International Business

Environment
associate professor Radu
Muetescu, PhD
[email protected]

The Economic Environment

Core dimensions:
Taxation
Currency and Inflation
Financial Industry (access to credit)
Economic Growth and Development
others.

Taxation
Taxation = the core instrument of the state
through which it:
- extracts resources from society in order to
finance the public sector;
- attempts to alter the behavior of individuals
(through higher taxation of bad behavior
excise duties);
- follows other objectives of policy (such as
economic growth or development)
- so on.
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Taxation
direct = paid by citizens (individuals and companies) as they
are directly targeted (they are the ultimate taxppayer)
income tax, property taxes, inheritance tax, so on.
indirect = paid by middlemen (economic agents on the value
chain of the production of the good) as the tax targets a good
or a service (certain transactions) the value added tax, the
import duties (tarrifs) and so on.
It is argued that indirect taxes can be rolled over (pass
through) to the ultimate taxpayer and are not, in fact, borne
by the first taxpayer however, the tax burden will negatively
impact the sales of such a company and such taxes cannot be,
in fact, perfectly passt through (the higher final price will
reduce the demand for the product)
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Direct Taxation versus Indirect

Taxation
- all the countries in the world employ
both of these types of taxes;
- however, there are countries where
indirect taxation is more important (as a
source of revenue for the government.
Ex. the countries member of the European
Union) while other countries where the
main tax revenue for the government is
direct taxation (such as USA)
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Does it matter?
some economists = it does not really
matter what taxes citizens are paying,
what it does matter is the total tax rate
other economists = yes, it does matter
= direct taxation induce citizens to
engage in economic activity while
indirect taxation penalizes those who
are transacting (promotes autarchy)

Total Tax Rate

global average = 47.8%: for 100 m.u. net income, you
pay 47.9 m.u.
Price Waterhouse Coopers 2011 Paying Taxes

The least levels

East Timor = 0.2%

Vanuatu = 8.4%
Macedonia = 10.6%
Qatar = 11.3%
Georgia = 15.3%

The highest levels

D. R. Congo (Zaire) =
339.7%
Gambia = 292.3%
Sierra Leone = 235.6%
Argentina = 108.2%
Uzbekistan = 96.6%
Bolivia = 80%
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The burden of tax administration

(the perspective of the taxpayers)
Doing Business, World Bank, 2011
Income
category of
the country

Number of Tax The time

Payments
necessary for
payment
(hours per
year)

Total tax rate

(% of income)

Low

38

295

71%

Average to low

35

359

40%

Avergae to high

31

272

43%

High

15

172

39%

Romania = 154 place from 183 countries richer countries have a

lower total tax rate and a smaller tax burden
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Number of tax payments

Doing Business, World Bank, 2011
The lowest number ot tax
payments

The highest number of tax

payments

Sweden = 2
Hong Kong = 3
Maldives = 3
Quatar = 3
Norway = 4
Singapore = 5

Ukrain = 135
Romania = 113
Belarus = 82
Montenegro = 77
Jamaica = 72
Venezuela = 70

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The structure of taxes versus

the level of taxation (total tax
rate)
It is a debate which is more important
Sweden has a low number of taxes
but the total tax burden is high while
other countries have a large number of
taxes but a lower level of overall
taxation taxation by itself does not
create wealth and only consumes it
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The flat tax versus

progressive taxation versus
regressive taxation
flat tax = the same percentage for any
income
progressive taxation = taxpayers with
higher income pay a higher percetage
of the tax
regressive taxation = taxpayers with
higher income pay a lower percetage of
the tax
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The flat tax versus progressive

taxation versus regressive
taxation
the most commonly met type of
taxation is progressive taxation:
starting with 1991 (Estonia), some
countries have adopted a flat tax
regime: Lethonia (1994), Lithuania
(1994), Russia (2001), Serbia (2003),
Ukraine (2003), Slovakia (2003), Georgia
(2004) and Romania (2005).
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Core advantages of the flat tax

from the perspective of its supporters
- simple fiscal formalities. Ex. in USA, there are 894 types and
levels of taxes there are hidden costs of the tax payments
(ex. tax consulting) that may reach USD 100 billion per year;
- socially just . Ex. As opposed to progressive taxation, which
punishes the taxpayers with higher incomes or the regreesive
taxation, which favors them;
- prevents tax loopholes, looked after by special interests (those
who pay lower taxes than their peers are favored/privileged);
- does not penalizes the acumulation of capital, so on.
Note: some other economists argue that what it is more
important is the total tax rate and not the way of calculating
the taxes
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The international dimenssion of

taxation
From an international perspective, there are countries with:
residence based (territorial) system of taxation = a state taxes all
the residents (those who are earning an income inside the
borders) the most frequently met principle
citizenship based taxation = a state taxes its citizens
irrespective where they earn an income , even abroad (for
activities outside the borders of the state) a small number
of states (such as USA, Israel)
In order to avoid the double taxation of the same income,
countries conclude treaties for avoiding double taxation
= the country of origin and the country of destination split the
income to be taxed (priority is for the destination country)

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The impact of differences in

taxation from an international
perspective

= when deciding to invest in a particular country, an

investor will pay attention also to the level and
structure of taxes in that particular country
ceteris paribus, he will prefer to invest in a country
with lower taxation
however, if a country with higher taxation is more
attractive from a business perspective, the investor
will localize the economic activity into this country
but may use different transactions in order to shift
income or transfer profits in the country with
lower taxation the core problem of transfer
pricing practised by international companies
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Transfer pricing
= practised by international companies with affiliates in
different countries where there are differences in tax
systems
Ex. the A affiliate is from a lower taxation country while
the B affiliate is from a higher taxation country
when there are transactions between the two
affiliates (intra-company trade), the headquarters can
impose transfer prices that are tax oriented = it will
attempt to artificially increase the profit in country A
and lower profit in country B
Ex. if A affiliate sells a product to B affiliate, the price
of such a transaction will be overvalued while if A
affiliate buys a product from B affiliate, the transaction
will be undervalued
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Empirical evidence mid 90s

(Government Accounting
Office, USA)
more than 40% of the largest companies that operate
in USA (assets of more than USD 250 mil.) do not pay
an income tax or an income tax of less than USD
100,000
under 40% of the largest companies operating in USA
pay taxes of more than 1,000,000
83 of the largest 100 companies listed on the stock
exchanges have affiliates in a tax heaven (2011)
the USA government loses more than USD 60
billion/year from such practices by transnational
companies
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United Kingdom, 2012

Google, Amazon, Starbucks = invited
in the Parliament in order to explain
why they pay so small taxes despite
their large business turnover (sales)
Starbucks = 700 outlets, sales of 400
mil. pounds, pays an income tax of
around 0

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Reactions of governments
to the tax arbitrage by taxpayers
tax competition between states = some governments
reduce taxation in order to attract FDIs (or prevent
capital flight): Ex. Romania (16%), Bulgaria (10%),
Ukraine (13%), Serbia (14%), Slovakia (19%), Hungary
(18-16%), etc;
tax coordination = in order to avoid competition, some
states cooperate in order to homogenize taxation =
adopt the same level of taxation in order to prevent
companies from choosing between them on tax grounds
fighting transfer pricing as tax evasion = prevent
transfer pricing by qualifying it as illegal
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The efforts of governments to fight transfer

pricing
the Organization for Economic Cooperation and
Development (OECD) proposed even from the 80s
the Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations
basically, it is a list of principles to be employed
by tax administrations in order to identify transfer
prices = not an easy task

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Some principles for identifying transfer

prices
How can somebody accept that the price of a transaction is a
reasonable or correct price from a tax perspective?
the most important is to identify an Comparable Uncontrolled
Price (= market price) between independent entities;
Resale Price Method = from the final price deduct the profit
margin of the distribution affiliate (approimately equal to profit on
the local market) and find the import price;
Cost Plus Method = add to the costs of the producing affiliate
a reasonable margin and identify the export price;
Profit Split Method = from the final price deduct the costs of
the producing affiliate and evenly split the overall profit between
the two affiliates
Global Formulary Apportionment = from the overall sales of a
MNE, deduct the costs of production and split the overall profit
among affiliates according to different formula (and get a profit
per affiliate)
and others
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The reaction of MNE

to the punishment of their transfer
prices
= in order to avoid the scenario of being accused of
engaging in transfer prices, MNEs increasingly try to
conclude Advanced Pricing Agreements (= APA)
with tax authorities = they present to the latter the
prices they intent to practice in a future period and
learn whether these are acceptable

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Challenges for APAs:

APAs may imply significant costs;

sensitive commercial information
must be presented to tax authorities;
tax authorities can engage in price
planning;

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Tax evasion
= breaking the legal / accounting rules in order to
avoid reporting / underreporting economic activity
= an entire sector of a national economy is operating
as underground economy, black market, informal
economy and so on
Smith (1994) = the production of goods and
services, either legal or illegal, which is performed on
market and is not detected by the official estimates of
the Gross Domestic Product of a country
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Causes:
taxation is heavy = higher taxation leads to a
higher informal economy;
complex and difficult to comply regulations
(minimum wage, labor standards and so on) = may
determine some firms to avoid reporting activity;
lack of legitimacy of the government = citizens fo
not pay their taxes because they consider that
they do not receive anything as public goods;
difficult macroeconomic conditions = firms attempt
to avoid bankruptcy at all costs, even by engaging
in illegal reporting;
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Estimates = difficult
Schneider and others
(2010): in 2007, the
underground
economy was:
28.3% in
developping
countries
19.4% in developped
41.1% in transition
countries (former
socialist)

Exemple:
Bolivia = 71%
Thailand = 58%
Romania = 39%
Germany =16,7%
USA = 9%
Switzerland = 9,1%
Singapore = 14%
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The informal economy, 2012,

(Schneider 2013)

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Considerations regarding
the underground economy
fundamentally, the allocation of resources
observes the market mechanism;
however, there are no legal protection
mechanisms enforcement is usually
criminal;
lack of transparency and the inability to spill
information increases the transaction costs;
there is also adverse selection = criminal
organizations and individuals are common
actors in the underground economy
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