Estonia has the Most Competitive Tax System in the OECD
September 29, 2014
According to this year’s International Tax Competitiveness Index, Estonia has the most competitive tax system in the developed world.
Key drivers for Estonia’s high rank are its relatively low corporate tax rate at 21 percent with no double taxation of dividend income, a nearly flat 21 percent income tax rate, a property tax that only taxes the value of land and not the value of building and structures, and a territorial tax system that exempts 100 percent of foreign profits.
Overall, Estonia scores highly in each of the five categories in the index. It ranks first in both corporate taxes and property taxes, second in income taxes, eighth in consumption taxes and eleventh in international tax rules.
Estonia’s Tax Structure
Not only does Estonia have relatively low tax rates, it also provides an example of a neutrally structured tax system that does not discourage saving and investment.
Estonia Has a Neutral Business Tax System
For its corporate tax, it all starts with the correct tax base. Estonia allows for full expensing of capital investment. This means that when business determines its profit, it is able to account for the full cost of capital investment (plant, equipment, structure, etc.) in the year in which it is incurred. Every other OECD country requires that business write off these business investments over multiple years and sometimes not at all.
Additionally, Estonia only taxes distributed profits and at a 21 percent tax rate. This means that if a business in Estonia earns $100 and pays that $100 to its shareholders, the business would be required to pay a tax of $21 on the distributed profit. Instead, if that business decides to reinvest that $100, the business would not have to pay tax on that $100.
Now, this does not mean that the income goes untaxed. Instead, the profit is potentially taxed as at Estonia’s 21 percent capital gains rate. If the business reinvests its $100 profit, it is probable that the value of the business would increase and, with it, the value of a shareholders shares. If a shareholder were then to sell their shares, they would face the 21 percent capital gains tax rate.
Estonia also provides a 100 percent exemption on all foreign earned income.
Estonia has Neutral Property Taxes
Estonia is one of three OECD countries to correctly define their property tax base by only taxing the value of land. This is important because many countries tax both the value of land and any buildings or structures built on top of this information. This, in effect, becomes a tax on capital; if a business builds any new structures or buildings, it will result in a higher property tax bill. Instead, Estonia’s tax system is neutral between land holding and development.
Additionally, Estonia does not levy an estate tax, nor any transfer taxes, wealth taxes, or financial transaction taxes as we see in other OECD countries.
Consumption and Individual Taxes
Estonia has a simple, broad-based value-added tax with a 20 percent tax rate, which is slightly above the OECD average. It also has a relatively flat, 21 percent income tax rate, which is half of the OECD average top marginal tax rate of 42 percent.
Estonia does have an above average tax burden on labor at close to 40 percent and a slightly above average capital gains rate, though the structure of its corporate income tax and its elimination of the double taxation of corporate income mitigates the economic harm of its capital gains tax.
Estonia Provides a Model Example on Business Taxes
Estonia’s tax system—with full expensing, a single layer of taxation on corporations via the 21 percent corporate rate or the 21 percent capital gains rate, the exemption of foreign earned income, and well-structured property taxes—gives it the most competitive tax code in the developed world.
When discussing business tax reform, congress should look to the example set by Estonia. A tax code that correctly defines business income and eliminates all the biases against saving investment would be a boon to U.S. investment and economic growth.