Poland Borrows an Idea from Estonia’s Tax System, but Misses the Point

December 2, 2020

Poland and Estonia have dramatically different tax systems. While Estonia has earned the top rank in our International Tax Competitiveness Index for seven years running, Poland consistently ranks toward the bottom of the Index. This year Poland ranks 34th out of 36 countries. While consumption and property tax policies are key contributors to this low rank, Poland could also benefit from reforms to business taxes.

Estonia has a cash flow tax on business income. This means that profits are only taxed when they are distributed to shareholders. This is an efficient system that allows businesses to invest and grow their operations and hire without those decisions being influenced by corporate taxes. The Estonian system represents an approach to taxing corporate income in a way that is neutral to business investment decisions and supportive of economic growth.

Poland has taken the Estonian approach to business taxation and decided to implement a reform that, in the end, looks almost nothing like the Estonian system.

This past weekend, the Polish government adopted new tax rules for small businesses that will apply beginning in 2021. Like the Estonian system, the new Polish rules allow businesses to only be taxed on their income when it is distributed to shareholders. However, unlike the Estonian system, the Polish rules only apply to business with revenues below 100 million PLN (US $27 million). This one distinction makes the new Polish rules Estonian in name only.

Limiting the reform only to businesses below the revenue threshold creates a new distortion in the Polish tax system. While some small businesses will likely benefit from the new rules, companies that are close to the revenue threshold will face new uncertainty. In fact, some small businesses will have to plan their tax affairs both under the small business rules and by those that apply for larger companies if their revenue expectations are close to the 100 million PLN cutoff.

The threshold could also drive some businesses to take advantage of the system by misreporting revenues to stay below the threshold.

The new small business regime in Poland joins a suite of other preferential rules that also complicate the corporate tax landscape. The Polish patent box and research and development scheme are just two other examples.

So, while the Estonian tax system is designed with neutrality in mind, Polish tax rules are full of distortions that make the task of complying with corporate taxes more challenging.

The Estonian system provides numerous examples of good tax policy that other countries should follow, but it is important for countries to understand the main lesson of the Estonian approach. That lesson is that taxes should be designed with an overarching approach to maximize neutrality and minimize complexity and distortions.

Instead of simply adopting a preference for small businesses, the Polish government should instead overhaul its corporate tax rules and truly adopt the Estonian approach to taxation.

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A patent box—also referred to as intellectual property (IP) regime—taxes business income earned from IP at a rate below the statutory corporate income tax rate, aiming to encourage local research and development. Many patent boxes around the world have undergone substantial reforms due to profit shifting concerns.