In a sign of increasing corporate tax competition in Europe, a Swiss canton has reduced its corporate tax rate to 6.6 per cent, which compares with Ireland's 12.5 per cent rate.
Last December, Obwalden in central of Switzerland, with 33,000 inhabitants, cut taxes for individuals and companies.
|Cows in the Swiss canton of Obwalden|
In the canton, corporate tax (including a separate tax levied by local authorities) has fallen to 6.6 per cent - undercutting the canton of Zug, where taxes have traditionally been the lowest.
In 2005, two US multinationals, Procter & Gamble and Colgate, relocated their European headquarters to Geneva. Biogen Idec, the US biotech group and partner of Irish drugs company Elan, has transferred from Paris to Zug.
The EU has raised concerns with the Swiss Government that low Swiss cantonal tax rates for companies violated the terms of the trade agreement between Switzerland and the EU.
This month, the Swiss plan to tell the EU to take a hike as countries like Ireland have rejected EU tax harmonisation efforts.
US to reduce Ireland's tax haven attractiveness
The US Treasury Department is working on rules to halt a tax abuse involving US companies transferring intellectual property and patents to overseas tax havens, Treasury Secretary John Snow said last week.
"We feel the existing rules have not been effective at getting at this problem," Snow told the Senate Finance Committee.
Senate Finance Chairman Charles Grassley, R-Iowa, referred to a November 2005 article in The Wall Street Journal that described how Microsoft had saved at least $500 million from its annual tax bill.
The article detailed how Microsoft's Round Island One Ltd. in Ireland, operated from a lawyers' offices and controls more than $16 billion in Microsoft assets. The Irish company receives licensing fees from copyrighted software code that originates in the US but pays no taxes on the income as patent royalty income is tax exempt in Ireland. In addition profits routed through Ireland from other overseas subsidiaries, are only liable for tax in Ireland at the low 12.5 per cent.
Secretary Snow said the pending rules aim to remove " some of the incentives to engage in the sorts of behaviors that deny revenues to the United States Treasury."
Snow said Treasury officials share Grassley's concern about the migration of intellectual and intangible property offshore. The Treasury issued proposed rules last August, and the rules should be finalised some time in 2006.
"I agree with you this is a serious issue and we need to deal with it," Snow said.
Ireland is the most profitable location of US multinationals and in the period 1998-2002, the profits of US companies with Irish facilities doubled.
Ireland's annual corporate tax revenue is about €5.3 billion ($6.3 billion). The Wall Street Journal said in its report that Microsoft Dublin-based Round Island One Ltd., which is used for routing patent a royalty income from overseas operations, paid the Irish Revenue $300 million in taxes in 2004.
Check link at bottom of page on risk for Ireland from a change in the current regime.
The following is an extract from the Economic Report of the President that was presented to the US Congress on Feb. 13, 2006. The report says that the United States has a combined (Federal and state) marginal corporate income tax rate of 39 percent, well above the OECD average of 30 percent, and second highest to that of Japan. The US is likely to reduce the marginal corporate tax rate in coming years.
International Comparison of Overall Tax Burdens
A common measure of the overall tax burden is the ratio of total taxes paid to all levels of government to the gross domestic product (GDP). This share represents the fraction of the total output of the economy that is taken in taxes in any given year, or the average tax rate. This measure of overall tax burden is particularly useful for international comparisons. First, it is unaffected by international differences in national versus subnational government responsibilities.
Second, it adjusts for differences in the overall size of the countries’ economies. Among countries in the OECD, the United States has a relatively low total tax burden (including Federal, state, and local taxes). Total taxes in the United States at all levels of government amounted to 26.4 percent of GDP in 2002, substantially lower than the OECD average of 36.3 percent. This share is also below the European Union (EU) average of 40.6 percent.
Chart 5-1 uses OECD data from 2002 to illustrate the average tax rates (total taxes as a share of GDP) for the 15 largest countries of the OECD.
Only Mexico, Korea, and Japan had total tax burdens smaller than that of the United States in 2002. OECD countries such as Sweden and Denmark, on the other hand, had tax burdens that were as much as 20 percentage points of GDP higher than that of the United States.
The United States faces a significant fiscal challenge in keeping the overall tax burden low in the future. Growth in Federal entitlement spending if not checked, threatens to require substantial increases in taxes, significantly altering the tax choices the United States has made in the past.
International Comparison of Tax Bases and Rate Structures
Beyond different choices about the scope and size of government, the OECD countries have also made different choices about the tax systems used to raise funds. Almost all of the OECD countries use some mix of personal income, corporate income, payroll, sales, and other taxes (e.g., estate and excise taxes), but they differ significantly in their degree of reliance on each.
Chart 5-1 illustrates the composition of each country’s tax revenue sources: personal income taxes, taxes on goods and services (consumption taxes), social security taxes, corporate income taxes, and other taxes.
The United States relies more heavily on personal income taxation than other OECD countries do. Indeed, in 2002 the United States collected 37.7 percent of its total taxes through the personal income tax compared to an OECD average of 26.0 percent. Given this difference, one might then ask how other countries finance their spending. The primary alternative tax base is consumption. OECD countries collected an average of 31.9 percent of total revenues from taxes on goods and services, mainly through value-added taxes (VATs). A VAT is a tax applied to the gross receipts earned by sellers of products, but sellers receive a tax credit for taxes paid on the inputs they use, so the tax effectively applies only to the value that they themselves added in the making of the product. Only 17.6 percent of U.S. tax revenues came from taxes on goods and services in 2002, primarily through state and local sales and excise taxes. Recall, however, that the personal income tax is actually a hybrid income-consumption tax, so that some of the taxes collected through the U.S. income tax system, and those of other countries, might be thought of as taxes on consumption.
The United States has also made different choices about the marginal tax rate structure to impose on its tax base. Chart 5-2 shows the top marginal personal income and corporate income tax rates in various OECD countries, including the 15 largest OECD economies and Ireland. The black bars illustrate the personal rate and the gray bars illustrate the corporate rate. The chart shows the OECD’s “all-in” definition of the top rate, which includes taxes collected by all levels of government and the employee portion of the social security tax. The top marginal personal income tax rate of 43 percent in the United States is comparable to that of several of the OECD countries such as the United Kingdom (41 percent), and slightly lower than those in France (47 percent) and Japan (48 percent), which matches the OECD average (48 percent), and significantly below the rates in Germany and the Scandinavian countries (all 55 percent or higher). At the same time, the United States has a combined (Federal and state) marginal corporate income tax rate of 39 percent, well above the OECD average of 30 percent, and second highest to that of Japan.
Chart 5-2 illustrates several important points. First, while the U.S. top individual income tax rate is comparable to those of other OECD countries, its top corporate rate is relatively high. Second, except for Mexico, each country’s top personal rate is higher than its top corporate rate. Third, there is no clear correlation between the top personal and corporate tax rates.
Ireland, for example, has a moderately high personal rate but a very low corporate rate, while Germany has high rates in both cases.
The United States has also chosen to tax on a worldwide basis, as discussed above, unlike some other countries. In 2003, 13 of 30 OECD countries taxed on a worldwide basis, including Japan, Korea, Mexico, and the United Kingdom. The majority of OECD countries (17 countries in 2003) tax on a territorial basis, including Canada, France, Germany, Ireland, Netherlands, Spain, and Sweden.
Finally, the United States has made different choices about the integration of personal and corporate income tax structures. The United States uses a classical system, which taxes corporate and personal income separately, based on the status of corporations as separate legal entities. This results in the double taxation of income earned in the corporate sector. Other countries using this system include Ireland, Sweden, and Switzerland. Alternatives to the classical system provide some form of dividend tax relief, thereby avoiding or reducing double taxation. Under the imputation system, shareholders are given a personal income tax credit for tax paid by the corporation on that portion of its profit. Countries using imputation systems (wholly or partially) include Australia, New Zealand, Norway, Canada, and the United Kingdom.
Another alternative is the dividend exclusion method, under which a portion of dividends paid to individuals is excluded from tax at the individual level.
Countries using this method include Germany, France, Finland, and Italy. A final method that can be used to avoid double taxation of dividend income is to apply a two-rate system. Under this approach, distributed corporate profits (paid out in dividends) and undistributed profits are taxed at two different rates with undistributed profits taxed at a higher rate. The extent to which this approach eliminates the double taxation of dividend income depends on the rates chosen.
Recent International Tax Reforms
We begin by reviewing several common trends in recent tax reforms that have been adopted by a diverse set of nations. We then examine the implications of these reforms for international tax competition and for reform of the U.S. system.
International Tax Reform Trends
According to the OECD, most countries making changes in their tax systems since 1999 have lowered personal and corporate income tax rates.
Those rate reductions were often financed, at least in part, by base broadening.
Within this overall pattern of lower personal and corporate income tax rates, there are four discernible trends.
One clear trend among OECD countries is reducing the taxation of wage and salary income. These taxes have been reduced through both rate reductions and increases in taxable income thresholds. The OECD average “all in” tax rate for a full-time production worker fell from 25.6 percent in 2000 to 24.8 percent in 2003. The corresponding marginal tax rate fell from 35.4 percent to 34.3 percent. Among G-8 countries since the year 2000, France, Germany, Japan, Russia, and the United States have all lowered personal income tax rates that apply to wage and salary income. Changes in the tax brackets and rate structures generally made these tax systems less progressive, although accompanying changes in exemptions, deductions, and credits complicate the distributional picture.
A second trend is reducing the tax rates applied to corporate income. The OECD average corporate income tax rate fell from 33.6 percent in 2000 to 30.8 percent in 2003. As in the case of wage and salary taxation, these rate reductions have typically been accompanied by base-broadening measures.
Since 1999, the G-8 countries of France, Germany, Italy, and Japan all reduced their corporate tax rates.
A third trend is reducing the taxation of capital income (especially capital gains and dividends) under the personal income tax. Top marginal tax rates on dividend income (corporate plus personal) fell over the period 2000-2003 among OECD countries from 50.1 percent to 46.4 percent. Reforms in Italy, Japan, and the United States, in particular, all reduced the personal income tax rates applied to interest, dividends, or capital gains. Six of the G-8 countries have also altered their tax systems to better coordinate their personal and corporate income taxes. Several countries of the EU, including France,Germany, and Italy, applied partial dividend exclusions, and Russia lowered its dividend tax rate.
A fourth trend is the increasing popularity of flat rate income tax schedules.
Since the mid-1990s, eight Eastern European countries, including Russia, have adopted income taxes with flat rate structures. The personal tax rates among these eight reform countries range from a low of 12 percent in Georgia to a high of 33 percent in Lithuania, and average 20.6 percent. On the corporate income side, the tax rates range from a low of 10 percent in Serbia to a high of 24 percent in both Estonia and Russia, and average 17.9 percent.
Countries adopting these flat income tax structures tend to also apply value-added taxes at relatively high rates, typically 18%.
Evidence on International Tax Competition
Evaluating the U.S. tax system in relation to other national tax systems is particularly important in a world where nations compete for business and mobile capital (including physical, financial, and human capital) by making their tax systems more attractive. A recent review of evidence on international tax competition suggests a systematic change in the pattern of tax rate setting.
From 1982 to 1999, there was a substantial increase in international capital mobility, reflected in the amount of foreign direct investment (purchase of buildings, machinery, and equipment) and other measures of the flow of international capital. At the same time, statutory corporate tax rates (tax rates established in the law) declined all around the world and corporate tax bases were broadened, resulting in little change in effective average rates. An exception to that general rule is that effective tax rates for foreign subsidiaries of U.S. firms located in small countries fell sharply between 1992 and 2000.
While the United States reduced its top combined corporate tax rate from 50 percent in 1982 to 39 percent in 2005, as measured by the Institute for Fiscal Studies, other countries have made even more significant reductions.
The United States now has the second highest combined corporate income tax rate among OECD countries, behind only Japan. With international taxrates falling overall, and a convergence between rates applied by large and small countries, the United States risks becoming less competitive in attracting capital. As capital becomes more mobile, it is increasingly easy for companies to move their productive activities, including physical capital, export/import operations, research and development activities, and other forms of knowledge creation, around the world in response to tax incentives.
(Chapter 7, The History and Future of International Trade, discusses the role of global engagement in firm performance.) In the current environment of international tax competition, the United States will be increasingly challenged as the destination of choice for internationally mobile capital and jobs.
US Multinationals Overseas Profits: Ireland's patent income tax-exemption may fund over 5% of Irish Government annual spending in 2006