4. Benefits of the NITDS
Since this tax system has only been in place for two financial years, it is difficult to be precise the consequences although some have been measured. This tax system seems to have prospective benefits and can be linked closely to the competition and monetary policy of the European Union. This is due to new companies investing in Belgium; a rise in competition for local companies is noticed. The effect of this can be shown in below in Figure 1.
The diagram suggests that due to an increase in aggregate supply of goods and services within the economy, prices of goods will decrease. This will happen as companies will adopt competitive pricing strategies in order to gain the largest market share in comparison to other companies. The diagram suggests a rise in real output from Y1 to Y2 and therefore a fall in prices from P1 to P2.
Due to an increase in competition, consumers will also benefit since the companies cannot exert monopoly power on the consumers. This will reduce the profit that companies can make but more importantly it will ensure that consumers do not pay higher prices than they should. Also due to the NITDS, companies will not worry about the lower profits earned before taxes since the tax amount will decline. This will ensure that companies are not forced to look at approaching the black market in order to find a new source of income.
Due to a substantial decline in corporate tax payments companies will be tempted to invest more and thus with an increase in aggregate supply, the country would experience a growth in the economy. Since the national output of goods will increase the government will see the following trend.
The above diagram shows that since the cost of production will decrease, companies will be more willing to produce goods. This would lead to a growth in the economy of the country since the production of goods and services will increase. This means that due to the NITDS the companies will not only produce at a lower cost but will also increase production. Due to an increase in national output, more people will be able to obtain the goods and thus those consumers that did not have access to the goods can now buy it at a lower price. Prices for the goods will be lower since there will be a decrease on the cost of the goods for the firm. This means that the country’s national output would increase, which is calculated by the expenditure method, which measures the value of all incomes earned in the economy :
The national income will change due to a change in any of the determinants of GDP (highlighted above.) In order to ensure that the effect of the NITDS is beneficial (growth of the economy); the government should ensure that the determinants of GDP increase only positively. Consumption can very easily change due to a change in income. This is one of the reasons why the NITDS could lead to an increase in national income since the costs of the companies have decreased and thus the income of shareholders has increased. Secondly, investment can vary due to interest rates and government taxes. Since, due to the NITDS, government taxes will be milder for companies, they will generally invest as much as possible in the hope of expansion, which will once again increase national income. Finally, exports will increase for Belgian companies due to an increase in production of goods and services as well as greater demand from China and India with greater disposable incomes further leading to a rise in national income.
It is imperative to understand that not only will the hypothetical tax rate be deducted but also the tax rate may be reduced to as much as 26% from the current 33.99% for businesses. This will mean that the Belgian tax rate is going to bring tax levels to the European average and will further stimulate investments in comparison to other European countries. Also this change will bring a significant change to the earnings of the general public which could see a rise in the gross domestic product (GDP) and the National Income of Belgium. This once again is a macroeconomic aim of the government and will benefit the general public of Belgium. The economic policy has the potential to raise living standards of the Belgian people and thus can improve their lives in an immense manner.
The initial effect of the tax system has been felt and has proven to be beneficial to the Belgian people. Looking at Appendix 1 we can come to the conclusion that the NITDS has benefited the public. This can be seen since there is an increase in the amount of internal financing within a business from the financial year 2006 to 2007. This may have happened since businesses are becoming more aware of the benefits of using the NITDS. This means that all the above benefits will be achieved in order to improve our lives since the aim of the tax system has been partially achieved and is expected to work more globally as the press begins to publicize it more internationally.
Further to this tax of the NITDS, discrimination between debt financing and equity financing will be reduced. When considering equity financing we are talking about both reinvestment of profits and issuing of new shares. The NITDS will also benefit small businesses as they can finance completely through equity and take advantage of deducting a hypothetical interest expense.
Due to a reduction in the tax, we can assume that the tax burden and government revenue will vary and can be seen below.
From the above diagram, we can see that due to a notional interest expense, the tax burden to businesses is reduced from P1Q1Pe to only P1Q1P2. This shows that even though the tax burden for producers remains constant, the consumers have more disposable income. Even though the notional interest expense acts like a “hidden subsidy,” the aim of the system is not to decrease prices but to increase employment, which it is doing successfully. Similarly, government revenue will be reduced from P1Q1C to only the P2Q1C. This presents the government with an opportunity cost since tax revenue will be reduced and thus spending on other areas of the economy will have to be reduced.
5. The balance between Debt and Equity Financing
After the introduction of the NITDS it has become very confusing to decide whether to finance through equity or debt. This is because when making the decision it is not as simple as to only take a look at the tax aspects and more importantly the cost-related aspects, the decision must be made based upon other factors as well. It is important to understand that the basis of the decision depends on considerations of the company such as the ‘internal organisation, method of governance, size, maturity, profitability, growth aspects, etc.’ The financing will also be affected by the factors operating in a given institution such as degree of competition and legal context like the protection of creditors versus the protection of shareholders of a country.
In order to understand the impact of the NITDS on corporate financing, two fictitious companies will be taken into consideration. Company A will be financed only by debt and Company B will be financed with its own resources. The effect can be seen in Figure 4. We must understand that in this simulation, each company’s profits before taxes and financial expenses are equal at €100. When Company A allocates all the money to interest payments, the private Belgian investor will receive a final interest income of €85 (100 minus 15% withholding tax.) However, when Company B finances entirely out of its own resources, a deduction cannot be obtained and so normal tax rates of 33.99% (approximately 34%) apply, thus leaving profits after tax at €66. The sum that the private investor will receive depends on whether dividends are issued or not. If dividends are issued, the private investor will receive €49.5 due to a 25% withholding tax. Conversely when dividends are not issued, the individual will obtain all the profit after tax, €66.00, since capital gains are not taxed in Belgium. This brings the conclusion that a company should primarily finance through debt, then equity without issuing dividends and finally equity financing with the issuing of dividends.
However, there is a difference when a borrower firm is financed through another company, for example by a “parent company.” Even though, the order in which one should finance changes, the amount that is received changes marginally in some cases as well as a large amount in other cases. For example, when Company A receives funds from Company C (parent company) the whole of the interest will be taxed and therefore the Company will receive €66, whereas when it is not financed through the parent company the individual will have €85. Conversely, for Company B there will be an increase in earnings instead of a decrease. This is because only 5% of the dividends paid will be taxed and therefore the profit remaining after taxation will be €98.3 instead of €75. This conveys that after the introduction of the NITDS the Belgian government will have a reduction in their working capital since they will receive less in tax revenue. (All the information is obtained from Figure 4.)
The diagram below conveys exactly how it works:
6. Drawbacks of the NITDS
For every system that has benefits, there are always drawbacks attached to them. Since there are no limitations on the system, it will be difficult for the government of Belgium to control to whom they offer the incentives. Businesses may use the NITDS to benefit an expansion of their business. Company A may expand in the form of equity and may open up company B. This can be a problem for the government since they are not receiving any tax from company B and can lead to a deduction in the government expenditure available. Also when company A decides to expand in such a way, company B has been financed only through equity of company A which could lead to the company becoming insolvent and thus the company may be completely broken down.
Secondly, the government will find it difficult to ensure that the system is being used effectively and correctly without illegal practises being carried out to ensure that no one is earning money in a hidden (black) market within the economy. Since there are no boundaries on who is eligible for the tax system the government will have to increase the costs of tax inspectors to make sure that they receive the money that they are accountable to.
As we have established above, tax revenue for the government will be reduced. This means that the government will have to make more choices and face more opportunity costs since they will not have enough funds to finance large projects. Also the government will have to ensure that the projects they do carry out are those that the public are in favour of and may need to increase marketing costs since they will not be able to provide all the same features as before.
The government has set up the NITDS hoping to reduce unemployment as well, while doing this the government should ensure that the policy does not lead to “crowding out.” This means that when the government try to run a budget deficit, they sell government bonds such as treasury bills or treasury bonds to financial institutions who then sell on to people who want to save their money. This leads to an increase in demand for savings or loanable funds in the economy. This can be seen on the diagram below.
From the above diagram we can see that there is a given number of savings within the economy, shown on the diagram as S (loanable funds.) The price of these loanable funds is the interest rate, and due to an increase in demand from D1 to D2 in order to remove the deficit leads to an increase in interest rate from i1 to i2. With an increase in interest rates, businesses will not be willing to invest the same amounts and thus the importance and objective of the NITDS will be destroyed. The fall in investments is shown by the decrease from I1 to I2. With the government wishing to increase the aggregate demand, they have in fact reduced aggregate demand due to a fall in private investment to fall.
7. International Awareness
This innovative tax change has created interest from other countries around the world also looking to adopt the tax reform. Belgian authorities had recently attempted to promote the NITDS in USA and China and after successfully having promoted the new tax system; it seems that these two countries will be the first after Belgium to adopt the new tax system.
After this tax reform has taken place, we have seen a significant change in investment within Belgium. The extent to which American investments in Belgium have increased is unimaginable; ‘American investment in little Belgium was more than four times that of U.S. investment in China.’ This figure suggests the extent to which Belgium can act as a global hub for foreign investors and that due to the impact of the NITDS in Belgium other countries will follow this example. After having conducted an interview with Marcel Klaes (Appendix 1) we are made aware of the fact that after the introduction of the NITDS, investment had increased by $4.5 billion in 2006. This conveys that Belgium is acting as an investment hub, and is interesting to see companies such as Genzyme to invest up to $300 million in a country the size of Maryland.
Belgium has potential to prove to be a land where investors can seek to invest. This will bring about a lot of benefits like, an improvement in infrastructure, lower prices for goods and services offered to consumers and an economic injection into the economy and thus a rise in jobs available. The three above effects will mean that the Belgian public will be able to gain better living standards since the surrounding they work in will be of higher quality. Also the macroeconomic aim of lower unemployment will be met, which is of major importance to the government and the Belgian people. It will also mean that there will be an increase in training and labour for the specific enterprises, leading to a more highly skilled labour force.
Belgium remains a major foreign investment played and was ranked sixth largest recipient of FDI at $34.4 billion. Even though investment in EU was at its lowest since 1998, FDI in Belgium was up 7.1%. Similarly, Belgium was ranked the 13th in the world for foreign R&D operations. Belgium was also considered a country with high FDI growth potential. Inflows to Belgium more than doubled to $72 billion, raising its total FDI stock to $603 billion, which was more than the country’s GDP at the end of 2006.
The graph below shows the investment levels in Belgium since 2000 until 2007.
Figure 7 conveys the increase in investment levels since the introduction of the NITDS in 2006. There has been an exponential increase in the investment, by understanding the trends, investment levels should increase in 2008. Figure 8 gives the idea of which sector the investments are being pumped into, which demonstrates that offices receive the most investments.
8. Changes encountered in statistics
Having looked at Appendix 2, we can see that after the drafting of the NITDS in 2005, unemployment has reduced from 596000 to 532000 in 2007. Prior to the introduction of the NITDS, the unemployment figures aggravated from 2001 till 2005, from 470000 till 596000. The unemployment figures fell from 8.66% to 7.6% in a time gap of two years. This shows that the NITDS seems to be having a positive benefit on the unemployment figures of the country.
However, even with a decrease in the unemployment figures, inflation has decreased as can be seen by Appendix 3. The opposite of what would be expected by the Phillips curve (shown below) has occurred.
‘In Belgium, inflation measured by the Harmonized Index of Consumer Prices (HICP) and when calculated on an annual basis, declined from 2.3% in 2006 to 1.8% in 2007. Thus Belgium recorded one of the lowest inflation rates in the Euro Zone, where the average rate was 2.1%.’ This suggests that after the introduction of the NITDS, two of the macroeconomic aims of the Belgian government were accomplished. The government could control inflation as well as unemployment, a major bonus to the NITDS.
We can also see an increase in GDP in Belgium, which would have occurred with an increase in investments. After the introduction of the NITDS, GDP increased from €301,966 million to €330,777 million. This is shown on Appendix 4. The increase in GDP once again shows a positive shift in statistics with the NITDS enforced in Belgium.
9. Other reasons for investing in Belgium
Even prior to the introduction of the NITDS, investors considered Belgium a hotspot due to many reasons. Belgium has been considered a safe place to make an investment largely due to the fact of its location. Belgium is situated at the heart of Europe and Brussels is the heart of the EU and NATO which makes it an attractive location to invest within Europe. Its proximity with the big cities of Europe, such as London, Geneva and Paris, and excellent transport routes makes it an ideal place to invest.
Secondly, the skilled workforce available in Belgium makes it easy for companies to recruit employees. The Belgian workforce is considered to be highly productive, educated and multilingual. Belgium’s workforce was ranked 3rd in terms of productivity per hour by the Conference Board’s 2006 Report.
From Appendix 5, we can see that Belgium has a reputation for strong business infrastructure. The road density and port infrastructure make transport easy and reliable. Antwerp has one of the largest ports in the world and along with the reliable air transport, suggests that the transport from Belgium to countries worldwide is very easy. Along with this in mind, real estate costs are amongst the lowest in Europe. The cost of office rents in Brussels is amongst the cheapest in Europe, where the cost is as low as €290/sq.m./year. Brussels occupied the 71th spot for cost of living in the 2006 ranking of 144 cities by Mercer Human Resources Consulting. London (5), Geneva (7), Milan (13), Paris (15), Amsterdam (41), and Luxembourg (56), and Frankfurt (61) were all more expensive. Also when considering the costs of opening factories in Belgium we should also consider the costs highlighted in Appendix 6 which suggests that both Antwerp and Brussels have low operating costs another benefit of investing in Belgium.
Belgium attracted the 4th largest amount of foreign direct investment in 2006, at $72 billion, only UK, USA and France attracted more foreign investments.
10. Conclusion
10.1 - Conclusion
It seems that with the introduction of the NITDS, many factors will bring an increase to investments in Belgium. Even though Belgium has many different reasons to encourage investments, surprisingly it was only after the introduction of the NITDS that investment increased. Since the NITDS had been launched in Belgium, it will bring Belgium ‘back into the spotlight for tax advisers and demonstrated it as to be an attractive place for overseas investors. Even though, the NITDS has some drawbacks, the benefits outweigh the disadvantages. This is suggested by the increase in American investments of $4.5 billion in 2006. After having looked over all the research and analysis it is possible to say that Belgium has had and will have a positive effect on Belgian investments and the Belgian economy as a whole.
The opinion of the conclusion provided above, is also shared by the Belgian Government. They are ‘confident that new measures will create a valuable alternative for the expiring coordination centre regime and increase the attractiveness of Belgium for capital intensive companies, equity-funded headquarters and treasury centres.’
With the world heading for a deep recession and with many companies filing for bankruptcy, it seems that all countries will increase their investment in Belgium. This is because they will try and reduce spending at all costs and since the NITDS will allow a reduction on tax expenditure, with companies needing to invest in order to survive they may highly consider investing in Belgium since it may be the safest and most efficient option as shown in Appendix 8.
According to a survey carried out by the daily De Tijd many companies have expressed their enthusiasm about Belgium’s latest tax cut for corporations. With this innovative tax system, corporate tax rate is reduced to approximately 25%. For example Arcelor Steel Group will pay €31 million less in taxes due to the introduction of the NITDS. New investment will come into Belgium as Randstad have shifted its headquarters into Belgium, both things happening this financial year. The government expects to miss out on €560 million; however Verhofstadt anticipates a broad recovery effect through increased economic activity.
10.2 - New Questions
But it is important to understand, that even Belgium’s innovative tax system has increased investments and has the potential to do so in the future, however will these increases be sustained? The Belgian government will have to ensure that they compete positively with fast developing economies, such as India and China.
10.3 - Limitations
It is very difficult to draw conclusions at such an early stage but even with this in mind we can observe that the NITDS has benefited the Belgian economy. It is very difficult to collect concrete data as highlighted in the interview with Marcel Klaes, who said that ‘the figures have a certain delay since the introduction of the NITDS was in 2006 we can see an increase but we cannot place that as the sole reason.’
11. Bibliography
All the following sources were used while writing the Extended Essay:
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Jocelyn Blink and Ian Dorton, Economics Course Companion, Oxford IBO, ISBN: 978099151240
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Economic and Financial development Report 2007, National Bank of Belgium, Publisher: Guy Quaden, Governor
- Report 2007, National Bank of Belgium, Publisher: Guy Quaden, Governor
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Paul Op de Beeck, Eric Warson, David Engelbos (all KPMG), April 2005. Belgium: Notional interest deduction on the right track , International Tax Review
- UN Investment Report
- Jones Lang Lasalle
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(Date accessed - 03/05/08)
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(Date accessed - 03/05/08)
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(Date accessed - 26/08/08)
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(Date accessed - 09/10/08)
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(Date accessed - 26/08/08)
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Deloitte Touche Tohmatsu – Belgium Tax Alert – 10 March 2005
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KBS Securities – Flash – 21 February 2006
The following sources may have influenced my thoughts; however they have not been directly quoted in the Extended Essay:
- De Tijd Newspaper
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12. Appendices
Appendix 1 – Demand for Bank loans by enterprises
Appendix 2 – Interview with Marcel Klaes
Appendix 3 – Labour Market, NBB Report 2007, p.185
Appendix 4 – Inflation in Belgium, NBB Report 2007, p.104
Appendix 5 – GNI and main Categories of Expenditure at Current prices, NBB Report 2007, p.183
Appendix 6 – World Competitiveness Yearbook, 2005/ Global Competitiveness Yearbook 2006-2007
Appendix 7 – Jones Lang Lasalle, 2005
Appendix 8 – Deloitte Touche Tohmatsu – Notional Interest Tax Deduction Brochure
Deloitte Touche Tohmatsu – Belgium Tax Alert – 10 March 2005
Economics Course Companion, Jocelyn Blink and Ian Dorton, Oxford, p.151
KBS Securities – Flash – 21 February 2006
National Bank of Belgium, Report 2006, p. 130
National Bank of Belgium, Report 2006, p. 131
Economics Course Companion, Jocelyn Blink and Ian Dorton, Oxford IBO, pg. 228-229
Francis X. Rocca, September/October 2007, Arrive, p.28
World Investment Report 2007 by the UN Trade and Development Organization, UNCTAD
Economic and Financial development Report 2007, National Bank of Belgium, p.103
Source: Jones Lang Lasalle, 2005
Mercer Human Resources Consulting, Ranking 2006
UN World Investment Report 2007
Tax Analysts Electronic Citation: 2007 WTD 215-3, Marc Quaghebeur, Vandendijk & Partners, Nov. 6 2007
International Tax Review, April 2005, Paul Op de Beeck, Eric Warson, David Engelbos (all KPMG), (last accessed: 16/09/08)
A Local Belgian Newspaper
This is known as the Notional Interest Deduction (NID) – the amount that is reduced
A Dutch Temporary employment agency