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. es are a crucial component of a country’s international competitiveness. In today’s globalized economy, the structure of a country’s tax code is an important factor for businesses when they decide where to invest, how much to invest, and which types of operations to locate in which countries. No longer can a country levy high taxes on business investment and activity without adversely affecting its economic performance. In recent years, many countries have recognized this fact and have moved to reform their tax codes to be more competitive. However, others have failed to do so and are falling behind the global movement.
The United States provides a good example of an uncompetitive tax code. The last major change to the U.S. tax code occurred 29 years ago as part of the Tax Reform Act of 1986, when Congress reduced the top marginal corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate from 46 percent to 34 percent in an attempt to make U.S. corporations more competitive domestically and overseas. Since then, member countries of the Organisation for Economic Co-operation and Development (OECD) have followed suit, reducing the OECD average corporate tax rate from 47.5 percent in the early 1980s to around 25 percent today. In 1993, the U.S. government moved in the opposite direction, raising its top marginal corporate rate to 35 percent. The result: the United States now has the highest corporate income tax rate in the industrialized world.
While the corporate income tax rate is a very important determinant of economic growth and competitiveness, it is not the only thing that matters. Several factors determine the competitiveness of a tax code; the structure and rate of corporate taxes, cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. of business investment, 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, income taxes, and tax rules for foreign earnings are some of the factors that determine whether a country’s tax code is competitive.
Many countries have been working hard to improve their tax codes. New Zealand is a good example of one of those countries. In a 2010 presentation, the chief economist of the New Zealand Treasury stated, “Global trends in corporate and personal taxes are making New Zealand’s system less internationally competitive.” In response to these global trends, New Zealand cut its top marginal 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. rate from 38 percent to 33 percent, shifted to a greater reliance on the goods and services tax, and cut its corporate tax rate to 28 percent from 30 percent. This followed a shift to a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. in 2009. New Zealand added these changes to a tax system that already had multiple competitive features, including no inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. , no general capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. Capital gains taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. , and no 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.
In a world where businesses, people, and money can move with relative ease, having a competitive tax code has become even more important to economic success. The example set by New Zealand and other reformist countries shows the many ways countries can improve their uncompetitive tax codes.
Our International Tax Competitiveness Index (ITCI) seeks to measure the business competitiveness of national tax systems. In order to do this, the ITCI looks at over 40 tax policy variables, including corporate income taxes, individual income and payroll taxes, 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, property taxes, and the treatment of foreign earnings.
The ITCI scores the 34 member countries of the OECD based on these five categories in order to rank the most competitive tax codes in the industrialized world.
Table 1. 2015 International Tax Competitiveness Index Rankings
|Country||Overall Score||Overall Rank||Corporate Tax Rank||Consumption Taxes Rank||Property Taxes Rank||Individual Taxes Rank||International Tax Rules Rank|
Estonia currently has the most competitive tax code in the OECD. Its top score is driven by four positive features of its tax code. First, it has a 20 percent tax rate on corporate income that is only applied to distributed profits. Second, it has a flat 20 percent tax on individual income that does not apply to personal dividend income. Third, its property tax applies only to the value of land rather than taxing the value of real property or capital. Finally, it has a territorial tax system that exempts 100 percent of the foreign profits earned by domestic corporations from domestic taxation, with few restrictions.
While Estonia’s tax system is unique in the OECD, the other top countries’ tax systems receive high scores due to excellence in one or more of the major tax categories. New Zealand has a relatively flat, low-rate income tax that also exempts capital gains (combined top rate of 33 percent), a well-structured property tax, and a broad-based value-added tax. Switzerland has a relatively low corporate tax rate (21.1 percent), low, broad-based consumption taxes (an 8 percent value-added tax), and a relatively flat individual income tax that exempts capital gains from taxation (combined top rate of 36 percent). Sweden has a lower than average corporate income tax rate of 22 percent and no estate or wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. es. The Netherlands has competitive international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s. Additionally, every country in the top five has a territorial tax system.
France has the least competitive tax system in the OECD. It has one of the highest corporate income tax rates in the OECD (34.4 percent), high property taxes that include an annual net wealth tax, a financial transaction tax, and an estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. . France also has high, progressive individual income taxes that apply to both dividend and capital gains income.
The United States places 32nd out of the 34 OECD countries on the ITCI. There are three main drivers behind the U.S.’s low score. First, it has the highest corporate income tax rate in the OECD at 39 percent (combined marginal federal and state rates). Second, it is one of the few countries in the OECD that does not have a territorial tax system, which would exempt foreign profits earned by domestic corporations from domestic taxation. Finally, the United States loses points for having a relatively high, progressive individual income tax (combined top rate of 48.6 percent) that taxes both dividends and capital gains, albeit at a reduced rate.
In general, countries that rank poorly on the ITCI have high corporate income taxes. The five countries at the bottom of the rankings all have higher than average corporate tax rates, except for Poland. All five countries have high consumption taxes, with rates of 20 percent or higher, except for the United States. They also levy relatively high property taxes on real property and have estate taxes. Finally, these bottom five countries have relatively high, progressive income taxes that apply to capital gains and dividends, except for Poland. Poland also receives a low score due to a poor corporate 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. and a relatively complex tax code.
Significant Changes from Last Year
Since last year, several countries’ tax codes have undergone notable changes that have impacted their rankings. Table 2, below, shows both the rank and score changes for each country from last year. 
- Chile enacted a tax reform that, among other things, increased its corporate income tax rate from 20 percent to 22.5 percent and cut dividend taxes from 25 percent to 22.58 percent. On net, Chile’s ranking did not change.
- The Czech Republic’s rank dropped from 11th to 14th due to changes to its value-added tax that restricted the deductibility of certain inputs.
- Estonia did not change in ranking; however, it further improved its tax code by cutting its corporate and individual income tax rates from 21 percent to 20 percent.
- Greece dropped one ranking, from 26th to 27th, due to lengthening asset lives for capital investment in both machines and buildings.
- Hungary dropped two ranks, from 20th to 22nd, due to changes in both its corporate income tax and its value-added tax. Hungary capped the number of years a company can write off losses at 5 years with a 50 percent yearly cap. Hungary also increased the turnover threshold at which businesses need to start paying the VAT, which narrows the country’s consumption tax base.
- Iceland improved by four ranks, from 24th to 20th. This move was the result of the repeal of its net wealth tax in 2015.
- Italy’s rank dropped from 30th to 33rd due to changes to both its individual income tax and international tax rules. Italy’s 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. on capital gains and dividends increased from 20 percent to 26 percent. In addition, Italy’s withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. taxes on dividends and interest increased from 20 percent to 26 percent, and Italy introduced a patent boxA 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. .
- Japan improved one place, from 26th to 25th, due to a reduction in its corporate income tax rate from 37 percent to 32 percent.
- Korea improved three places, from 16th to 13th, due to changes to its individual income tax. Specifically, it reduced the income level at which the top marginal income 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. applies from 8.7 times the average Korean income to 4.4 times the average Korean income.
- Mexico dropped three places, from 21st to 24th, due primarily to individual income tax changes that raised the top marginal tax rate from 30 percent to 35 percent and made the income tax brackets more progressive by applying the top marginal tax rate at 29 times the average Mexican income, up from 4 times.
- Portugal improved by two ranks, from 33rd to 31st. Portugal enacted a number of reforms that improved its tax code. It cut its corporate income tax from 31.5 percent to 29.5 percent, increased the number of years businesses can carry forward losses, and enacted a participation exemption system that exempts capital gains on foreign assets from domestic taxation.
- Slovenia dropped four places, from 14th to 18th, due to VAT changes that restricted the deductibility of certain inputs.
- Spain improved two place from 31st to 29th due to a reduction in its corporate tax rate from 30 percent to 28 percent and a reduction in its dividend and capital gains tax rate from 27 percent to 24 percent.
- The United Kingdom improved two places, from 13th to 11th, due to a cut in its corporate income tax rate from 21 percent to 20 percent.
Table 2. Changes from Last Year
|Country||2014 Rank||2014 Score||2015 Rank||2015 Score||Change in Rank||Change in Score|
The International Tax Competitiveness Index
The International Tax Competitiveness Index (ITCI) seeks to measure the extent to which a country’s tax system adheres to two important principles of tax policy: competitiveness and neutrality.
A competitive tax code is a code that limits the taxation of businesses and investment. In today’s globalized world, capital is highly mobile. Businesses can choose to invest in any number of countries throughout the world in order to find the highest rate of return. This means that businesses will look for countries with lower tax rates on investments in order to maximize their after-tax rate of return. If a country’s tax rate is too high, it will drive investment elsewhere, leading to slower economic growth.
However, low rates are not the only component of a good tax code: a tax code must also be neutral. A neutral tax code is simply a tax code that seeks to raise the most revenue with the fewest economic distortions. This means that it doesn’t favor consumption over saving, as happens with capital gains and dividends taxes and estate taxes. This also means no targeted tax breaks for businesses for specific business activities.
Another important piece of neutrality is the proper definition of business income. For a business, profits are revenue minus costs. However, a country’s tax code may use a different definition. This is especially true with regard to capital investments. Most countries do not allow a business to account for the full cost of many investments they make, artificially driving up a business’s taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . This reduces the after-tax rate of return on investment, thus diminishing the incentive to invest. A neutral tax code would define business income the way that businesses see it: revenue minus costs.
A tax code that is competitive and neutral promotes sustainable economic growth and investment. In turn, these lead to more jobs, higher wages, more tax revenue, and a higher overall quality of life.
There are many factors unrelated to taxes which affect a country’s economic performance and business competitiveness. Nevertheless, taxes play an important role in the health of a country’s economy.
In order to measure whether a country’s tax system is neutral and competitive, the ITCI looks at over 40 tax policy variables. These variables measure not only the specific burden of a tax, but also how a tax is structured. For instance, a 25 percent corporate tax that taxes true business income is much better than a 25 percent corporate tax that overstates a business’s income through lengthy 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. schedules.
The ITCI attempts to display not only which countries provide the best tax environment for investment, but also the best tax environment in which to start and grow a business.
 Norman Gemmell, Tax Reform in New Zealand: Current Developments, June 2010, http://www.victoria.ac.nz/sacl/about/cpf/publications/pdfs/4GemmellPostHenrypaper.pdf.
 New Zealand has no general capital gains tax, though it does apply a tax on gains from foreign debt and equity investments. See New Zealand Now, Taxes, http://www.newzealandnow.govt.nz/living-in-nz/money-tax/nz-tax-system.
 Every OECD country except the United States, Norway, and Chile has cut their corporate tax rate since 2000. See Organisation for Economic Co-operation and Development, Tax Reform Trends in OECD Countries, June 30, 2011, http://www.oecd.org/ctp/48193734.pdf.
 Due to some data limitations, some more recent tax changes in some countries may not be reflected in this year’s version of the International Tax Competitiveness Index.
 For a discussion of the methodology and a list of data sources, please see the Appendix.