Vol. 19, No. 2
Harri Hietala and Seppo Kari:
Investment Incentives in Closely Held Corporations and Finland’s 2005 Tax Reform (pp. 41–57)
This paper analyses the effects of the recent Finnish income tax reform on the behaviour of a closely held corporation (CHC) and its owners. The main elements of the reform are cuts in corporate and capital income tax rates and the replacement of the full imputation system by a partial double taxation of distributed profits. Considerable exemptions are applied to relieve the taxation of dividends from CHCs. The analysis indicates that the change in the CHC’s cost of capital depends on the marginal tax rate (MTR) of the owner. In the case of a high-MTR entrepreneur, the cost of capital increases or is retained at the present level while at lower MTRs the cost of capital may well decrease. The latter observation is due to the increase in the tax rate gap between earned income and capital income. Thus the reform does not remove the earlier reported non-neutralities of the Finnish tax system. The reform also improves the position of wage income as a form of compensation. This will cushion the effect of the dividend tax changes on the CHC’s cost of capital.
(JEL: H24, H25, H32)
Mark J. Holmes:
Is a Low-inflation Environment Associated with Reduced Exchange Rate Pass Through? (pp. 58–68)
This paper investigates the extent of pass through from the US dollar exchange rate to consumer prices in the European Union. A relatively new line of empirical research is pursued that considers whether or not the extent of exchange rate pass through is related to the inflationary environment. In contrast to previous empirical studies, recently developed panel data cointegrating techniques to measure long run pass through are employed. While there is evidence that long-run pass through has declined since the 1970s, it actually increased during the early ERM years despite the presence of lower inflation.
(JEL: E31, F41, F49)
Measuring a Roller Coaster: Evidence on the Finnish Output Gap (pp. 69–83)
The output gap – which measures the deviation of actual output from its potential – is frequently used as an indicator of slack in an economy. This article estimates the Finnish output gap using various empirical methods. It evaluates these methods against economic history and each other by a simulated out-of-sample forecasting exercise for Finnish CPI inflation. Only two gap measures, stemming from a frequency-domain approach and the Blanchard-Quah decomposition, perform better than the naïve prediction of no change in inflation – but do not improve upon a simple autoregressive forecast. The pronounced volatility of output in Finland makes it particularly difficult to estimate potential output, producing considerable uncertainty about the size (and sign) of the gap.
(JEL: E31, E32, E37)