A fundamental tax reform in Norway : a comparison of the allowance for corporate equity system and the comprehensive business income tax system in a Norwegian setting

Abstract

This thesis seeks to answer what are the main distortions in the Norwegian tax system and to determine which of the ACE or CBIT systems that best could replace the current system. First, the thesis considers the current distortions in the Norwegian tax system. I find that the current tax system is distortive with regards to the tax-treatment of debt versus equity, as only cost of debt is deductible for tax purposes, while cost of equity is not. Moreover, the current system is distortive regarding depreciations, as the system implies inequality between real economic depreciations and taxable depreciations. I also do an analysis on multinational companies (MNCs)’ use of transfer pricing and thin capitalization. I show that MNCs shift profits out of Norway, which reduces the Norwegian tax base. To cope with such problems, I suggest a decrease in the Norwegian tax rate. Second, the thesis examines two fundamental tax systems, Allowance for Corporate Equity (ACE) and Comprehensive Business Income Tax (CBIT). I analyze both tax systems with regards to the distortions I found in the current system. Both systems are less distortive than the current system. As ACE allows deductions of cost of equity, I find the system to increase symmetry regarding tax-treatment between debt and equity. Moreover, I show that ACE ensures correct depreciations. ACE also reduces a firm’s cost of capital, and thus increases investments. I find that CBIT ensures equal treatment between debt and equity, as the system disallows deductions for both cost of debt and cost of equity. However, the system does not solve the problems of incorrect depreciations, as real economic depreciations are still different from taxable depreciations. CBIT decreases investments due to increased cost of capital. Based on research on welfare-effects by implementing ACE or CBIT, I understand CBIT to raise welfare in economies with high tax rates and a large multinational sector. The CBIT system increases the tax base, which is favorable as I also recommend a decline in the Norwegian tax rate. As a conclusion I recommend an implementation of the CBIT system.