Making Austria a more attractive place to do business has been a core focus of the new government, which has been in charge since 2017. In contrast to previous governments–which offer up taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform ideas but managed to implement few—the current Austrian administration is in prime position to implement a comprehensive tax reform. Since economic growth is solid and above-average in comparison to other EU member states, now is an opportune time to follow through with these plans.
In the 2018 International Tax Competitiveness Index, which compares the tax systems of 35 OECD countries, Austria ranks in tenth place overall, despite only coming in in 15th place on business taxes and 21st on individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es. The government collected taxes equal to 41.8 percent of GDP in 2017, mainly levied through taxes on labor, such as income taxes, social security contributions, and payroll and workforce taxes.
The income tax system has clear deficiencies. For one, the system is highly progressive with a top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. of 55 percent, the third highest in the OECD. The total tax burden on labor, often also called the tax wedgeA tax wedge is the difference between total labor costs to the employer and the corresponding net take-home pay of the employee. It is also an economic term that refers to the economic inefficiency resulting from taxes. , is the fifth highest. For single workers, the tax wedge is 47.4 percent compared to 35.9 percent in the OECD on average. This means that the average worker in Austria only takes home half of his income. A large portion of the tax burden is payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es, which fund pensions and social insurance programs.
On corporations, Austria boasts a higher tax rate than any neighboring country other than Germany and Italy. Though the 25 percent corporate tax rate is significantly lower than the 34 percent Austria was boasting before a reform in 2005, it still is above-average in global comparison. The Austrian system also does not allow the full costs of capital assets to be deducted from a company’s net income. Thus, taxes are levied on both business profits as well as partially on business costs. While businesses can indefinitely carry forward net operating losses to offset future profits, they cannot carry unused losses backwards to help offset tax liabilities. Finally, a minimum tax on companies, regardless of their income, is in place, which can prevent smaller enterprises from achieving economic success. All of this nonetheless only comprises for 5.9 percent of Austria’s tax revenue.
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To be sure, there are reasons why Austria’s tax system is internationally recognized as relatively pro-growth. There are no damaging wealth or inheritance taxes, its property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es are efficient and much less distortive than those in other developed countries, and Austria’s consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es, including value-added taxes, are simple, comprehensive, and well-designed.
A reform of the Austrian tax system then has to focus on corporate and individual income taxes. On corporate taxes, eliminating taxes on retained earnings—as countries like Estonia have done–a reduction of the corporate tax rate to 20 percent, improving the treatment of capital investment and net operating losses, and eliminating the minimum tax, would lead to Austria becoming more competitive and more attractive for companies interested in settling in the country.
As for individual income, reducing the progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. system to a flatter, broader tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. with a lower rate is of the utmost importance. For instance, Austria could include a 20 percent flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. on income which could be revenue neutral when applied to a broad tax base. In addition, indexing tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and eliminating special tax treatments for the 13th and 14th salaries could be beneficial, too. Austria should also move toward a system that does not punish savings and investment. After the important reform of the social insurance system in 2018, there is now also an opportunity to lower social security contributions. These measures would reduce the cost of labor significantly.
Instead of focusing on the introduction of distortionary measures like a digital services tax, the Austrian government should use its unique opportunity and implement a comprehensive tax reform. By lowering taxes and simplifying the tax code, Austria would become more competitive internationally, and be a place companies as well as individuals want to do business and live in.
A Menu of Austria Tax Reform Solutions
The history of tax reform in Austria is a long one. Unfortunately, reforms of the past either increased the burden on taxpayers or were much less ambitious than they needed to be. Nonetheless, many of these changes were sold as the “biggest tax reform of all time.” Overall, the effects of these attempts were disappointing. Many more comprehensive reforms would have been necessary to have a significant impact.
The last reform of Austria’s tax system, which occurred in 2015 and 2016, is a good example. This reform was also labeled the “biggest tax reform of all time” by its proponents, but consisted mostly of changes to income tax brackets. Most experts agreed that it lacked crucial elements, like provisions to limit bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. , and ignored the urgent need for structural reforms. Without these important changes, it was just another attempt at turning some small cogs and selling it as a great success. As expected, the last “biggest tax reform of all time” failed to have a significant impact.
Now, with the new government in Austria, there might be a chance to deliver tax reform that deserves to be called significant. One thing is for sure: if Austria wants to remain competitive in the future, there are several reforms it must undertake.
Tax systems should be neutral towards consumption and investment while minimizing economic distortions. High marginal tax rates and multiple layers of taxation for the same income can impact the growth outlook for a country. Each of the following options would move Austria closer to an optimally designed tax system.
Eliminating Taxes on Retained Earnings. Some countries, including Latvia, Estonia, and Georgia, have adopted tax systems that are completely neutral toward business investment and only tax business earnings when profits are distributed to shareholders. Austria could change its corporate tax base from net earnings less costs and allowable deductions to one that only includes distributed earnings. This could be paired with eliminating shareholder taxes on dividends, resulting in a single layer of tax for corporate earnings levied when those earnings are distributed.
Lowering the Corporate Tax Rate. The Austrian corporate tax rate is above the OECD average and higher than all but two of its neighbors. Lowering the corporate tax rate to 20 percent or below would allow Austrian businesses to be more competitive with their international counterparts.
Improving Treatment of Capital Investment. Capital investment is vital to long-term economic growth, but Austria lags its peers in capital productivity. Providing the ability to fully deduct the cost of acquiring new machinery and equipment in the year it is acquired will minimize the distortions of the current straight-line depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. system. Shortening the asset lives for buildings and structures will also improve the system. Importantly, changes to depreciation schedules take into account the time value of money and the way the current system inflates taxable profits.
Eliminating Minimum Taxes on Business. The current policy of applying minimum taxes on businesses has very little revenue impact as those taxes can be credited against future tax liability. These taxes can be a squeeze on small or growing businesses that may have negative earnings in a difficult year. Removing this barrier to business growth could have immediate impacts for some sectors.
Improving Treatment of Net Operating Losses. The current limit on net operating loss carryforwards results in some businesses not being taxed on their average profitability. Allowing businesses to offset taxable earnings with the full value of their operating losses would result in a more neutral tax system.
The above options would result in the following changes to Austria’s overall and corporate tax ranking in the International Tax Competitiveness Index.
Note: a: This assumes immediate write-offs for machinery and equipment, 25-year asset lives and straight-line depreciation for building and structures, and 12-year asset lives and straight-line depreciation for intangible assets. b: The ITCI does not include a category for minimum taxes on businesses.
|Overall Rank||Corporate Rank|
|Eliminate Taxes on Retained Earnings||7th||5th|
|Lower the Corporate Tax Rate to 20 percent||9th||9th|
|Improve Treatment of Capital Investment (a)||9th||10th|
|Eliminate Minimum Taxes on Businesses||(b)||(b)|
|Improve Treatment of Net Operating Losses||9th||12th|
|Both Eliminate Taxes on Retained Earnings and Lower the Corporate Tax Rate to 20 percent||5th||3rd|
Individual Income Tax
Flattening the Tax Structure. The progressive income tax system of Austria is particularly steep. If tax systems are too progressive, they can disincentivize workers to earn more, since they may lose out in the end by having to pay an even larger share in taxes. Flattening the system is one option to prevent this. A 20 percent flat tax, for instance, could even be revenue neutral when applied to a broad tax base.
Reducing the Top Marginal Tax Rate. At 55 percent, Austria’s top marginal income tax rate is the third highest among OECD countries, behind Sweden at 61.8 and Denmark at 55.8 percent. Austria’s rate kicks in for those earning more than one million euros annually. Having such a high marginal tax rate creates serious economic distortions and can incentivize tax avoidance. It can also lead to higher-income individuals seeking to move away to other countries instead of living and investing in business and financial operations domestically.
Indexing Tax Brackets for Inflation. When inflation occurs, but the tax brackets in a progressive income tax system are not adjusted, this can cause so-called “bracket creep.” Since prices rise, but the tax brackets stay the same, taxpayers potentially pay more over time. In Austria, the “bracket creep” problem could be solved by indexing tax brackets to inflation, so that tax brackets adjust from year to year.
Eliminating Special Tax Treatment of 13th and 14th Salaries. The 13th and 14th month salaries for holidays in the summer and for Christmas in winter are taxed differently than the twelve other monthly payments. The system for the 13th and 14th salaries is hard to fully grasp; it’s an added layer to an already complicated tax structure. Eliminating these special tax treatments and lowering taxes overall would make the system more transparent.
Adopting a Universal Savings Account. Broad-based income taxes are not neutral between saving and consumption. A system that is neutral between choices of savings and consumption taxes income one time and allows returns to savings to be tax-exempt. A universal savings account would allow individuals to save their after-tax earnings without facing an extra layer of tax on the gains to those savings.
Lowering Social Security Contributions. Payroll taxes, which finance pensions and social insurance programs, are a major contributor to the cost of labor, making up 36.2 percent of pre-tax labor costs. After important reforms to the social insurance system by the current government, including simplifications and spending cuts, a reduction in contribution levels is also in order. This would reduce the cost of labor, making Austria more competitive internationally, and let workers keep more of their income.
The above options would result in the following changes to Austria’s overall and individual tax ranking in the International Tax Competitiveness Index.
Note: a: The ITCI does not include a categories for these policy changes.
|Overall Rank||Individual Rank|
|Implement Flat Income Tax of 20 Percent on a Broad Tax Base||7th||8th|
|Eliminate the 55 Percent Tax Bracket||9th||18th|
|Index Tax Brackets for Inflation||(a)||(a)|
|Eliminate Special Tax Treatment of 13th and 14th Salaries||(a)||(a)|
|Adopt a Universal Savings Account||9th||17th|
|Lower Social Security Contributions Rates by 5 Percentage Points||10th||21st|
|Both Implement a Flat Income Tax of 20 Percent and Adopt a Universal Savings Account||7th||3rd|
Simplifying and Broadening the VAT Base. A well-designed VAT can be one of the more efficient ways for a government to raise revenue, but exemptions or special rates create distortions. Austria should continue to adopt reforms to its VAT that subject more categories of goods and services to the standard VAT rate rather than special rates. A broader tax base could allow for a lower standard rate.
Avoiding Burdensome New Taxes
Rejecting a Digital Services Tax. The current debate at the global level regarding the taxation of profits generated from intangible assets has led some countries to propose narrow taxes on revenues of certain businesses. Digital services taxes are inherently distortive and discriminatory, representing a significant departure from the principles of sound tax policy: simplicity, transparency, neutrality, and stability.
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