The structure of a country’s 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. code is an important determinant of its economic performance. A well-structured tax code is easy for taxpayers to comply with and can promote economic development, while raising sufficient revenue for a government’s priorities. In contrast, poorly structured tax systems can be costly, distort economic decision making, and harm domestic economies.
Many countries have recognized this and have reformed their tax codes. Over the past few decades, marginal tax rates on corporate and individual income have declined significantly across the Organisation for Economic Co-operation and Development (OECD). Now, most nations raise a significant amount of revenue from broad-based taxes such as 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 and value-added taxes (VAT).
New Zealand is a good example of a country that has reformed its tax system. 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. 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 taxes.
Some nations, however, have not kept up with the global trend. The United States, for example, has not reduced its federal 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 35 percent since the early 1990s. As a result, its combined federal, state, and local corporate tax rate of 39 percent is significantly higher than the average rate of 25 percent among OECD nations. In addition, as most OECD nations have moved 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. , the United States has continued to tax the worldwide profits of its domestic corporations.
Other nations have moved further from well-structured tax policy. Over the last few decades, France has introduced a number of reforms that have significantly increased marginal tax rates on work, saving, and investment. For example, France recently instituted a corporate income surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. that pushed its corporate income tax rate from 33.3 percent to as high as 38 percent. In addition, it has other distortive taxes such as the financial transactions tax, a net 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. , and an inheritance tax.
The International Tax Competitiveness Index
|Country||Overall Score||Overall Rank||Corporate Tax Rank||Consumption Taxes Rank||Property Taxes Rank||Individual Taxes Rank||International Tax Rules Rank|
The International Tax Competitiveness Index (ITCI) seeks to measure the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality.
A competitive tax code is one that keeps 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. s low. 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 investment 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. In addition, high marginal tax rates can drive tax avoidance.
A neutral tax code is simply one 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 investment taxes and wealth taxes. This also means few or no targeted tax breaks for specific activities carried out by businesses or individuals.
A tax code that is competitive and neutral promotes sustainable economic growth and investment while raising sufficient revenue for government priorities.
There are many factors unrelated to taxes which affect a country’s economic performance. 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 more than 40 tax policy variables. These variables measure not only the specific burden of taxes, but also how taxes are structured. The index looks at a country’s corporate taxes, individual income 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 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, and the treatment of profits earned overseas. The ITCI gives a comprehensive overview of how developed countries’ tax codes compare, explains why certain tax codes stand out as good or bad models for reform, and provides important insight into how to think about tax policy.
For the third year in a row, Estonia has the best 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 (with a combined top rate of 33 percent), a well-structured property tax, and a broad-based value-added tax. Latvia, which recently joined the OECD, has a relatively low corporate tax rate of 15 percent, speedy 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. , and a flat individual income tax. Switzerland has a relatively low corporate tax rate (21.1 percent), a low, broad-based consumption tax, and a relatively flat individual income tax that exempts capital gains from taxation. Sweden has a lower than average corporate income tax rate of 22 percent, no estate or wealth taxes, and a well-structured value-added tax and individual income tax.
For the third year in a row, 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, 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.
In general, countries that rank poorly on the ITCI levy relatively high marginal tax rates on corporate income. The five countries at the bottom of the rankings all have higher than average corporate tax rates. 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.
Notable 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 and 2014.
|Country||2014 Rank||2014 Score||2015 Rank||2015 Score||2016 Rank||2016 Score||Change in Rank||Change in Score|
Belgium lengthened 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. lives of intangible assets, boosted its VAT threshold from $6,300 to $30,400, and slightly reduced its top marginal income tax rate from 59.4 percent to 58.3 percent. In addition, it increased 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. As a result, Belgium fell two places, from 26th to 28th.
In 2014, Chile enacted a major tax reform that, among other things, increased its corporate income tax, changed how shareholders are taxed, and strengthened anti-avoidance rules. This year, the tax reform continued to phase in. The corporate income tax rate increased from 22.5 to 24 percent, capital gains are now taxed as ordinary income, and the top marginal individual income tax rate is now 40 percent. As a result of these changes, Chile’s rank fell from 29th to 30th.
Denmark improved from 22nd to 21st place as it continues to phase-in a corporate rate reduction from 24 percent in 2014 to 22 percent in 2016.
Greece dropped four spots, from 28th to 32nd. The fall is due to changes to both its corporate income tax and individual income tax. Greece increased its corporate income tax from 26 percent to 29 percent, raised its top marginal income tax rate from 45 to 50 percent, and introduced a special “solidarity charge” on individual income.
Ireland fell two spots, from 12th to 14th place. This move was driven by the introduction of 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. ,” which provides a special rate of 6.25 percent to profits attributable to patents.
Israel made several changes to its tax system in the past year. Israel cut its corporate income tax rate from 26.5 percent to 25 percent. It reduced its value-added tax from 18 percent to 17 percent while slightly narrowing the base. Israel also increased its dividend tax rate from 30 percent to 32 percent and slightly increased its tax burden on wage earners from 20.5 percent to 21.5 percent. Lastly, it cut withholding taxes from 26.5 percent to 25 percent for both interest and royalty payments. On net, Israel’s rank improved from 27th to 26th place.
Japan continues to phase in a corporate rate cut. Its corporate income tax rate fell from 32.1 percent in 2015 to 29.9 percent in 2016. However, Japan fell one place, from 24th to 25th, due mainly to a narrowing of its VAT base and an increase in its top marginal income tax rate from 51 percent to 56.1 percent.
Korea fell from 11th to 12th place. Korea worsened cost recovery by limiting loss carryforwards to eight years, from 10 years. In addition, corporate tax complexity increased, as reflected in longer compliance time and an increase in the number of required payments.
Mexico improved from 25th to 24th place. This improvement was driven primarily by improvements in its corporate compliance time (measured in hours a year), which declined from 170 hours to 122 hours. Conversely, Mexico’s top marginal income tax rate increased from 31.65 percent to 35 percent and applies narrowly to income 29 times the average national income.
Norway enacted a number of changes that impacted the taxation of capital income in 2016. Norway reduced its corporate income tax rate from 27 percent to 25 percent. In addition, it reduced its capital gains tax rate from 27 percent to 25 percent and raised its dividend tax rate from 27 percent to 28.75 percent. Norway’s rank improved from 13th to 11th place.
Spain improved four places, from 31st to 27th, due to a number of improvements to its tax code. It improved its corporate tax by reducing the rate from 30 percent to 28 percent, speeding up cost recovery for both machinery and buildings, and by reducing compliance costs. Spain also improved its individual income tax system. It reduced its capital gains and dividend tax rates from 24 percent to 23 percent, reduced its top marginal tax rate on ordinary income from 52 percent to 46 percent, and flattened the tax system by applying its top rate to income over 2.4 times the average national income, down from 11.6 times.
 Norman Gemmell, Tax Reform in New Zealand: Current Developments (June 2010), http://www.victoria.ac.nz/sacl/about/cpf/publications/pdfs/4GemmellPostHenrypaper.pdf.
 OECD Tax Database Table II.7, http://www.oecd.org/tax/tax-policy/tax-database.htm
 Due to some data limitations, some recent tax changes in some countries may not be reflected in this year’s version of the International Tax Competitiveness Index. Last year’s scores published in this report can differ from previously published rankings due to methodological changes and corrections made to previous years’ data.