Saving serves a crucial economic function; it helps fund productive investments that drive economic growth, and it generates returns on those investments that allow individuals to build wealth and finance future consumption. However, in many cases, the tax code penalizes saving and investment by subjecting it to multiple layers of taxation. A new study on 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. rates on capital income presents the statutory tax rates on five types of capital income across 33 Organisation for Economic Co-operation and Development (OECD) member countries and analyzes the biases these taxes create at the individual level.
The study, by Michelle Harding and Melanie Marten of the OECD, reviews the top statutory rates applied to dividends, interest income, and capital gains as of July 1, 2016. Quite notably, the United States taxes four of the five categories at above-average rates, while a rate for the fifth category (capital gains on long-held property) was not included in comparisons because of the complex nature of the U.S. tax code in that particular area.
The countries surveyed as part of the study vary widely both in how they define and tax the three main types of capital income: dividends, interest income, and capital gains. Generally, this is the structure of each tax treatment:
- Dividends are taxed first at the corporate level as company profits and then taxed again when distributed. Between 2012 and 2016, the average combined statutory rates on dividend income for countries in the study increased from 39.7 percent to 40.4 percent.
- Interest income is taxed at the individual level on interest received from bank accounts and corporate bonds. The average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes. for interest on bank accounts is slightly lower than for interest on corporate bonds. Average tax rates for both categories increased slightly from 2012 to 2016 for countries in the study; bank accounts rose 1.5 percentage points to 27.1 percent and corporate bonds rose 1.2 percentage points to 28.2 percent.
- Capital gains income on shares is assumed to be derived from reinvested corporate profits that have been subjected to corporate level taxes, which reduce the amount of return to the shareholder. The study explains that in most countries, capital gains income is measured as the difference between the sale price of the asset and the asset’s acquisition cost. Tax treatment at the individual level can vary depending upon the length of time the share has been held, with shorter-held shares sometimes facing higher tax rates. From 2012 to 2016, average combined tax rates on long-held capital gains shares increased from 34.9 percent to 35.4 percent for countries in the study.
| United States rate | Mean rate in OECD | |
|---|---|---|
| * Mean for all countries (both countries where the tax treatment of short-held shares differs from the tax treatment of long-held share and those that treat both the same). | ||
| ** Mean for countries that tax capital gains on real property, excluding the United States. | ||
|
Combined top statutory rate on dividends |
56.3% | 40.4% |
|
Top statutory rate on retail bank interest income |
47.3% | 27.1% |
|
Top statutory rate on corporate bond interest income |
47.4% | 28.2% |
|
Combined top statutory rate on long-held capital gains |
56.2% | 35.4% |
|
Combined top statutory rate on short-held capital gains |
67.7% | 40.4%* |
|
Top statutory rate on capital gains on real property |
Because gains from the sale of property are taxed in many various ways in the United States, a comparison was not made for the U.S. in this category. | 26.5% ** |
After comparing the different rates applied to these types of capital income, the study analyzes biases these different tax treatments create. At the corporate level, bias occurs because the tax code typically allows businesses to deduct the cost of borrowing (interest payments) from corporate income, but not the cost of equity (dividend payments). This tax treatment distorts the choice between debt financing and equity financing, creating a favorable bias towards debt.
The study shows similar results at the individual level as well: tax codes in 26 of the 33 countries in this study are more favorable towards debt than equity at the individual level (weighting the combined rates on dividends and capital gains equally). However, the relative differential in tax rates is lower than the statutory corporate tax rate, meaning the debt bias at the personal level is less than the debt bias at the corporate level. From 2012 to 2016, the overall debt bias declined from 8.9 percentage points to 8.2 percentage points; the debt bias in the United States decreased from 10.6 percentage points to 6.8 percentage points.
This new study shows that capital income in the United States is taxed at relatively high rates that distort the saving and investment decisions made by businesses and individuals. Ideally, the tax code should be neutral across all types of economic activity, subjecting each dollar to just one layer of tax. The recently enacted Tax Cuts and Jobs Act included several provisions to lessen the bias against equity and reduce the burden on investment, such as limits on interest deductibility and full expensing, respectively. These changes should improve the competitiveness of the United States going forward, though there remains opportunity to reduce the tax bias against saving and investment.
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