The Effect of the Tax System as an Institutional Factor on the Business Structure in Europe

Abstract

This chapter focuses on the influence of tax systems and taxation rules on the firm structure of the 28 European Union member economies. It is argued that higher taxes and more complex tax rules lead to smaller firms, and that, on the other hand reduces macroeconomic performance. It is found that the firm size and corporate tax rates are negatively correlated in case of mediumsized (R=-0.4; p=0.03) and large (R=-0.41; p=0.03) firms. Indications were found that higher transaction costs caused by taxation lead to smaller firms, as a significant negative correlation was found between the number of hours per year needed to administer tax payments, and the share of large firms (R=-0.41 & p=0.03), and also between KPMG’s comment length (an indicator for tax system complexity) and the share of medium-sized firms’ turnover from the total turnover (R=-0.39 & p=0.045). More complicated tax rules might also cause a smaller proportion of firms to grow quicker, but the significance level of these relationships is not very convincing.

Keywords: tax system; tax rate; institutions; firm size

JEL Classification: H21, L11