as a result of these two parameters and, consequently, distrust refers to either the incompetence or the bad motivation of the government. The question should therefore not be “Do you trust the government with your tax money?”, but rather “do you have trust in the competence of the government?” and “Do you trust the government to be well-intentioned?”. Additionally, the duty heuristic mentioned in the second paragraph of this will also find itself operationalised in this thesis’ field research: The duty heuristic described that taxpayers are willing to accept current tax levels if they feel that the government –and society at large- also keep their side of the bargain. Whether how taxes are

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spent therefore influences a company owner’s willingness to accept higher corporate tax rates will therefore also be part of the operational work of this thesis.

As it has been shown, an ample amount of literature exists on the relationship between government trust of the citizens of a country and their tax compliance. Without exception, the relationship between these two variables was found to be positive. However, what none of these studies has looked into is whether these outcomes would also hold true in the case of company owners. Given that in all major industrialised countries, corporate tax payments account for a noteworthy share of overall tax revenues, only researching government trust in relation to the tax compliance of income tax payers cannot show the full picture. Hence, this thesis will seek to narrow that gap in the academic literature.

2.2 The Economic Concept of Rational, Utility-maximising Individuals

The previous section has studied existing theories as to the effects a ‘soft’ term like government trust and its competence with public money has on taxpayers. However, traditional economic emphasises more quantifiable angles. At the centre piece of all economic assumptions stands the idea of rational and utility-maximising individuals. This concept forms the econometric foundation of every economic calculus across ideological streams within the discipline of Economics. It goes back to the basic economic concept of finite resources, which Parkin et al. describe as the constant situation that the wants of individuals exceed the resources that are available to satisfy them. Hence, they are forced to make choices in trying to get the maximum benefit out of the available resources (Parkin et al. 2005). In other words, they will seek to maximise their total utility (Parkin et al. 2005). Hence, the very foundation of Economics is that individuals are seen as utility-maximisers. To act upon the desire to maximise total utility is then what defines a rational economic individual (Hammond 1997). This is assumed for individual consumers, firms, the state and all other economic actors. An individual would always choose the highest benefit at the lowest possible costs (Hammond 1997). This means that economic individuals make “rational economic decisions in their own interests” (Harvey 2005: 68). Despite the observation that the literature is anchored on the concept of rational economic individuals as the very core assumption of Economics, large gaps as to what defines rationality in practice remain. For example, does this rationality have to be clearly quantifiable, or would it

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also apply to less tangible cases? For instance, it is largely agreed on that education is one of the most importance assets advanced economies have in order to remain competitive in a globalised world. Consequently, would a company owner who is supporting higher tax rates in order to fund a better education system act in out of self-interest or out of philanthropic motivations or a mix of the two? Similarly, the presence of adequate road, port, airport and railway infrastructure is likewise vital for a country’s businesses to grow and prosper. However, they also constitute a public good that is used by many people purely for leisure. Economists pay little attention to whether tax increases would be rationally acceptable or even welcomed from a business owner’s point of view. To narrow the gap in the academic literature, this issue will therefore be a key concern for this thesis. However, the above shown, potential overlap between self-interest and societal responsibility already shows that this thesis will have to be very diligent in how to operationalise the concept of rational, utility-maximising individuals and how to distinguish philanthropic motives from economic self-interests. Therefore, the semi-structured interviews of the field work will not only ask company owners if and when they would agree to a corporate tax increase, but also why. Furthermore, in order not to bias the interview subjects, the question as to why using a tax increase for a certain government budget but not for others should not be asked by giving suggestions. The interviews will be semi-structured and interviewees should mention where and why they would support/reject a tax increase without being given examples. This is not only relevant for closing the gap in the literature that has under-researches the non-selfish interests company owners may hold, but also is key to delivering any substantial policy advice. Whereas this section has briefly looked into the pillars that form the foundations of Economics across ideological persuasions, the following section will have a closer look at a few core assumption of the neoliberal school in particular.

2.3 Neoliberalism

Considering neoliberal thoughts on the issue of corporate taxation emerges out of the factum that Neoliberalism has been the predominant economic and political stream of thought across the Western world for over 30 years (Swank 2015). The reader will recall from the introduction that corporate tax levels have convergence significantly. According to Duane Swank, this is a direct result of neoliberal tax reforms first pursued by the United Kingdom and the United Stated and

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then being implemented in continental Europe (Swank 2015: 1). This development and especially the rationale behind it is directly linked to the research question of this thesis regarding what company owners opinions’ are on corporate taxation. As it lies outside the scope of this theoretical framework to cover every aspect of Neoliberalism, we will focus merely on two aspects: (1) the theoretical deliberations the theory offers on the effect of corporate taxes on a company’s investment spending and (2) the corporate tax competition triggered by the aforementioned Anglo-Saxon economies. Beforehand, this requires a brief definition of Neoliberalism. The Palgrave Macmillan Dictionary of Political Thought defines Neoliberalism as the pursuit “of the free economy, free trade, and small government. Neo-liberals (…) advocate a renewal of the enterprise culture, and a pursuit of market solutions to social and political problems” (Scruton 2007: 472). As already pointed out, one of the practical implementations of this philosophy of liberalisation from the government and an emphasis on the enterprise culture was a sharp reduction in corporate tax rates across the Western world (Swank 2015: 1). As mentioned, this will be one of two aspects this theoretical framework will touch on, given its relevance to this thesis’ research. The other one is, however, what we will now look at first: the Neoliberal take on the effect increased corporate taxes have on companies’ investment spending abilities.

2.3.1 Neoliberalism and Investment Spending

Apart from the philosophical underpinning of Neoliberalism that low tax rates contribute to more freedom of the individual and inevitably a lesser capacity of the government to steer individual decisions, tax reductions are also said to have a very positive effect that is much more economically quantifiable: Reductions in corporate tax rates should encourage higher investment spending since the amount of money left in the hands of the firm increases (Fazzari et al. 1988). A wealth of existing literature deals with the effect taxes that are levied on corporate profits or dividend pay-outs have on firms’ investment spending. Fazzari states that with higher corporate taxes, less financial resources are available to be devoted to investments in the following years (Fazzari et al. 1988: 200). He argues that especially for firms that depend on their own capital stock in order to fund their capital expenditures “the amount of earnings devoted to taxes matters for investments” (Fazzari et al. 1988: 200). In making that statement, he assumes that as a

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consequence of a tax increase (and therefore lower net profits), less money will be available to the company for increasing its capital stock. This claim is at the very core of why neoliberal policymakers have aimed to reduce corporate tax rates for the past 30 years. However, this argumentation neglects that there are two scenarios of how a company could respond to a reduced net profit after a tax increase. Scenario 1 is that the company adds less money to its capital stock. This is the consequence pointed out by Fazzari. Scenario 2 is that less money is taken out of the company by the owner(s) as a dividend. A combination of both scenarios is of course also possible. Hence, instead of affecting their capital stock, company owners could instead make the decision to reduce the dividend pay-outs of the company in the wake of a corporate tax increase. This human variable is consistently neglected in the existing economic literature. It is therefore critical for the operationalisation of the sub-research question on this issue to ask company owners which of the two above decisions they would make in response to a tax increase.

As pointed out, the only other option apart from adding less money to the capital stock would be to cut dividends. This brings us to another angle on why tax hikes could be damaging for investments. It should not only be considered which impact tax increases have on the ability of firms to pursue investments, but also on their ability to attract investments themselves. In this context, Cummins et al. argue that an increase in corporate tax levels reduces the marginal incentive to invest in capital, because of a reduced net return on investment after the corporate tax increase (Cummins et al. 1996: 260). Outside investors will therefore be less incentivised to invest in a company if their return (in form of dividends) is negatively affected by a tax increase. This view, however, supposes that investments into companies occur in the form of internal finance, which means that an investor buys a part of the company. Even though this thesis focuses on owner-run businesses, it could still be possible that some of them have -maybe in the wake of the crisis of 2008/09- sold minority stakes in the company to outside investors that have provided this internal finance. However, many medium-sized firms may primarily rely on external financing, such as bank loans, for funding. Since the debt repayments and interest services for those loans are costs to the company, a higher corporate tax would not impact the ability of a company to repay existing loans, because the basis for corporate taxation is the profit after all costs. To turn this observation around, the risk for a bank to receive its money back is independent from the corporate tax regime the company is situated in. This paragraph has a

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strong implication for the operationalisation of this thesis. When answering the sub-question of the research question on the impact a corporate tax increase would have on investment spending, it is crucial to integrate the question about which sources of financing the companies use into the research process. Should they rely exclusively on bank loans or other forms of external financing, then a lower net profit after a tax hike would not impact their ability to access this financing. However, it will make them less attractive to investors providing internal finance.

On the topic of bank loans, an additional angle still needs to be covered. Even though dividend cuts would not affect a company’s creditworthiness, lower capital stock increases than before the tax increase could. Since banks generally require certain capital stock thresholds before approving loans, a lower capital stock (for example, compared to peers) would not only reduce a company’s ability to conduct investments itself, but also its access to external finance. Even if a loan is not declined, a bank could ask for higher interest rates in the wake of low a low capital ratio. If company owners decide to add less money to the capital stock instead of cutting dividends, a tax increase could therefore harm their abilities to both conduct investment spending out of its own reserves as well as by the means of external finance. Hence, it is imperative that to operationalise the research question by asking company owners whether they would react to a tax hike with dividend cuts or lower capital stock increases. This is also where this thesis seeks to narrow a gap in the literature. The human factor as a decision maker will be central to the investigations of this thesis and is where it aims to contribute to the academic debate. If the field research can confirm that company owners would reduce investment spending as a response to increased tax rates, then the neoliberal argument that high corporate tax rates impact the economy negatively would hold true in this context and therefore a tax increase might not be wise even if the company owners express acceptance of it.

2.3.2 Neoliberalism and International Corporate Tax Competitiveness

As mentioned above, neoliberal theories first diffused into political decision-making under the governments of Ronald Reagan in the US and Margaret Thatcher in the UK. The tax policies of these two countries have had a knock-on effect on those of other industrialised nations. Hyeon Seok Park, for example, argues that “the corporate tax rate of a country is positively affected by the tax rate of other countries with interdependence” (Park 2012: 99). The question arises where

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this interdependence comes from, meaning why governments seemed to see the need to keep up with changes in corporate tax rates when other countries changed them and vice versa. Duane Swank attempted to offer an answer to this question. He performed an extensive analysis of corporate tax developments amongst all major industrialised countries based on tax data from 1982-2008 (Swank 2013). This time period precisely coincides with the advent of neoliberal policies until the global financial crisis of 2008. Hence, his research covers the time span within which Neoliberalism became and remained the dominant economic and political ideology across the Western world. Swank’s extensive analysis comes to the conclusion that: “National policy makers responded to common international and domestic pressures. Increases in international integration of markets for goods, services and capital militated toward adoption of market-conforming tax structure” (Swank 2013: 33). Hence, it was necessary for countries to adjust corporate tax rates to remain competitive in a globalised economy, with increasingly mobile markets for goods and, in particular, capital. The economic rationale behind this is that, ceteris paribus, firms will always be motivated to increase their profits and will hence always seek to establish themselves in a country with the lowest possible tax rates.

In practice, however, this ceteris paribus does of course not exist and any given location for a company is different from any given other. The OECD argues that the question therefore should not be whether tax rates in another country are more attractive to a certain company, but whether the difference in tax rates offsets other advantages of the current location of the company (OECD 2011: 7). As already touched on in the introduction, the OECD states that corporate tax rates need to be seen as only one element that affects locational decisions of companies: “if the competitive pillars of an economy are strong, it is generally more able to impose corporate income tax without discouraging investment” (OECD 2011: 7). Therefore, the question that needs to be addressed is which factors might hold a company in a certain country or despite a tax increase. This directly links to the operationalisation of this thesis. The reader will recall that one of the sub-questions of this thesis’ research question is precisely the quest for factors that might make company owners willing, or even supportive, of a tax increase on themselves. Hence, the research will put this exact question to the interviewees. To theoretically embed the potential factors a company owner might name, this thesis will now conclude this section on Neoliberalism and shift its attention to the last section of this theoretical framework and with it a core theory of economic geography: economic clustering.

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2.4 Economic Cluster Theory

Scholars like Allan Scott, Richard Florida and especially Michael Porter have pointed out the importance of economic clusters for a thriving business environment in a variety of industries. Before turning to their theories, it should be defined what an economic cluster is and what its significance is in the context of this thesis. The OECD defines clustering as referring to “local concentrations of horizontally or vertically linked firms that specialise in related lines of business together with supporting organisations” (Möhring 2005: 21). If a company is based in such a concentration of interlinked and mutually supporting firms, then relocating the company’s operations to another country, for example for seeking lower tax rates, means to remove it from this cluster (Möhring 2005). The question a company may have to face therefore is whether the cluster brings enough economic benefits to set off a potentially unfavourable tax environment.

A key scholars of the concept of clustering can be found in Michael Porter. In the words of Chris van Egeraat, “Michael Porter’s concepts of (…) industrial clustering have given rise to an enormous number of publications” (van Egeraat 2012: 276). Porter defines a cluster “as an inter-linked set of firms and institutions, from a geographically proximate group of firms and institutions” (van Egeraat 2012: 276). One of the advantages of clusters is that they increase the speed of intra-industry knowledge circulation, which benefits their competitive position (van Egeraat 2012). Möhring adds that “by clustering together, firms can achieve economies of scale and scope and lower their transaction costs due to geographical proximity and increased interaction” (Möhring 2005: 21).

An additional angle on clusters is offered by Allan Scott. He adds that clusters enable firms to share infrastructure and even establish infrastructure themselves that would otherwise not be economically viable (Scott 2012: 16). An example of this could be a consulting company for whom it would not be viable to establish itself in a location if there was only one, small company of the consulting industry present. Clusters are also pools of market information, thus enabling firms easier and faster access to them (Scott 2012: 16). In addition to these softer factors, the agglomeration of multiple sellers also makes the cluster an attractive marketplace, both for buyers as well as sellers (Scott 2012: 16). Essentially, Scott argues that for economic aggregation processes (scale) to occur, it is beneficial if economic agglomeration (clusters) are present (Scott 2012).

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It is not the intention of this theoretical framework to dive even deeper into the concepts of economic clusters as this would certainly warrant its own master’s thesis. However, only when having an understanding of what economic clusters and their benefits are is it possible to seek an answer to the question of whether these benefits could offset an increase in corporate taxes. This has two consequences for operationalising the cluster theories. Firstly, it must be found out in the interviews if company owners would be more willing to accept a tax increase if the money was invested in strengthening the clusters they might be based in. Secondly, the field work has to ask if the advantages of the cluster are so strong that the companies would not relocate after a tax increase even if they disapprove of it.

2.5 Concluding the Theoretical Framework

To sum up this theoretical framework, the following aspects have been established:

1. Trust of the citizens in the government positively affects tax acceptance and compliance. However, a gap in the literature remains on whether this also holds true for company owners and corporate taxes.

2. In Economics, individuals, and therefore also company owners, are viewed as rational utility-maximisers. It is therefore relevant to research if there are circumstances under which company owners would support a tax increase because they see it as being in their own, rational interest.

3. Neoliberalism has been the predominant economic paradigm in the Western world for about 3 decades.

3.1 It has been shown that Neoliberalism argues for low corporate tax rates in

order to incentivise companies to increase investment spending. However, a gap in the literature remains about whether lower capital stocks and/or lower dividend pay-outs will be the response of company owners to a tax increase.

3.2 Domestic corporate tax levels need to be seen in the context of international tax competitiveness. However, a gap in the literature has been found regarding which other economic variables could offset an increase in corporate taxes.

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literature has not yet theorised if these effects might even persuade companies to remain in a certain location despite unfavourable tax rates.

To seek the results of the field work on these issues, the next chapter will turn to which methods the research will employ.

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3. Methodology 3.1 Units of Analysis

The introduction and research question has outlined the research scope of this thesis. According to the research question, the units of analysis to be considered are medium and large-sized, Dutch businesses that have to be owner-run. These criteria break down into 3 variables that need to be defined:

1) “Medium and large-sized”

According to the European Commission, medium-sized enterprises are

defined as firms generating a turnover of at least €10mn per year and/or employing more than 50 people; unless they generate a turnover of over €50mn per year and/or employ more than 250 people, in which case they are defined as large-sized enterprises

(ec.europa.eu website, 2016: “What is an SME?”)

2) “Dutch”

For this thesis, the term will mean that the company must have its physical head office in The Netherlands and that the owner that takes up the function as the director of the company must be a Dutch citizen.

3) “Owner-run”

Owner-run businesses will be defined as such where the director of the company is also an owner or co-owner of it.

The method of data collection will be semi-structured interviews. The following section will elaborate on why this method has been chosen.

3.2 The Choice for Semi-structured Interviews

Opting for semi-structured interviews has two key reasons. Firstly, the objective of this thesis is to get an in-depth understanding of the opinions and thought processes of company owners. For

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example, only semi-structured interviews allow the possibility of follow-up questions, which are critical in order to find out why the interview subjects gave a certain answer and which experiences they have made or which facts they draw on that led them to their answer. Furthermore, the data this thesis seeks to collect are very sensitive. The interviewees will be asked about their financial and tax data, their number of employees, the ownership structure of the company, the capital stock of the company, the dividend pay-outs of the company, etc. For Dutch besloten vennotschappen, this information is not publicly available unless the company voluntarily gives out the information. For many instances, this is not expected to be the case, because making these data public could, for instance, give competitors insights into the financial health of the company. Since these data are, however, at the heart of the research question of this thesis, it is crucial to establish a trust base with the interviewees in order to obtain these data. This is another, essential reason why the interviews will be held in person and not, for example, over the phone. It will be significantly more difficult to build a rapport with a company director over the phone and they might be more reluctant to give information related to their taxes and other financial data. As a consequence of the absolute necessity to gather these data in order to answer the research question, it follows that an interview that will end without having obtained these data is of no worth to this thesis. Since interviewees will likely not give these information ahead of the in-person interview, for the reasons just pointed out, there is a risk that an interview is arranged, which is associated with significant travel efforts, but will not be fruitful. In order to limit the risk of an unsuccessful interviews and obtain the required information, the interviewee will be made aware before the interview starts that he/she will be free to choose whether he/she would like to have his/her name or the name of the company mentioned in the thesis or prefer to remain anonymous. The possibility of anonymity will likely increase the willingness of interviewees to give information about sensitive financial data. In regards to the timeline, given the in-depth nature of the interviews, it is expected that each interview will take around 1:30 hours.

3.3 The Process of Arranging Interviews

In order to find interview subjects that fit into the research scope, it is imperative to concentrate on companies that fulfil the criteria outlined at the beginning of this chapter. However, there is

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no official, publicly accessible database with a list of besloten vennootschappen ranked by their turnover or employee numbers. This is, as the name suggests, a stark contrast to the availability of data about publicly-listed companies. As a consequence, a proxy needs to be found that can give an idea of the size of a company before making an interview appointment. A proxy that will give an indication of the size of a company is necessary in order to avoid setting up an interview, travelling to the location and spending time there only to realise during the interview that the company does not fulfil the earlier stated criteria. Two proxies will be used after one another before arranging any interview. The first proxy will be to scan Google satellite images of industrial areas (“bedrijventerreinen") and large office buildings. Conveniently, Google automatically superimposes the names of companies registered at the location onto the satellite images. This makes it a very quick and easy way of searching for companies. The size of the office building or, especially, the size of a production site of a manufacturing company on Google satellite images should give a good approximation of the size of the company. However, this proxy certainly gives only a vague idea of the company size. Therefore, based on that first proxy, the websites of the company at that location will be checked. The website will give a great amount of further information. That information could be the number of branches/offices the company has in The Netherlands and abroad and the industry the company operates in. Additionally, the "About us" section of most company's websites will reveal further hinds as to their size, history and, in some cases, the numbers of employees. Based on these sources, the companies will be contacted. Ultimately, only the interview itself can reveal whether the company is big enough to fit into the research scope of this thesis. However, using this approach for selecting interviews should limit the risk of having an unfruitful meeting significantly. The second stage after having made a list of companies that potentially fall into the research scope therefore will be to arrange an interview. The interviews will be arranged by calling the companies since sending emails will likely lead to a lower response rate. However, it is expected that in many cases the companies will not commit to an interview immediately over the phone, but would like to receive further details about it before confirming any appointment. Moreover, in the case of larger companies it is unlikely that the phone number of the director him/herself is provided on the website or that I will be put through directly. This further increases the chances that the company will ask to receive further information about the interview before putting it to the director for an appointment. After having arranged a few interviews, a higher hit rate than

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through this approach might be achieved by asking interviewees for contacts of other company owners they may know as acquaintances or friends. However, using this approach of a snowball sampling method might be very limited in its ability to answer the research question. This is because business acquaintances of a company owner in a certain industry are highly likely to be from the same or a closely related industry. This would strongly bias the research towards that particular industry and therefore not adequately address the much broader research question at hand. In order to obtain a data set across several industries, an approach of randomisation was therefore chosen for approaching potential interview subjects over the phone. This will allow the research to not be biased towards a particular industry. Based on the methodology outlined here, the attention of this thesis will now turn to the results the field work has delivered.

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Research Results

4. Company Owners’ Trust in the Government to Manage Public Money

As analysed in the theoretical framework, the degree of trust in the government can greatly influence taxpayers' perceptions of the appropriateness of tax payments and their compliance with them. However, it has also been carved out that a gap in the literature persists on whether this relationship also holds true for the case of corporate taxes and company owners. It is

perceivable, that company owners who express a lack of trust in the government to appropriately deal with public money are less inclined to commit to tax increases or would seek legal means to reduce their tax burden in the event of a tax increase or are doing so already anyway. Before analysing the results on whether such a relationship between government trust and the

willingness to pay taxes exists for company owners, it is imperative to first establish what levels of trust the interviewees had in the government.

4.1 The Influence of Corruption and Expenditures of Politicians on Government Trust

I would like to draw the reader's attention to table 3 below. It shows which areas of government spending or of dealings of the government with public money in general create distrust by the interviewees. The first observation that can be made is that not a single interviewee expressed negative views about the spending behaviour of politicians as individuals or the perks that come with holding political office. Nobody stated that the salaries of ministers or MPs are too high, that they travel too much, that government cars are too costly, etc. This must be seen as a very positive result.

TABLE 3: Areas proactively named by interviewees that cause distrust in the government

Company Corruption Political Expenses Infrastructure projects Health care Civil service Administrative landscape Company 1 x Company 2 x x Company 3 x