ECONOMIC POLICY ECONOMIC POLICY ECONOMIC POLICY ECONOMIC POLICYMACROECONOMICS ECONOMIC POLICY | | | ECONOMIC POLICY ECONOMIC POLICY ECONOMIC POLICY ECONOMIC POLICY | Prosperity Insight Series | | | ECONOMIC POLICY ECONOMIC POLICY ECONOMIC POLICY INCOME TAXATION OF TOP EARNERS IN HONDURAS: | LINKING PERSONAL AND ECONOMIC POLICY CORPORATE TAXES | | | ECONOMIC POLICY ECONOMIC POLICY ECONOMIC POLICY MARCH 2025 Thiago Scot (World Bank, DECDI), Pierre Bachas (World Bank, DECRG), | Santiago Cesteros (World Bank, DECDI), Tatiana Flores (World Bank, DECDI), Gabriel Oqueli (PUC-Chile), Edgardo Enrique Espinal Hernandez (SAR), Wilman ECONOMIC POLICY Alonso Ponce Nuñez (SAR) and Sahira Rocio Canales Licona (SAR). | | | MIC POLICY MIC POLICY IC POLICY | NOMIC POLICY | ECONOMIC POLICY | ECONOMIC POLICY | ECONOMIC POLICY | ECONOMIC POLIC INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES MARCH 2025 Thiago Scot (World Bank, DECDI), Pierre Bachas (World Bank, DECRG), Santiago Cesteros (World Bank, DECDI), Tatiana Flores (World Bank, DECDI), Gabriel Oqueli (PUC-Chile), Edgardo Enrique Espinal Hernandez (SAR), Wilman Alonso Ponce Nuñez (SAR) and Sahira Rocio Canales Licona (SAR). 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Used with the permission of Studio-FI. Further permission required for reuse. TABLE OF CONTENTS 1. Introduction 3 2. Personal and Corporate Income Tax Systems in Honduras 5 3. Top Earners’ Comprehensive Income 6 4. How Much Taxes Do Top Earners Pay? 11 5. A Detailed Look At Shareholders At The Top 14 6. Conclusion 18 A Appendix: Methodology 19 A.1 Income Definition 19 A.1.1 Capital Income 19 A.1.2 Wage Income 20 A.1.3 Mixed Income 20 A.1.4 Undistributed Corporate Profits 21 A.2 Effective Tax Rates Computation 21 A.3 Analysis Approach 21 INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 5 Prosperity Insight Acronyms and Abbreviations ETR ETR Effective Tax Rate FTZ FTZ Free Trade Zone GPD GPD Global Domestic Product PIT PIT Personal Income Tax PPP PPP Purchasing Power Parity VAT VAT Value-Added Tax INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 6 Prosperity Insight This note is an innovative example of using tax records in a developing country to assess the effective income tax rates of top earners, considering a comprehensive measure of income by linking personal and corporate income. It builds on an extensive collaboration with the Honduras Tax Authority (Servicio de Administración de Rentas, SAR), that allowed for the construction of comprehensive income, connecting firms to their shareholders and assigning undistributed profits to them. The results highlight the crucial link between the design of personal and corporate income taxes, since a large share of income attributable to top earners consists of undistributed profits. We document that undistributed corporate profits represent more than 50 percent of total comprehensive income for the top 0.05 percent of earners, whereas distributed capital income represents less than 15 percent. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 7 Prosperity Insight INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 1 Prosperity Insight EXECUTIVE SUMMARY This note examines the effective income tax rates of top earners in Honduras, using a novel approach that links personal and corporate income tax data. This comprehensive income measure, achieved through collaboration with the Honduras Tax Authority (SAR), reveals a crucial link between the design of personal and corporate income taxes. The findings indicate that over 50% of total comprehensive income for the top 0.05% of earners comes from undistributed corporate profits, while distributed capital income accounts for less than 15%. The effective tax rate (ETR) for the top 0.01% of earners hovers around 25%, which is relatively flat compared to the significant drop observed in high-income countries. This is attributed to Honduras’s flat corporate income tax rate of 25% aligning with the highest marginal rate for personal income. A significant number of top earners hold meaningful shares in corporations, particularly large ones. Despite average ETRs being flat at the top, tax exemptions play a crucial role in explaining the dispersion of ETRs, as top earners are more likely to own firms benefiting from corporate income tax exemptions. The large difference between distributed and retained earnings suggests potential income- shifting strategies to avoid taxes. Moreover, offshore income, which is not captured in this analysis, likely underestimates the true income and overestimate the ETRs of the top earners. The findings highlight the need for a more integrated approach to tax policy and tax administration, considering the significant role of corporate income in top earners’ overall income. Piecemeal tax reforms, that ignore the complex interactions between Personal and Corporate Income Taxation, might miss important behavioral responses from taxpayers and fall short of their goals. Additionally, strengthening tax enforcement mechanisms with a focus on top earners, both domestically and through international cooperation to exchange information on offshore income, is a promising avenue to assure a more equitable and efficient tax system. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 2 Prosperity Insight Acknowledgements We extend our gratitude to Marlon Ochoa, Christian Duarte, Mariana Rios, and Alessandra Díaz for their endorsement to conduct this research. We also extend our thanks to Anne Brockmeyer, Alastair Thomas and Kinnon Scott for their valuable feedback on previous versions of the report. We thank the Global Tax Program at the World Bank for generously supporting the funding for this research. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of SAR or the World Bank, its Board of Executive Directors, or the governments that they represent. Opinions and errors are all those of the authors. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 3 Prosperity Insight INTRODUCTION Developing countries face high financing needs in a progressive manner, while also reducing tax to invest in human and physical capital, reduce evasion and minimizing distortions. Currently, little poverty, and adapt to climate change. Who is know about the effective taxation at the very should bear this burden is at the core of the top of the income distribution. This is attributable debate in raising domestic revenue mobilization. to the absence of top earners from survey data, Income inequality across the globe is large: the top as well as the complexity of their income sources, 10 percent of highest earners within each country which includes capital gains, dividends, and other receive over half of the total income (Chancel et non-wage earnings. al., 2022). Governments should aim to raise taxes INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 4 Prosperity Insight When considering the very richest individuals and Fairfield and Jorratt De Luis (2016) for Chile). (top 0.1 percent and above), the typical concept As will be demonstrated here, this exercise can also of income, as reported in surveys or in personal be performed in a lower-middle-income country, income tax data, is misleading. Specifically, it despite data challenges. does not consider that most top earners have at The results highlight the crucial link between their disposal income within businesses that they the design of personal and corporate income own. This income can be much larger than the taxes, since a large share of income attributable realized and reported personal income (Kopczuk to top earners consists of undistributed profits. and Zwick, 2020; Smith et al., 2019; De Rosa and We document that undistributed corporate Vilá, 2023), and previous research has shown that profits represent more than 50 percent of total the distinction between corporate and personal comprehensive income for the top 0.05 percent income is porous: for example, when incentives of earners, whereas distributed capital income to retain earning in corporations decrease, represents less than 15 percent. In high-income shareholder substantially increase distribution countries, the effective tax rate (ETR) of top and realize more income at the individual level earners drops substantially; this is not the case (Alstadsæter et al., 2016; Smith et al., 2022). For in Honduras: the ETR is mostly flat at close to 25 these reasons, our goal in this note is to consider a percent for those at the top 0.01 percent. This is more comprehensive measure of individual income, because corporate profits are taxed at a flat 25 approaching the Haig-Simons concept of income as percent rate which is the same as the highest changes to opportunity of consumption over time. marginal rate for personal income. This note is an innovative example of using This note proceeds as follows. Section 2 tax records in a developing country to assess summarizes the key features of the Personal the effective income tax rates of top earners, Income Tax (PIT) and Corporate Income Tax (CIT) including a comprehensive measure of income in Honduras. Section 3 then describes the measure by linking personal and corporate income. It of comprehensive income in tax records, and the builds on an extensive collaboration with the level and composition of income for top earners. Honduras Tax Authority (Servicio de Administración Section 4 documents the effective tax rate faced de Rentas, SAR), that allowed for the construction by top earners, including their composition, before of comprehensive income, by connecting firms to providing a detailed view of the importance of their shareholders and assigning undistributed corporate ownership at the top in Section 5. Section profits to them1. Similar exercises have mostly been 6 provides some conclusions and implications. performed in high-income countries, including in Latin America (De Rosa and Vilá (2023) for Uruguay 1. The databases we use in this note were developed by Del Carmen et al. (2024), which also provides more information on the background data. 2. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 5 Prosperity Insight PERSONAL AND CORPORATE INCOME TAX SYSTEMS IN HONDURAS The Personal Income Tax (PIT) in Honduras Corporations in Honduras face a 25 percent flat is characterized by the flat taxation of capital income tax rate, but several special regimes income and progressive rates on labor income, can substantially change the effective rates. with a high exemption threshold. Capital income The standard Corporate Income Tax (CIT) in Honduras (mostly dividends and interest) is taxed regime in Honduras applies a 25 percent tax at a flat 10 percent rate at the source. However, it rate to firms’ profits, calculated as gross revenue does not need to be reported separately in the PIT minus deductible costs. Three special regimes declaration. Other labor and mixed income, notably complement the standard regime and might raise wages and income from commercial activities firms’ tax liabilities. First, the ”solidarity tax” and service provision, are taxed at a progressive functions as a surcharge of 5 percent on taxable schedule of marginal tax rates. In 2019, annual income above L 1 million (US$ PPP 88,000). incomes about below 160,000 Honduran Lempiras, Second, firms might be liable to pay a presumptive L, (purchasing power parity [PPP] US$ 14,000) tax on net assets instead of profits if declared were fully exempt from income taxes, and incomes profits are too low. Third, firms with very large above that level were taxed at marginal rates of 15 gross revenue (above L 600 million or US$ PPP 53 percent until about L 240,000 (US$ PPP 21,000); million in 2019) must pay the maximum between at 20 percent until L 564,000 (US$ PPP 50,000) the 25 percent standard rate and 0.75 percent and at 25 percent above that level. All taxpayers of their gross revenue. These last two regimes in Honduras benefit from an automatic deduction (the Net Asset and Corporate Minimum Tax) are of L 40,000 (US$ PPP 3,500) related to medical complementary, in the sense that firms pay the expenses. Thus, in practice, annual incomes up maximum tax liability between them.3 Moreover, to L 200,000 (US$ PPP 18,000) are exempt and Honduras provides several fiscal incentives, remaining thresholds are shifted by L 40,000 (US$ particularly for exportoriented firms, that fully PPP 3,500). Other incomes are also exempt from exempt some corporations from income taxes. taxation, including the common 13th and 14th These exemptions are large in aggregate terms. In salaries2 of formal wage workers. fact, yearly CIT exemptions account for 25 percent of total tax expenditure in the country or 1.7 percent of gross domestic product (GDP).4 2. The 13th and 14th salaries are additional annual bonuses mandated by law to support workers, commonly referred to as aguinaldo and decimocuarto mes, respectively. 3. For additional discussion on Honduras CIT regimes see Lobel et al. (2024); and for additional figures on corporate effective tax rates see Bachas et al. (2023). 4. Tax expenditures numbers are provided by Honduras Finance Ministry in the yearly budget report. 3. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 6 Prosperity Insight TOP EARNERS’ COMPREHENSIVE INCOME This section describes the population of interest meaning that a large share of formal workers is not and how their comprehensive incomes from tax observed in the data. In 2019, for example, about returns are constructed; details are provided in 650,000 taxpayers with any income were observed Appendix A.1. Income levels and composition at in the tax records, however, less than 25 percent of the top are then presented before proceeding to a them have incomes above the exemption threshold. discussion of effective tax rates. For all taxpayers below, low capital income from bank interest and dividends is mostly observed. The analysis concerns the top 1.5 percent of These are withheld at the source and not subject adults with the highest incomes in the population. to exemptions. It should also be highlighted that This is the population for which we consider that these individuals represent the highest 1.5 percent tax records closely reflect the income received by earners among the adult population, and not only individuals.5 This is driven by several factors. First, among taxpayers. In 2019, the adult population the high levels of informality in Honduras (estimates over the age of 20 in Honduras was estimated at put labor market informality rates at 80 percent) 5.42 million individuals. The results presented here suggest that a large share of income outside are for the approximately 81,000 individuals with the very top is not in the tax records. Second, the highest incomes in the tax data. Further details the exemption threshold for filing and declaring on the construction of the undistributed corporate personal income taxes in Honduras is among the profits are provided in the box below. highest in Latin America (Bergolo et al., 2023), 5. Del Carmen et al. (2024) show that when merging household and tax records data, more income is typically observed in surveys than in tax records, until the top 1 percent highest earners. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 7 Prosperity Insight Box 1: Assigning Undistributed Corporate Profits to Shareholders The measure of undistributed profits is developed by first computing the firm’s taxable profit from corporate income tax (CIT) declarations as the difference between taxable revenue and total allowable costs. After the profit measure is calculated, we net out the total amount of dividends distributed by the corporation in the corresponding fiscal period. Next, the net-of-dividends corporate profits to each shareholder are allocated, in proportion to their ownership stake in the firm. This step relies on a detailed list of corporate shareholders and their ownership shares. Although Honduras currently lacks an official, comprehensive, and regularly updated corporate shareholder database, the Tax Administration collects shareholder information at the time of firm’s registration, as well as through occasional updates. However, this information is not systematically verified, leading to data quality limitations. To address this, we collaborated with the Tax Administration to harmonize and merge multiple administrative sources, resulting in the creation of a comprehensive corporate shareholder database, including detailed ownership shares. When corporations were owned by other corporations, we conducted a recursive process with five levels of iterations to trace the individual shareholders of the parent companies and allocate their shares back to the original firm. The final shareholder dataset includes 250,000 relationships at the shareholder-firm level, representing over 104,000 firms and 170,000 individual shareholders, of which 64,000 hold a significant stake (over 5 percent of the firm’s total shares). This dataset represents the most comprehensive list of corporate shareholders currently available in Honduras. Once the shareholder list was built, the last step was to merge it with yearly CIT declarations that include our adjusted profit measure. Undistributed profits were computed by assigning each individual the proportion of the net-of-dividends firm profit equivalent to their equity in the firms. The measure of comprehensive income includes provision and commercial activities outside the wages and capital income distributed to corporate sector. In addition to these distributed individuals, as well as undistributed corporate incomes, we also assign to each individual the profits retained in corporations. Thus, all income undistributed profits of corporations they own. attributable to individual taxpayers from four To achieve this, we use a newly constructed main sources are pooled together, including: shareholder dataset that includes the identity and distributed capital income, wages, mixed income, participation of all shareholders in corporations, and undistributed corporate profits. Distributed which allows us to assign profits in proportion to capital income is composed of dividends, interests, shareholders’ participation.7 Throughout this note, and rental income; wages include all base salaries comprehensive income is used when discussing plus untaxed extra income paid to most workers in our income definition inclusive of undistributed Honduras6; mixed income is income from service corporate profits.8 6. Most formal workers in Honduras receive 13th and 14th salaries at the end of the year, and these are nontaxable up to some amount. See Appendix A.1 for details. Our wage measures do not include social security contributions by either workers or employers. 7. More information on the attribution of retained earning to shareholders is in Appendix A.1. 8. Alstadsæter et al. (2016) refer to this as the accrual approach, as income is assigned to individuals as they accrue to firms and not when they are realized by individuals (via dividend distribution, for example). Fairfield and Jorratt De Luis (2016) similarly refer to it as the accrued profits approach. Both papers discuss how this approach approximates the Haig-Simmons income definition: ”the sum of an individual’s consumption and the increase in the individual’s consumption opportunities over a period” (Alstadsæter et al., 2016) INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 8 Prosperity Insight Individuals at the top 0.1 percent of the the top 1 percent is L 359,000 or approximately comprehensive income distribution earn more US$ PPP 32,000 (column 2).9 Those within the top than US$ PPP 121,000 a year. Table 1 provides 0.1 percent have income of at least L 1.4 million summary statistics concerning the number of or US$ PPP 121,000. We also present, for each individuals and income levels for selected bins at quantile, the average total comprehensive income the top of the distribution in 2019. Throughout this above that level and the average income above that note, statistics for 33 bins are presented - 14 bins level excluding undistributed corporate profits: for those in the top 1.5 percent of the distribution the comparison between these two provides but below the top 0.1%; 9 bins for those in the information on the importance of undistributed top 0.1 percent and below the top 0.01 percent; profits at the top of our comprehensive income and 10 bins for the top earners within the top distribution. A graphical illustration of the average 0.01 percent. As mentioned, our results for 2019 total comprehensive income per bin is presented in refer to approximately 81,000 individuals, and the Figure 1a. minimum annual comprehensive income to be at Table 1: Comprehensive Income Distribution - 2019 3. Mean Annual 4. Mean Annual Income 2. Annual Comprehensive Comprehensive Income Beyond Threshold Exc. 1. Number of Individuals Income Threshold Percentile Beyond Threhold Und. Profits Above that Level 000s HNL 000s HNL 000s HNL [000s USD PPP] [000s USD PPP] [000s USD PPP] 289 861 570 98.5 81,331 [26] [76] [50] 363 1,129 697 99 54,220 [32] [100] [62] 1,375 6,229 2,226 99.9 5,422 [122] [551] [197] 9,891 35,258 7,152 99.99 542 [875] [3,120] [633] 17,329 57,405 9,251 99.995 271 [1,533] [5,080] [819] 20,517 67,178 9,663 99.996 216 [1,816] [5,945] [855] 26,603 81,904 10,560 99.997 162 [2,354] [7,248] [934] 39,315 106,949 10,458 99.998 108 [3,479] [9,465] [925] 68,371 161,807 10,784 99.999 54 [6,050] [14,319] [954] Source: Authors’ calculations. Notes: This table describes the income distribution for the top 1.5% of the distribution. Column (1) shows the number of individuals included within each percentile of income (for example, percentile 98.5 involves the top 1.5% of the distribution, which includes 81,331 individuals). Column (2) indicates the total income threshold necessary to belong to each income percentile. Column (3) indicates the mean total income (including undistributed profits) of all individuals that belong to each group and the subsequent groups. Similarly, Column (4) displays the mean total income, but excluding undistributed profits. Columns (2), (3), and (4) are expressed in in local currency (1,000s Lempiras) in the main line and in 1,000s USD ppp in brackets. The income threshold in Column (2) was constructed using total income including undistributed profits. The same threshold is also used when displaying the mean income excluding undistributed profits for each percentile in Column (4). 9. We use the PPP conversion rate of 11.3 for private consumption from local currency to US dollars in 2019 (World Bank, 2024). INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 9 Prosperity Insight Figure 1: Income Level and Composition (2019) a) Income Level (log-scale) 200,000 Income Level (000s) 200 2,000 20 Top [1.5%,1.4%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% b) Income Composition 100 Interests Undistributed Share of Total Income (%) Rental Corporate Profits Wage 80 Mixed Dividends 60 40 20 0 Top [1.5%,1.4%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% Source: Authors’ calculations. Notes: Panel (a) presents the (log) average income for each bin of the distribution in local currency (Lempiras). Total individual income in tax records is comprised of four components: wages, mixed income, capital income (which includes dividends, interests, and rental income), and undistributed corporate profits. Panel (b) presents the composition of total income for each bin of the distribution. It decomposes total income into six sources - interests, rental income, wages, mixed income, undistributed profits, and dividends. Both graphs include 33 bins for the top 1.5% highest earners - 14 bins for those in the top 1.5% of the distribution but below the top 0.1%; 9 bins for those between 0.1% and 0.01%, and 10 bins for those at the top 0.01%. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 10 Prosperity Insight Wages account for 80 percent of income below close to the top 0.1 percent (approximately 5,000 the top 0.1 percent. Within the top 0.1 percent, taxpayers with highest incomes), for whom wage undistributed profits start to increase and income as a share of total income rapidly falls, become the dominant income for the top 0.01 while mixed income slightly rises and undistributed percent highest earners. Even among those just profits start to play a large role. For the 500 within the top 1.5 percent of the income distribution, individuals with highest incomes (within the top wage income represents approximately 80 0.01 percent), undistributed profits represent percent of total income, with income from mixed over 60 percent of total income, dividends around sources (service provision and other commercial 10 percent, mixed income 20 percent, and wages activities) accounting for most of the remaining only 10 percent. Below we provide a detailed income. Conversely, distributed capital income diagnostic of business ownership at the very top of and undistributed profits are a very small share the distribution. of aggregate income. This changes for individuals 4. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 11 Prosperity Insight HOW MUCH TAXES DO TOP EARNERS PAY? Within the top 1.5 percent earners, the effective starts to be taxed at the higher marginal rates of 20 tax rates increase with total income. When percent and then 25 percent. discussing how much taxes the highest earners in Honduras pay, we focus on effective tax rates (ETR): Within the top 0.01 percent or 500 highest the ratio of total taxes paid to total income. On the earners, the average ETR profile becomes flat one hand, we note that our measure of total income and dispersion increases substantially. For the is more comprehensive than only personal taxable top 0.01 percent highest earners, the average ETR income: it includes income that is not taxable, is stable at around 25 percent. This is driven by such as the L 40,000 (US$ PPP 3,500) medical i) the top marginal tax rate on labor income of 25 exemptions and extra-wages for wage workers, percent, such that individuals with very high labor and also income taxable at the corporate level only, incomes are effectively paying an average income i.e., undistributed corporate profits. On the other of about 25 percent and ii) the flat corporate income hand, we are unable to observe income sources tax rate that is also 25 percent and the fact that the that are not declared to the tax authority, including main income at the top is undistributed profits, informal wages, non-incorporated business income which only face the corporate tax. Note that, in that is undeclared, income that is reported as costs Honduras, we do not observe a significant reduction to businesses (often referred to as ”consumption of average ETRs at the very top of the distribution, through the firm”), and income earned offshore. contrarily to what has been observed in higher- These are important limitations, which likely imply income countries with similar studies (France, that we underestimate the true income at the top, Italy, Netherlands, USA).10 This is likely because and overestimate the ETR. We present average rich countries’ top PIT marginal rates are much ETRs across the different bins at the top in Figure 2 higher than their corporate tax rate, such that top for the year 2019. Individuals just within the top 1.5 earners are taxed at a lower rate when they make percent have incomes of approximately L 290,000 most of their income from undistributed profits. In (US$ PPP 26,000) and pay on average L 10,000 Honduras, on average, the CIT acts as a ”backstop”, (US$ PPP 1,000) in income taxes or less than 4 and ensures that top earners with corporate income percent of their total income. This is consistent pay the same top marginal tax rate that applies to with their income composition coming mostly labor.11 These results are illustrated in Figure 3a, from wages and mixed income (self-employment): where we plot for each quantile the composition of considering the overall exemption threshold of ETRs. Among the top 0.01 percent highest earners, L 159,000 (US$ PPP 14,000) in 2019, plus the L corporate taxes represent approximately 20 p.p. 40,000 in medical exemptions, and additional of the 25 percent average ETR paid, with taxes salaries, only around L 70,000 (US$ PPP 6,000) of on labor corresponding to most of the remaining their income are taxable at the lowest marginal rate 5 p.p., and taxes on distributed capital playing a of 15 percent. As income grows within the top 1.5 small role. The predominance of corporate income percent of highest earners, effective rates increase taxes as the main source of taxation among highest to 15 percent for those at the top 0.1 percent. The earners is also observed in other countries such as slope of ETR growth also increases, since income France (Bach et al., 2023). 10. See Bach et al. (2023) for France, Bruil et al. (2022) for the Netherlands, Guzzardi et al. (2023) for Italy and Saez and Zucman (2019) for the United States. 11. In Figure A1, we show that the pattern of 2019 is similar to that observed in several other years in our sample. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 12 Prosperity Insight Figure 2: Average ETR (2019) 30 3030 Undistributed Corporate 30 30 30 Undistributed Corporate (%) 30 Tax Profits Corporate Undistributed Corporate (%) Undistributed 30 25 Profits Tax Undistributed Corporate (%) (%) 30 30 30 30 25 Undistributed ProfitsTaxCorporate Tax (%) 25 Profits Undistributed Corporate 25 Profits Tax (%) 25 Undistributed Undistributed Undistributed Undistributed Undistributed ProfitsCorporate Corporate Corporate Corporate Corporate Tax Rate 25 Undistributed Labor Corporate TaxTax Income (%) (%) Profits 25 (%) (%) Rate (%) Rate Labor Income Tax (%) 25 Profits Profits Profits Profits Profits Tax Tax Tax Tax Tax 20 Profits Tax Rate Labor Income Tax Rate Labor Income Tax 25 25 25 25 20 Capital Income Tax Rate Income Labor Income Tax Rate Labor IncomeTax 20 Capital Tax 20 20 Rate Rate Labor Income Tax 20 Capital Capital Income Income Tax Tax Rate Tax Rate Labor Labor Labor Labor Labor Income Income Income Income Income Tax Tax Tax Tax Tax 20 Rate Labor Capital Income Income Tax Tax Tax 20 15 Capital Income Tax Capital Income Tax 20 20 20 Tax 20 15 Tax Tax Capital Capital Capital Capital Capital Income Income Income Income Income Tax Tax Capital Income Tax Tax Tax Tax 15 Tax 15 Tax 15 Tax 15 15 Tax Effective 15 10 Tax Effective Tax 10 Tax Effective 15 15 15 15 10 Effective Effective Effective 10 10 Effective 10 Effective 10 Effective 1010 Effective Effective 0 Effective 105 10 55 5 0 55 510 5 5 0000 0 5 5 5 [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% 00 [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% 0 0 0 [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% Top [1.5%,1.4%] [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% Top [1.5%,1.4%] [1%,0.9%] Top [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Source: Authors’ calculations. Notes: This figure displays the average effective tax rate (ETR) for each bin of the distribution. The effective tax rate is computed as the total tax liability divided by the total income. The graph includes 33 bins for the top 1.5% highest earners - 14 bins for those in the top 1.5% of the distribution but below the top 0.1%; 9 bins for those between 0.1% and 0.01%, and 10 bins for those at the top 0.01% Figure 3: ETR Composition and Distribution (2019) a) ETR Composition 10 15 20 25 30 Undistributed Corporate Effective Tax Rate (%) Profits Tax Labor Income Tax Capital Income Tax 5 0 Top [1.5%,1.4%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 13 Prosperity Insight b) Median ETR, P25, and P75 40 Effective Tax Rate (%) 30 20 10 0 Top [1.5%,1.4%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% Source: Authors’ calculations. Notes: Panel (a) plots the average effective tax rate (ETR) for each bin of the distribution for three different taxes. The effective tax rate is computed as the tax liability corresponding to each specific tax divided by the total income. Panel (b) displays the median effective tax rate (ETR) for each bin of the distribution together with the percentiles 25 and 75. The effective tax rate is computed as the total tax liability divided by the total income. Both panels include 33 bins for the top 1.5% highest earners - 14 bins for those in the top 1.5% of the distribution but below the top 0.1%; 9 bins for those between 0.1% and 0.01%, and 10 bins for those at the top 0.01%. ETRs vary widely for the very highest earners, that at the very top, often one-quarter of individuals according to the composition of income and the pay less than 20 percent ETR while another CIT regime and exemptions of the firms they quarter pays above 30 percent. This dispersion is own. In Figure 3b, we plot three moments of the a result of different income compositions across ETR distribution in each bin: the 25th percentile, individuals together with differential corporate the median, and the 75th percentile. Among those income tax rates and exemptions. As we discuss just within the top 1.5 percent, we see virtually no in the following section, low ETRs at the top are dispersion - since the majority of income comes driven by individuals whose main income source from wages and mixed income, there is very little is undistributed corporate profits and whose variation in effective rates across individuals since corporations face generous tax exemptions. On they all face the same tax schedule and standard the contrary, individuals with high ETRs are either exemptions. This starts to change within the top 0.1 corporate owners whose corporations face high percent and becomes more pronounced for those ETRs (because of presumptive corporate taxes within the top 0.01 percent – median ETRs are and minimum taxes) or those receiving dividends, often slightly above 25 percent, and the percentile which are taxed both at the corporate level, at 25th is below 20 percent in some cases while the 25 percent and then at the individual level, at 10 percentile 75th is above 30 percent. This means percent, upon distribution. 5. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 14 Prosperity Insight A DETAILED LOOK AT SHAREHOLDERS AT THE TOP Undistributed corporate profits at the top of rank corporations by their gross revenue in 2021 and the income distribution play a crucial role: compute the share of firms with at least one foreign retained earnings represent over 60 percent owner or shareholder that is also a corporation. of total comprehensive income for the top 0.1 Among smaller corporations—those outside the top percent, and corporate income taxes amount 10,000 firms—corporate or foreign ownership is to 80 percent of total taxes paid. Most studies rare: most firms are owned exclusively by domestic cannot observe corporate ownership and might residents, meaning that we can directly assign their assign undistributed corporate profits based on profits to their owners. As we consider larger firms, distributed earnings (e.g. dividends). We directly the picture changes significantly: among the top observe corporate shareholdership: In this 1,000 firms in terms of revenue, over one-quarter section, we provide details about the nature of have foreign shareholders, and 20 percent have at corporate shareholdership and corporate income least one corporate owner. These numbers reach taxes in Honduras, to study the driving forces of 60 percent and 40 percent, respectively, among the the individual effective tax rates we observe. In largest 100 firms in the economy. The large share of 2019, we observe over 33,000 corporations filing foreign owners at the top means that we are unable corporate income taxes in Honduras. On aggregate, to assign income to their shareholders, since these corporations declare L 56 billions (PPP US$ they are not domestic taxpayers. In Figure 4b, we 5 billions) in taxable profits (9 percent of GDP). We document a strong negative correlation between use a newly constructed corporate shareholder the share of revenue and profits in each bin that registry to list all shareholders for each firm.12 Our can be assigned to a valid domestic owner and the original shareholder list includes shareholders that size of firms: whereas we are able to assign close to are themselves corporations. To assign ownership 90 percent of profits for the smallest 30,000 firms, to individuals, we iterate over up to five layers that rate falls to below 40 percent for the top 100 of corporate ownership to assign shares to final firms. A similar profile emerges when we instead individual owners. plot the share of positive profits we can assign to valid domestic shareholders. For smaller firms we Large corporations are more likely to have can almost assign all their profits, whereas for the corporate owners but also foreign owners, largest 1,000 corporations we can only assign 40 meaning that profits are not assigned to any percent.13 domestic individual taxpayer. In Figure 4a, we 12. For more details on the construction of shareholder registry see Del Carmen et al. (2024). 13. To consider the assignment of positive profits, we restrict our sample to corporations with positive profits in the period. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 15 Prosperity Insight Figure 4: Corporate Shareholder and Assignment of Profits a) Share of Foreign and Corporate Shareholders 1.0 Share of Shareholders 0.8 0.6 Foreign Shareholder 0.4 0.2 Firm Shareholder 0.0 Top 40,000 Top 30,000 Top 10,000 Top 5,000 Top 1,000 Top 500 Top 100 Top Firms 2021 (Revenue) b) Share of Revenue & Profits Assigned to Shareholders 1.0 Share Assigned to a Valid RTN Turnover 0.8 Profits 0.6 0.4 0.2 0.0 Top 40,000 Top 30,000 Top 10,000 Top 5,000 Top 1,000 Top 500 Top 100 Top Firms 2021 (Revenue) Source: Authors’ calculations. Notes: This figure shows the relationship between firm size and shareholder type, revenue assignment, and profit assignment. Firms are classified by their total gross income in 2021. Each category on the Xaxis is asymmetric, which implies that it does not contain the same number of firms. Panel (a) presents the average share of firms with at least one foreign shareholder and the average share of firms with at least one shareholder who is a legal person for each company group. Each share type is defined as the number of shareholders of each category divided by the total number of shareholders of that firm. Panel (b) shows the average share of revenue and the average share of profits that is attributable to a shareholder with a valid RTN for each company group. The share of revenue is defined as the amount of revenue that corresponds to shareholders with a valid RTN based on their firm share divided by the total firm revenue. The share of profits is defined as the amount of profit that corresponds to shareholders with a valid RTN based on their firm share divided by the total firm profits. To compute this, we restrict the sample to firms with non-negative profits. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 16 Prosperity Insight Most top earners in the comprehensive income firms with highest gross revenue. As we follow distribution have meaningful participation in individuals with higher comprehensive income, corporations, particularly in very large ones. large shareholders become more common: In Figure 5a, we document the extensive margin half of those within the top 0.05 percent are of corporate ownership: less than 10 percent of shareholders and 30 percent are shareholders of taxpayers just within the top 1.5 percent of earners major corporations. Within the top 0.01 percent are meaningful shareholders in any corporation,14 more than 80 percent own significant shares of any and almost none has a meaningful participation in corporation and over 60 percent own shares of a very large corporations, defined as the 10 percent large corporation. Figure 5: Shareholders at the Top of the Distribution (%) 30 (%) 30 5 10 15 20 25 30 15 20 25 30 (%) 30 (%) 30 (%) 30 5 10 15 20 25 30 15 20 25 30 (%) 30 Undistributeda) UndistributedShareholders Undistributed Undistributed Corporate Undistributed Corporate Corporate at the Corporate Corporate Top of the Distribution b) Number Undistributed Undistributed Undistributed of Undistributed Corporate Undistributed Corporate Firms in Corporate Corporate which Individuals Corporate are Shareholders Tax Rate (%) Effective Tax Rate (%) Effective Tax Rate (%) Effective Tax Rate (%) Profits Profits Tax Profits Tax Profits Profits Tax Tax Tax Tax Profits Profits Profits Tax Profits Tax Profits Tax Tax 20 25 20 25 20 25 20 25 20 25 20 25 80 100 15 Rate 15 Rate 15 Rate Labor Labor Income Labor Income Tax Tax Income Labor Income Labor Income Tax TaxTax 8 10 15 Rate 15 Rate 15 Rate Labor Labor Income Labor Income Tax Tax Income Labor Income Labor Income Tax TaxTax 100 10 Individuals Capital Capital Capital Income Capital Income Tax Income Tax Capital Income Tax Income TaxTax Firms Capital Capital Capital Capital Income Income Tax Tax Capital Income Tax Income Income Shareholder TaxTax Individuals 60 80 (any corporation) [1%,0.9%] 0 2 4 6 8 of Firms 5 10 Tax 5 10 Tax 5 10 Tax 5 10 Tax 5 10 Tax 5 10 Tax Shareholder 40 60 (top decile corporation) 6 of Mean 0 Effective 0 Effective 0 Effective Top 0.001% 0 Effective 0 Effective 0 Effective 0 Effective 5 10 10 Top [1%,0.9%] Number Number 20 40 of 4 Top [1%,0.9%] 0 Share Top [1.5%,1.4%] Share 5 of 0 20 2 Median Top [1.5%,1.4%] 0 0 0 0 [1.5%,1.4%] [1.5%,1.4%] [1.5%,1.4%] Top [1%,0.9%] [1%,0.9%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top 0.001% Top 0.001% Top 0.001% Top 0.001% [1.5%,1.4%] Top [0.1%,0.09%] Top [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] 0.001% Top [1.5%,1.4%] [1%,0.9%] [1.5%,1.4%] [1.5%,1.4%] Top [1%,0.9%] [1%,0.9%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top 0.001% 0.001% 0.001% Top [1.5%,1.4%] Top [0.1%,0.09%] Top [0.01%,0.009%] 0.001% Top Top TopTop Top TopTop Top Top Top Top Top Top Top Top Top Top Top Top Top (%) 30 (%) 30 5 10 15 20 25 30 30 (%) 30 Undistributed Undistributed Undistributed Corporate c) Corporate Exempted Undistributed Corporate Undistributed CorporateIncome Corporate Dynamics (%) Effective Tax Rate (%) Tax Profits Profits Profits Profits Tax Tax Profits Tax Tax Individuals/Profits 20 25 20 25 25 20 25 0.6 0.8 15 Rate 15 Rate 15 Rate Rate Labor Labor Income Labor Income Tax Tax Income Labor Income Labor Income Tax TaxTax 0.8 Individuals/Profits 20 Capital Capital Capital Income Capital Income Tax Income Tax Capital Income Tax Income TaxTax Shareholders of 0.4 0.6 5 10 Tax 5 10 Tax 5 10 Tax Tax Exempted Firms 15 0.2 0.4 0 Effective 0 Effective 0 Effective Effective 10 0.2 Share of Share of 5 0 0 0.0 Exempted Profits 0 Top [1.5%,1.4%] Top [1.5%,1.4%] Top [1%,0.9%] [1.5%,1.4%] [1.5%,1.4%] Top [1%,0.9%] [1%,0.9%] Top [1%,0.9%] Top [0.1%,0.09%] [0.1%,0.09%] Top [0.1%,0.09%] Top [0.1%,0.09%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top [0.01%,0.009%] Top 0.001% Top 0.001% Top 0.001% Top 0.001% Top [1.5%,1.4%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% TopTop Top Top Top Top Top Top Source: Authors’ calculations. Notes: Panel (a) displays the share of individuals in each bin that are shareholders in any corporation (in blue) and those that are shareholders in top decile corporations, defined as those with the highest 10% gross revenue in 2019. Panel (b) displays the mean (blue) and median (green) number of firms at the bin level in which individuals are shareholders. Panel (c) displays the mean share of shareholders that have shareholdings in at least one firm with exempted income (blue) and the mean share of exempted profits (green) at the bin level. Corporate Income Tax (CIT) exemptions in Honduras amount to approximately 2% of GDP and are concentrated in export-oriented regimes such as Special Economic Zones. For more details, see the 2023 Tax Expenditure Report. In all the three panels we restrict the definition of shareholder to individuals with a participation of at least 5% in any corporation they are shareholders – that excludes individuals with very small participations in large financial institutions with thousands of members, for example. 14. We define meaningful shareholders as those with a participation of at least 5 percent in any firm. We do this to exclude from these definitions individuals who have only a small participation in very large financial institutions and mostly receive small amounts of dividends each year. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 17 Prosperity Insight The typical top earner shareholder has from corporate income taxes. We documented concentrated ownership in one or a few firms. previously the dispersion of ETRs at the top and that While we observe that a large share of income at low ETRs are partly driven by income originating from the top is attributable to undistributed corporate tax exempted corporations. Here we provide more profits, the profile of top earners could be direct evidence that this is the case. In Figure 5c, very different: these could be individuals who we plot the percentage of shareholders in each bin have meaningful participation in a wide array that are owners of at least one exempt corporation, of corporations, or alternatively that are major as well as the total share of undistributed profits shareholders in a few firms, which explains most in that bracket that are exempt from CIT. First, we of the profits attributable to them. In Figure 5b, note that, throughout the top of the distribution, we show that it is the latter: conditional on having at least one in five shareholders own shares in an participation in at least one firm, the median exempted company. That percentage increases shareholder within the top 0.1 percent is a large at the top, reaching close to half within the top shareholder in a single firm, whereas those at the 0.05 percent of earners. The share of aggregate top 0.01 percent are shareholders in two firms. The profits that are exempt, on the other hand, is much average number of corporations they own is slightly smaller, at 10-15 percent of total profits for most larger, between two and four, since some taxpayers of the distribution and rising to over 20 percent at own dozens of corporations. the very top. These findings show that taxpayers at the very top of the income distribution are more Shareholders at the top of the income distribution likely to benefit from exemptions provided at the are also much more likely to own firms exempted corporate income tax level. 6. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 18 Prosperity Insight CONCLUSION The increasing availability of micro administrative between income earned at the corporate and data, including on corporations’ shareholders, individual levels, evidence shows that taxpayers can provide information on the improved design take advantage by shifting income between of Personal and Corporate Income Tax systems. sources (Kopczuk, 2023; Harju and Matikka, 2016; Tax authorities and policy-makers often have a Romanov, 2006). The large difference between partial view of total individual incomes, lacking a distributed income and retained earnings observed consolidated measure of income earned through in Honduras suggests avoidance motives. We show different sources including: salaries, distributed that top earners only receive a small share of their capital income, and retained corporate earnings. incomes as distributed profits from the corporations For most taxpayers, income is derived from a single they own, with a larger share retained in firms. source (for example, wages); top earners, on the Previous research documents the existence of other hand, are particularly likely to have many “consumption through the firm”: individuals declare income source, including income earned through personal expenses as firm costs, with the double businesses which is not directly observed in PIT gain of reducing the taxable income of their firms declarations in most countries. and avoiding taxation at the moment of dividend distribution (Leite, 2023; Alstadsæter et al., 2014). We show that, for Honduras, connecting Personal and Corporate Income Tax data is key An important source of income missing from our to understand top earners’ taxation. Within the analysis is income held and derived offshore. top 0.05 percent highest earners, the dominant Previous analysis linking offshore leak data with source of income is undistributed corporate profits, administrative tax records in Honduras shows retained within firms. This is similar to what has that individuals identified in offshore leaks data been documented in high-income countries and were more likely to be the top income earners and shows that many of the patterns observed among shareholders of large firms (Bachas et al., 2024). high-earners in rich countries appear similar in Since 2017, Honduras has moved from a worldwide middle-income ones. However, in Honduras, top taxation system, in which all income of residents earners do not pay lower taxes than individuals is taxable in Honduras, to a territorial system in lower in the income distribution because the which only domestic income is taxed. However, top marginal rate on PIT is the same as the flat this definition can also be manipulated: In Ecuador, corporate tax rate. Therefore, on average, those domestic firms pay dividends to offshore entities, at the very top pay close to 25 percent in effective who then distribute those dividends to the owners tax rates. Instead, we observe a large dispersion of of the domestic firm in tax havens such that taxation tax rates at the top, driven by CIT exemptions: top at the individual level is minimized (Brounstein, earners are more likely to be shareholders in firms 2023). The existence of such optimization benefiting from tax exemptions. strategies suggests both that the effective tax rate can be underestimated, but also that agreements Moreover, the distinction between incomes to exchange information on offshore income of earned at the corporate and individual levels is residents can help tax authorities better enforce porous and can be manipulated to avoid taxes. domestic laws. Although tax codes might clearly differentiate INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 19 Prosperity Insight A APPENDIX: METHODOLOGY A.1 Income Definition We provide here a detailed description of how we + Wage income construct income variables in the tax records. We ++ Wages (reported on yearly tax filings and/or start by presenting the composition of total income DMR 111 ) and then discussing in detail each of its components. Our measure of total individual income consists of + Mixed income four components: wages, mixed income, capital income, and undistributed corporate profits. These ++ Income from service provision (yearly tax are the main elements of each of the components: filings and/or DMR 112) Total individual income = ++ Income from commercial activities (yearly tax filings and/or other third-party sources) + Capital Income ++ Income from non-banking interest, ++ Dividend income (DMR 113) commercial rent, and other income (yearly tax filings) ++ Interest income (DMR 115) + Undistributed corporate profits ++ Rental income (DMR 106) A.1.1 Capital income Capital income is defined as the sum of yearly gross to 10% of gross dividend income). Whenever that income from dividends (DMR 113), earned interest happens, we consider the withholding information (DMR 115), and rental income (DMR 106).15 This to be correct and adjust the reported income information is provided by withholding agents, accordingly (e.g., a common case is an agent which report both the total amount of gross reporting withholding equal to gross revenue, income earned and the tax withheld. We often which we interpret as incorrect filing of the gross observe inconsistencies in this reporting (e.g., in revenue, i.e., the tax base). the case of dividends, withholding should be equal 15. DMR is the Spanish acronym for the Monthly Withholding Form (Declaraci´on Mensual de Retenci´on, the source of information for incomes directly withheld and not self-declared in the yearly PIT form. The numbers refer to the code of specific tax forms. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 20 Prosperity Insight A.1.2 Wage income For individuals who do not file an income tax For individuals who do file an income tax declaration, we recover yearly gross wages from declaration, we potentially have an additional wage withholding (DMR 111). In addition to source of wage information, namely the self- monthly wages, formal workers receive the 13th declared wage on their tax filing. In the following, and 14th month salaries as benefits, which are we discuss how we adjust wages and mixed- exempt up to certain levels, so we adjust incomes income when we observe two independent accordingly. sources of information (withholding and PIT self- declaration). A.1.3 Mixed income For those not filing income taxes, we compute and that in third-party reports. We then use gross revenue from commercial activities as the the values from the source with the largest maximum between withholding from honorary and total amount as the correct amounts for both fees (DMR 112); and the sum of five third-party wages and service income. informed sources of income: sales through debit • We then proceed to apply the allowable and credit cards (ATC); sales to the government deductions for all self-declared revenue (SIAFI); sales to other firms used as VAT credit (wages, service, commercial, interest, rent, (DMC); exports and sales to large firms (DMR and other income) to obtain income net of 135). This is gross revenue, nonetheless, and expenses. we are interested in profits (gross revenue net of production costs). Below we discuss how we • Finally, we consider the possibility that the impute profit margins for those individuals. total revenue informed by third-parties is larger than the total revenue claimed by For those filing income taxes we take the following taxpayers. Once again, since taxpayers often steps: mislabel sources of income in their filings, • Often individuals mislabels wages and income we do not attempt to make comparisons by from services in their self-declaration: if we specific income sources: we simply compute take the withholding reports as the ground the difference between total self-reported truth, we can often observe taxpayers income and total third-party revenue amount. declaring the correct amount of income When the third-party amount is larger, we but labeling wage income as honorary, for impute that difference as additional revenue example (which does not have impact on tax to the taxpayers and apply deductions as liabilities and therefore can be seen as low discussed below to obtain net income. stakes). In order to deal with that, we adopt For individuals who do not file an income tax the following rule: we define the total income declaration but are reported as having revenue from wages and services as the maximum of from commercial activities, we need to impute the self-declared income in the yearly filing INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 21 Prosperity Insight deductions in order to obtain net income. We do industry. We then estimate the net income from so by using deductions from individuals who file commercial and service provision activities for taxes. For each year, we compute the median profit individuals not filing taxes by multiplying revenue margin rate by department (19 regions) and 2-digit by the imputed profit margin rate. We use the same industry. When information at that level is missing, imputed profit margin rate to recover the additional we simply impute the median margin at the 1-digit unreported net income, using third-party reports. A.1.4 Undistributed Corporate Profits See box ”Assigning undistributed corporate profits to shareholders” for details of our procedure. A.2 Effective Tax Rates Computation We compute our measure of Effective Tax Rates of total tax liability by aggregating the tax liability (ETRs) by implementing the following procedure. obtained from implementing a 10 percent tax rate We first aggregate the different sources of income on distributed capital income, the labor income tax listed above (wage income, mixed income, liability, and the corporate income tax liability from undistributed profits, and distributed capital undistributed profits. The share of the aggregate income) into a total income variable, which will tax liability out of the total income is our measure be our denominator. We then compute a measure of the effective tax rate paid by each individual. A.3 Analysis Approach To conduct our analysis, we characterize our top 0.1 percent but below the top 0.01 percent main variables of interest at the top of the income (≈ 500/bin); and 10 bins for those at the top distribution by separating the top 1.5 percent 0.01 percent (≈ 50/bin). We take this approach highest earners in 33 bins - 14 bins for those throughout the report, both to describe income between the top 1.5 percent but below the top levels and composition and effective tax rates and 0.1 percent (≈ 5,000/bin); 9 bins for those in the tax liability. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 22 Prosperity Insight Figure A1: ETRs By Year 2018 30 30 2019 2016 30 3030 Undistributed Corporate (%) Profits Corporate Undistributed Undistributed Corporate Tax (%) 25 (%) ProfitsTax Profits Undistributed Tax Corporate 30 25 (%) 25 25 30 30 (%) 30 10 15 20 25 30 (%) (%) 30 Rate Labor Income Profits Tax Tax 30 Undistributed Corporate 25 Rate Labor UndistributedIncome Undistributed Tax Corporate Corporate Undistributed Undistributed Undistributed Corporate Corporate Corporate (%) 20 Rate Labor Income Tax 30 Profits Undistributed Tax Corporate Effective Tax Rate (%) (%) (%) Rate Capital Income Tax 25 20 Profits Profits Tax Tax Profits Profits Profits Tax Tax Tax (%) 20 Rate Labor Profits Tax 20 25 25 20 25 20 25 25 Undistributed Capital IncomeCorporate Capital Income Tax Tax (%) 20 Tax 20 Rate Labor TaxTax Income Profits 15 Capital Income Tax 25 Rate 15 Rate 15 Rate 15 Rate Labor Labor Income Income Labor Tax Labor Labor Tax Income Income Income Tax Tax TaxTax Tax Tax 20 15 Rate Labor Income Tax 15 Capital Income Tax 2013 20 20 Tax Rate Labor Capital Capital Income Income Tax Capital Capital Capital Tax Income Income Income Tax Tax TaxTax 15 Effective Capital Income 10 20 Tax Effective Effective 15 Effective 10 15 Capital Income Tax Tax 5 10 Tax 5 10 Tax 5 10 Tax 10 15 Tax 15 Effective 10 Tax 155 Effective 10 Effective 0 Effective 0 Effective 0 Effective 10 55 Effective 10 10 Effective 555 0 010 05 5 [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% 50 [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% 0 0005 [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] Top [1.5%,1.4%] 0 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1.5%,1.4%] [1%,0.9%] [1%,0.9%] Top [0.1%,0.09%] [0.1%,0.09%] Top [0.01%,0.009%] [0.01%,0.009%] Top 0.001% 0.001% Top [1.5%,1.4%] [1.5%,1.4%] Top [1%,0.9%] Top [1%,0.9%] Top [0.1%,0.09%] Top [0.1%,0.09%] [0.01%,0.009%] Top [0.01%,0.009%] Top 0.001% 0.001% Top [1%,0.9%] [0.1%,0.09%] Top [0.01%,0.009%] Top 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% Top Top [1.5%,1.4%] [1%,0.9%] [0.1%,0.09%] [0.01%,0.009%] 0.001% Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top Top TopTop Top Top Top Top Top Top Top Top Top Top Top Source: Authors’ calculations. Notes: This figure displays the effective tax rate (ETR) for each bin of the distribution for four different years (2013, 2016, 2018, and 2019). The effective tax rate is computed as the total tax liability divided by the total income. The graph include 33 bins for the top 1.5% highest earners - 14 bins for those in the top 1.5% of the distribution but below the top 0.1%; 9 bins for those between 0.1% and 0.01%, and 10 bins for those at the top 0.01%. INCOME TAXATION OF TOP EARNERS IN HONDURAS: LINKING PERSONAL AND CORPORATE TAXES 23 Prosperity Insight References Alstadsæter, A., M. Jacob, W. Kopczuk, and K. Telle (2016, December). Accounting for Business Income in Measuring Top Income Shares: Integrated Accrual Approach Using Individual and Firm Data from Norway. Alstadsæter, A., W. Kopczuk, and K. Telle (2014, January). Are Closely Held Firms Tax Shelters? Tax Policy and the Economy 28(1), 1–32. Publisher: The University of Chicago Press. Bach, L., A. Bozio, A. Guillouzouic, and C. 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