Following my post on Sweden, someone commented that another reason why Scandinavian economies fare well compared to some of their European counterparts is because of their low corporate marginal tax rates. KPMG publishes a list of world-wide corporate marginal tax rates every year. While the January ’05 figures are not available on the net, I found those for January 2004 (see here).
In its report, KPMG explains that the trend is towards lower corporate tax rates world-wide, especially in Europe where many countries now have rates around 30% and a few much below that threshold (e.g. Portugal and Ukraine are below 20%). The idea that Scandinavian countries have relatively low corporate marginal tax rate seems true: Finland’s marginal rate is 29%, while Sweden’s and Norway’s rates are a notch lower at 28%. This is below the EU average of 31.3%. It also compares favorably with the US Federal corporate tax rate of 35%.
As Israel Kirzner argues in Taxes and Discovery: an Entrepreneurial Perspective, taxation reduces the likelihood that unnoticed opportunities will be perceived. In other words, taxation not only affects the incentives to pursue an already-known alternative, but it also affects the incentives to adopt a not-yet-known course of action. This is because taxation reduces pure profit, which is the lure of entrepreneurial discovery. Doing so makes an unnoticed opportunity less likely to be noticed.
Marginal corporate tax rates are only part of the picture; other policies are necessary to obtain sustained prosperity. However, all the talk about Ireland cannot detract from the fact that the country dramatically lowered its corporate tax rate in the last twenty years. It now stands at 12.5% and this annoys EU bureaucrats and other European tax-addicts who see upward harmonization of tax rates as the preferred path. Low taxation is underrated in the world of policymaking. Even in New Zealand, where a “broad-base, low-rate” tax policy was adopted early on, the marginal tax rates have not gone below 33% (this is still hotly debated, see here for instance). In fact, David Lange fired Roger Douglas from his post for proposing a 23% income flat tax in late 1987. This was regrettable considering the enormous economic benefits of low taxation.
However, comparing corporate marginal tax rates on paper is not always useful. A rate that appears high on paper may not be applied in practice. A better comparison should use effective marginal tax rates. Though, the effective marginal rate will often vary from company to company. Using effective marginal tax rates makes cross country comparisons all the more difficult.
As far as Scandinavian countries are concerned, the idea that Sweden for instance has two economies running side by side (one export oriented and the other one domestic) is reasonable. The existence of a 28% corporate tax rate reinforces the idea that the Swedes know the price of the welfare state. Sweden, like other social democracies, faces the following problem: capital is highly mobile, and if it doesn’t go to Sweden, it will go somewhere else. Taxing capital less than labor seems, in these conditions, rational. However, this creates other issues, for instance with regard to the capital-labor boundary. Some individuals (especially sole-entrepreneurs and artisans) may characterize part of their labor income as capital income to benefit from the lower taxation of capital. This is good for the economy but was not intended by the legislators.
This example is a reminder that the distinction between labor income and capital income is an illusion. All income is the result of human action. Taxation of corporate income is, fundamentally, taxation of the returns on the savings of those who invested in the company's equity.
At the end of the day, while having different marginal tax rates for income and capital helps countries such as Sweden stay afloat, it opens the door to lobbying and complexity. Differential and progressive taxation cannot “properly” (i.e. according to the canon of optimal tax theory) be achieved by governments because the information necessary for its implementation is not available. Moreover, altruistic social planners are not part of this world. The result is that taxation should always and everywhere be simple and the marginal rates should be low. From Hong-Kong to Ireland, it has consistently delivered good results.
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