Sep 22nd 2005
From The Economist print edition
A study of corporate taxes yields some unexpected results
SWEDEN, a bastion of egalitarianism where the state claims around 60% of GDP, is surprisingly friendly to capitalists. On the other hand, communist China, the darling of foreign investors the world over, demands a great deal from its suitors. Both findings emerge from a new report on capital taxation by Duanjie Chen, Jack Mintz and Finn Poschmann of the C.D. Howe Institute, a Canadian think-tank.
The simplest way of comparing countries’ capital taxation would be to look at statutory tax rates on corporate income. But that, says the authors, misses a lot of factors that affect the taxes which firms actually pay. Governments use different rules for the treatment of depreciation, inventories and other things. All of these cause actual tax rates to diverge from the statutory figures.
The authors have calculated a ranking according to the â€œeffectiveâ€ tax rate–the proportion of the pre-tax return on capital swallowed by the state (see chart). China comes out on top, largely because of a 17% value-added tax on purchases of machinery and equipment. However, lucky firms can sometimes negotiate a full refund, which cuts the effective tax rate from 46% to only 18%.
Canada, America and Germany are also among the top corporate taxers. Although Canada has a lowish statutory tax on corporate income, high capital and sales levies on inputs by its provincial governments lift its effective rate.
Sweden allows fast write-offs for capital investment, which pull its effective tax rate down. Singapore and Hong Kong also offer liberal deductions and concessions that yield more favourable tax regimes.
How important are tax policies in encouraging foreign direct investment? All other things equal, a higher tax rate reduces the return on investment. However, all other things are seldom equal: differences in market size, labour costs, the quality of infrastructure and political stability, among other things, are also important for attracting investment. Foreign investors falling over each other to set up factories in China are plainly not put off by tax.
Still, the authors believe that taxes do matter, and increasingly so for industrialised countries that face stiff competition for investment, especially from the Chinese. In Germany, corporate-income taxes may be on the way down whatever the colours of the next government. Similar pressures may lead America and Canada to cutting their rates as well.