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 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 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 about 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. , which joined 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
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 rates low. In today’s globalized world, capital is highly mobile. Businesses can choose to invest in any number of countries throughout the world to find the highest rate of return. This means that businesses will look for countries with lower tax rates on investment 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 lead to 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.
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 level 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.
|Country||Overall Rank||Overall Score||Corporate Tax Rank||Consumption Taxes Rank||Property Taxes Rank||Individual Taxes Rank||International Tax Rules Rank|
For the fourth 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 to the value of real property or capital. Finally, it has a territorial tax system that exempts 100 percent of foreign profits earned by domestic corporations from domestic taxation, with few restrictions.
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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 individual 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 fourth 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, except for Poland at 19 percent. In addition, all five countries have high consumption taxes, with rates of 20 percent or higher, except for Chile at 19 percent.
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 2015.
|Country||2015 Rank||2015 Score||2016 Rank||2016 Score||2017 Rank||2017 Score||Change in Rank||Change in Score|
- Austria substantially reduced the complexity of its VAT as measured by hours spent on compliance, which helped drive an improvement from 16th to 13th.
- Chile continued the implementation of its 2014 Tax Reform Law, increasing the top corporate rate from 24 percent to 25 percent (rising to 27 percent in 2018) and creating two separate corporate tax systems, an attributed income system and a partially integrated system. Net operating loss carrybackA Net Operating Loss (NOL) Carryback allows businesses suffering losses in one year to deduct them from previous years’ profits. Businesses thus are taxed on their average profitability, making the tax code more neutral. In the U.S., a Net Operating Loss cannot be carried back (only carried forward). s have also been eliminated. As a result, Chile fell three places, from 29th to 32nd.
- The Czech Republic amended its income tax law to allow the deductibility of tax losses from the sale of shares by nonresidents, and compliance hours fell significantly for both corporate and individual income taxes. These changes drove an improvement of four places, from 13th to 9th.
- Greece raised its VAT rate one percentage point, to 24 percent. The top individual income tax rate rose from 50 to 55 percent, while the capital gains tax increased from 15 to 25 percent. The country’s dividend 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. rate increased from 10 to 15 percent. The corporate tax rate is scheduled to decline from 29 to 26 percent in 2019. Because other countries with low rankings on the ITCI also adopted changes which hurt their scores, Greece did not decline in ranking.
- Hungary converted its two-rate corporate tax, with a top rate of 19 percent, into a 9 percent flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. . This rate reduction resulted in an improvement of three places, from 23rd to 20th.
- Israel fell one spot, from 25th to 26th. That 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 percent on profits attributable to patents.
- Japan reduced the amount of losses that can be carried forward to subsequent years, ratcheting the cap down from 80 to 55 percent. However, compliance time declined substantially across all tax categories, and Japan expanded its treaty network, leading to an improvement of four places, from 26th to 22nd.
- Latvia capped net operating loss carryforwardA Net Operating Loss (NOL) Carryforward allows businesses suffering losses in one year to deduct them from future years’ profits. Businesses thus are taxed on average profitability, making the tax code more neutral. In the U.S., a net operating loss can be carried forward indefinitely but are limited to 80 percent of taxable income. s at 75 percent of losses and its VAT base shrunk, leading the country to slip one place, from 3rd to 4th overall.
- Luxembourg cut its statutory corporate income tax rate from 21 to 19 percent, leading to an overall corporate tax rate of 27.08 percent, down from 29.22 percent (taking surtaxes and municipal business taxes into account). At the same time, however, the minimum net wealth tax increased and net operating loss carryforwards were limited to 17 years. Despite the latter changes, the lower corporate rate drove a two-spot improvement, from 7th to 5th.
- In the Netherlands, the implementation of the 2017 Dutch Tax Package brought modest increases in individual income and dividend tax rates, which contributed to a modest slide, from 6th to 8th overall.
- The Slovak Republic reduced its corporate income tax rate from 22 to 21 percent. However, the country now taxes foreign-earned dividend income at a rate of 35 percent for nontreaty jurisdictions and 7 percent for treaty jurisdictions. These policy changes offset, and the Slovak Republic remains 10th overall.
- Slovenia adopted a corporate tax increase, raising the rate from 17 to 19 percent. As a result, Slovenia slipped four places, from 14th to 18th.
- The United Kingdom, which determines its corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). tax rate each year, reduced the rate from 20 to 19 percent, with a larger reduction in capital gains taxation. These changes drove an improvement of three places, from 17th to 14th.
 Norman Gemmell, “Tax Reform in New Zealand: Current Developments” (June 2010), https://web.archive.org/web/20160429192333/http://www.victoria.ac.nz/sacl/about/cpf/publications/pdfs/4GemmellPostHenrypaper.pdf.
 Organisation for Economic Co-operation and Development, “OECD Tax Database Table II.1 – Corporate income tax rates: basic/non-targeted 2000-2017,” updated April 2017, http://www.oecd.org/tax/tax-policy/tax-database.htm.
 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. Last year’s scores published in this report can differ from previously published rankings due to both methodological changes and corrections made to previous years’ data.Share