Tax Foundation Report – International Tax Competitiveness Index (2014)
Taxes 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. No longer can a country tax business investment and activity at a high rate 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 Tax Foundation’s International Tax Competitiveness Index (ITCI) measures the degree to which the 34 OECD countries’ tax systems promote competitiveness through low tax burdens on business investment and neutrality through a well-structured tax code.
The ITCI considers more than forty variables across five categories: Corporate Taxes, Consumption Taxes, Property Taxes, Individual Taxes, and International Tax Rules.
The United States provides a good example of an uncompetitive tax code. The last major change to the U.S. tax code occurred 28 years ago as part of the Tax Reform Act of 1986, when Congress reduced the top marginal corporate income tax rate from 46 percent to 34 percent in an attempt to make U.S. corporations more competitive overseas. Since then, the OECD countries have followed suit, reducing the OECD average corporate tax rate from 47.5 percent in the early 1980s to around 25 percent today. The result: the United States now has the highest corporate income tax rate in the industrialized world.
The United States ranks 32nd out of the 34 countries in the OECD. This puts the United States behind countries such as Spain and Italy and just in front of Portugal and France.
There are a few main drivers behind the U.S.’s low score in the ITCI. There are the obvious ones: the U.S. has the developed world’s highest corporate tax rate at 39.1 percent and it is one of six remaining OECD countries that taxes corporate income no matter where in the world it’s earned.
But there are also some less obvious factors for the U.S.’s poor ranking. The United States has higher than average, progressive, top marginal income tax rate at 46.3 percent (federal and state average). This is higher than income tax rates in countries like Belgium, the United Kingdom, and Norway. It is also more progressive than income taxes in Germany, Finland, and Sweden. (In Sweden, the top tax rate applies to income above $88,180 whereas, in the U.S., the top rate applies to income above about $400,000.)
The U.S. also has above average taxes on capital gains and dividends. When looking at both federal and average state taxes, the United States taxes capital gains at a top marginal rate of 28.7 percent, which is sixth highest in the OECD. The story is much the same for dividends. The U.S. has the 9th highest top marginal dividend tax rate in the OECD at 28.6 percent.
Finally, the U.S. ranks poorly on property taxes. This is due to the U.S. estate and gift tax, and the poor structure of state and local property taxes.
The largest issues with the U.S. tax code are due to the federal tax system. States are constantly searching for ways to improve their tax codes, with governors from both parties enacting meaningful reform in the last year. But there is only so much states can do. If the U.S. wants to compete on a global stage, the federal tax code will need to change. A lower corporate tax rate, lower tax rates on investment, and a shift to a territorial tax system would be a good start.
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 21 percent tax rate on corporate income that is only applied to distributed profits. Second, it has a flat 21 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 profit earned by domestic corporations from domestic taxation with few restrictions.
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 tax. France also has high, progressive individual income taxes that apply to both dividend and capital gains income.
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.