Tax competition: the state of the race

Governments have long been competing for investment, and one obvious way of doing that is offering advantegous tax rates to corporations.

As Keller and Schranz (2013) point out, however, tax rates are but one component of a whole package known as “tax attractiveness”. The authors develop an index of tax attractiveness based on 16 indicators, which proves that even countries with relatively high tax rates can adopt policies that make them competitive.

The factors taken into account by the authors are the following:

  1. statutory tax rate,
  2. taxation of dividends received,
  3. taxation of capital gains,
  4. withholding taxes (on dividends, on royalties and on interest),*
  5. EU membership (because withholding taxes on dividends, interest and royalties are abolished within the EU),
  6. loss offset rules (i.e. current losses can be used to offset past or future profits and hence can lower the tax burden of the company),*
  7. group relief (i.e. whether multiple subsidiaries can file one consolidated tax return, which means loss-making subsidiaries can be used to offset profitable ones to lower overall tax burden),
  8. double tax treaty network (i.e. whether transferring profits abroad will be taxed in both jurisdictions or not),
  9. thin capitalization rules (i.e. are interest expenses tax deductible),
  10. controlled foreign corporation rules (i.e. whether say a U.S. company whose profits are legally in a tax haven country can – under certain circumstances – still be taxed under U.S. jurisdiction),
  11. anti-avoidance legislation,
  12. personal income tax rate,
  13. special holding regime (i.e. whether favorable rules apply to holding companies, such as exemption from certain taxes, etc.).

* = thus point (4) represents three factors and point (6) represents two (carrying losses back- and forward) making this a total of 16 factors.

The weights are equal (1/16 for each factor, as there 16 factors in total). Of course, as the authors point out depending on which factors are more important for a multinational company, the weights and thus the ranking could be different. Fortunately, they provide the unweighted data for all 16 factors for all countries, so one could make their own ranking with customized weights.

Now let us get to the ranking. It is no surprise that Caribbean countries dominate the top of the list, then come – somewhat surprisingly – a bunch of European countries. The full ranking of 100 countries is too long to publish here (see paper for that), but below is a short list of selected (mostly developed, OECD) countries. The index can take on values between 0 and 1, and the closer it is to 1, the more attractive a country is.

Countries by tax attractiveness

There are clear differences between regions as both the ranking and this figure attest:

Regional tax attrativeness differences

Indeed, the authors test the differences of the mean values of each region and discover that the Caribbean and Europe are significantly better than the other three regions. Furthermore, the other three regions do not differ significantly from each other, whereas the Caribbean appears to be significantly better than Europe according to the t-test but not so according to the Wilcoxon rank-sum test.

Finally, notice the terrible position of the U.S. in the ranking above (#94). I had no idea the situation was so bad. Could this be a reason for why jobs are going overseas? At least one other source indicates the answer is yes.

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