The leading industrial economies should reform their corporate tax systems by reducing taxes on capital to attract new investment if they are to overcome Asian countries’ advantage in labour costs, a study by a Canadian economic research institute says.
ELMAT: But how can they cut taxes, that they use to redistribute to the voters that elect them, if those voters will kick them out of office if they do?
Taxes in leading economies serious disincentive to capital investment
By Finfacts Team
Sep 20, 2005, 06:22
The leading industrial economies should reform their corporate tax systems by reducing taxes on capital to attract new investment if they are to overcome Asian countries’ advantage in labour costs, a study by a Canadian economic research institute says.
The CD Howe Institute says while taxes in such countries as the US, the UK and Germany may appear low relative to the size of their economies, the structure of their tax regimes is a serious disincentive to capital investment.
Sweden’s effective tax rate on capital is just 12.1 per cent, thanks to rapid depreciation rates for tax purposes Photo credit: Stockholm Sweden Travel Guide
The report Attention G7 Leaders: Investment Taxes Can Harm Your Nations’ Health, which is due to be published today in Toronto, has been pre-released to the Financial Times.
“Heavy taxes on investment discourage businesses from buying the new-vintage capital and latest technologies that improve labour productivity”, the study concludes. “In the absence of such modernisation, production processes age, businesses fall behind and they have difficulty increasing their employees’ incomes ...Lowering taxes on capital investment holds the key to growth.”
The FT reports that the study says tax competitiveness should not be judged by a government’s revenues as a proportion of gross domestic product. Using that yardstick, larger countries have a lower tax burden than many smaller ones. Furthermore, “some taxes have more harmful effects than others...Personal and corporate taxes with high marginal rates are much more harmful to growth than levies on consumption and immobile assets such as land”.
Nor do corporate income taxes tell the full story because they do not take account of differing rules on depreciation, inventory costs and other business expenses, nor of sales taxes, financial transaction taxes and other levies on investments.
The study seeks to take all these levies into account by calculating an “effective” corporate tax rate for 36 countries. Sweden illustrates the gap between traditional measures of tax competitiveness and the all-encompassing “effective” rate.
Government revenues from direct taxes, user fees and profits from state-owned enterprises are almost two-thirds of gross domestic product, one of the highest in the world. The basic corporate tax rate is a middling 28 per cent. But Sweden’s effective tax rate on capital is just 12.1 per cent, thanks to rapid depreciation rates for tax purposes.
Other countries with favourable tax regimes for investment, the study finds, include Singapore, Hong Kong, Turkey, Slovakia and Ireland. The pay-off is seen in relatively high levels of foreign investment.
For instance, the ratio of foreign direct investment to GDP in Ireland is 18.2 per cent, Hong Kong 15.2 per cent, Singapore 14.1 per cent and Sweden 8.2 per cent. By contrast, FDI in Germany is 2.7 per cent of GDP, and in Canada 3.8 per cent.
The FT reports that the G7 industrial countries and three of the largest developing nations – China, Brazil and Russia – impose the heaviest effective tax burdens on capital. China’s 46 per cent rate stems largely from a 17 per cent value-added tax on machinery. The US ranking, at 38 per cent, is hit by a relatively high basic corporate tax rate and by substantial state taxes on capital.
Note: We will provide more detailed analysis on the report, later Tuesday.
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