Mirror, Mirror on the Wall, Who Has the Best Tax System of Them All?

In a recent article, I tried to make the case for tax competition as an aspect we should consider more often when we talk about tax policy. After all, it is one thing to argue for a better tax system per se, but it might be even more practical to find a framework which incentivizes politicians to do the right thing – even if they do not even intend to do so. Here, tax competition comes in play: by having to compete with other countries in the world, governments will be forced to pursue policies that provide a favorable environment for both businesses as well as private individuals – or else could face an exodus quickly.

Thanks to increasing worldwide connectedness and more profound trade across borders, tax policy has become a global business. It might be necessary to reiterate what the results have been on this: as Daniel Mitchell shows, corporate tax rates have for example been reduced all around the world in the last few decades. While in 1980, corporate taxes averaged 46 percent worldwide, it is only 26 percent today, having been reduced most starkly in Europe.

For those, however, who need even more proof of how tax competition is of great importance, and how it is changing the way individual countries approach tax policy, the Tax Foundation has released its 2018 edition of the International Tax Competitiveness Index in October. The index, which was created by Daniel Bunn, Kyle Pomerleau, and Scott Hodge, compares the tax systems of all OECD countries by looking at 40 different variables, which includes corporate, income, consumption, and property taxes, and looks at both the level as well as the structure of those taxes.

The idea behind it is similar to what I have been explaining:

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.

Which country, then, has the best tax system – and what can other countries learn from it?

For the fifth 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.

This is in stark contrast to the country which is last for the fifth year in a row, too. France boasts – or perhaps should not boast about, high taxation across the board, including one of the highest on corporations in the OECD at 33 percent as well as a progressive, high income tax system. It also has various other taxes, including a net wealth tax, a financial transaction tax, and an estate tax.

Is it truly surprising under these circumstances that it is countries like Estonia which have seen new enterprises come into being, seen foreign companies locate there, and which have seen immense economic growth?

And is it then surprising that France can say nothing of that sort, and is it then not understandable why the French of all places are a leading voice in European efforts to harmonize taxes, eventually stopping any competition on the continental level?

The International Tax Competitiveness Index shows that all countries in the world should be more like Estonia or Latvia – or should at least follow reforms like those implemented by Belgium and the United States (which both made significant jumps in the ranking compared to 2017), and should let go of the illusion that you can raise taxes as much as you want without it having any negative consequences on your economy’s performance. The economy is global today – and so is competition between states all around the world. If a country does not follow the best of the best, it might be left stuck in economic stagnation.