Nations Competing With Tax Cuts, Not Increases
Barack Obama’s election has elicited debate about whether he will drive America toward a European-style economy, one that is heavy regulated and relies on high taxation of the rich to redistribute income and finance generous government programs.
How ironic, then, that Europe itself is moving away from European-style taxation as part of a broader trend by developed and developing countries to compete more extensively for capital and talent. In the past five years alone, 33 countries, including 20 in Europe, have cut their top personal income tax rates, according to a study released just before the U.S. presidential election (and predictably ignored in the U.S. media) by the accounting firm KPMG International. Even more impressively, in the past four years, 60 countries have cut their corporate income tax rates, according to a World Bank survey.
The tax-cutting binge is taking place in what some have called “Old Europe.” France, Germany, Italy, and Spain have cut their top personal income tax rates since 2003. Germany, Italy, Spain and the U.K., meanwhile, have trimmed corporate tax rates, too, in just the past year.
Driving the Western European governments is aggressive tax policy in New Europe, that is, Eastern European countries, which are competing for workers and investment. Many of these countries had the opportunity to design their own tax systems after the fall of the Soviet Union and they have often opted for tax schemes that are simpler than the U.S. or Western European systems. Many feature only a few tax brackets and a few are flat tax schemes. Bulgaria has a new flat tax rate of 10 percent, down from a top tax rate of 29 percent in 2004. Estonia has cut its flat tax rate to 21 percent from 26 percent, while the Slovak Republic has trimmed its top rate from 38 percent to a flat tax rate of 19 percent. Romania has eliminated its top rate of 40 percent and gone to a flat tax of 16 percent.
In Asia-Pacific, Hong Kong’s low taxes (top rate, 16 percent) have continued to make it a magnet for both people and money and prompted tax cuts in other countries. Australia cut its top income tax rate two percentage points to 45 percent to try and lure back talent fleeing to Hong Kong and Singapore, but Australia has a long way to go to be competitive. Singapore has countered by slashing its top rate to 20 percent from 22 percent.
“It is common to hear from foreign workers that once families have become accustomed to the huge increase in spending and saving power that low tax rates provide, it can be very difficult to justify going home,” says KPMG’s Rosheen Garnon of the tax battle in the Pacific.
The tax cutting of the past few years has eroded the United States’ competitive position. One measure of where the U.S. is competitively: According to the KPMG study, the average top personal income tax rate worldwide have fallen to 28.8 percent today, from 31.3 percent in 2003, while our top rate remains at 35 percent. On corporate taxes, the U.S. now ranks second highest within the OECD, below just Japan. We sport a top rate of 35 percent, compared to an average rate of 26.6 percent among the OECD 30. However, many U.S. states also have their own corporate income taxes which they layer on top of the federal rate, making the combined tax in many states among the highest in the developed world. And we have obstinately ignored a worldwide trend. As the World Bank writes in its publication, Paying Taxes 2009, “Reducing corporate taxes has been the most popular reform” of tax codes around the world in the past four years.
Although there was plenty of talk about U.S. tax policy in the presidential campaign, little of it seemed to have anything to do with international competitiveness. Perhaps we simply believe that the U.S. is too attractive a place to worry about competing for talent and capital with the rest of the world. Or maybe we cling to outmoded notions about the prevalence of the European welfare state and haven’t noticed how much and how rapidly tax policy is changing elsewhere.
Perhaps it is time for a little bit of reevaluation. During the presidential campaign, Obama justified his plans to raise taxes on those earning more than $250,000 a year on the grounds that these households needed to “pay their fair share.” He never explained why he didn’t think these folks are paying a fair share in our progressive income tax system. But perhaps someone should point him to OECD data on the progressiveness of household taxes (that is, income and payroll taxes) around the world.
According to the OECD calculations, in the U.S., the top 10 percent of households earn one third of the country’s total income and pay 45 percent of all household taxes. That’s the highest ratio of taxes-to-income among OECD members. In France, for instance, the top 10 percent earn a quarter of national income and pay 28 percent of all taxes; in Sweden they earn 26.6 percent and pay 26.7 percent of all taxes; in Canada, it’s 29 percent of earnings and 35 percent of all taxes.
Most surveys taken before the presidential election showed that residents of foreign countries in the developed world, particularly in Western Europe, heavily favored Obama and would have voted for him if they had been American citizens. Considering how uncompetitive America is becoming on taxes and the direction Obama would take us, I think I now understand why.