Comparative Taxation
Some Basic Points
Philip R. West
Steptoe & Johnson LLP
Presentation to
Congressional Working Group
on International Taxation
November 8, 2002
What makes one system better than another?
• Economic efficiency: Is it good for the economy?
– This may differ from whether it is good for any particular taxpayer
• Simplicity: Can it be complied with and administered?
• Fairness: Are distributional effects politically desirable?
– Businesses, not only individuals, argue for fairness (largely vis-àvis foreign competitors) under the name of “competitiveness”
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How do we compare tax systems?
• What taxes do the systems use to raise revenue?
• What is the balance?
– To what extent is revenue raised by each tax element of the
system?
• What are the technical rules used to implement each
tax?
2
Keep in mind
• Marginal rates alone may tell little
– The tax base may be more relevant
• What income is included in the tax base?
• What tax deductions, exemptions and credits are available?
• Are tax “holidays” available?
• “Fairness” and “competitiveness” are hard to measure,
or even define
– “Competitiveness” may be a shorthand way of saying that “taxes on
U.S. businesses should be lower, compared to their foreign competitors”
– “Fairness” may be a shorthand way of saying that “taxes should be
imposed based on ability to pay”
– Fairness may be measurable through distributional or incidence
analyses, but there does not appear to be any reliable way to compare
the effect of tax systems on competitiveness
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What taxes are used to raise revenue?
•
Income taxes
–
–
•
Employment taxes
–
•
E.g., social security taxes
Consumption taxes
–
•
•
•
Corporate
Individual
E.g., state sales taxes, VAT
Excise taxes
Property taxes
User fees and other charges
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Total tax receipts as a percentage of GDP
•
–
U.S.: 28.9%
–
OECD average: 37.0%
–
EU average: 41.3%
Source: OECD in Figures, 2001
5
Comparative tax burdens as a percentage of total
collected revenues (Source: OECD in Figures, 2001)
Personal
income tax
plus
employee
portion of
social
security
Corporate Consumption
income
taxes
tax plus
employer
portion of
social
security
50.7%
21.2%
16.2%
OECD 34.1%
Average
23.8%
31.3%
U.S.
6
Office of Management and Budget,
Citizen’s Guide to the Federal Budget, 2001
•
As a percentage of collected revenues, over
the past 50 years:
•
•
•
•
Both corporate income taxes and excise taxes
have declined significantly
Social insurance taxes have grown significantly
Individual income taxes have grown slightly
“Corporate income taxes have shrunk
steadily as a percent of GDP, from 4.5
percent in 1955 to an estimated 1.9 percent
in 2001.”
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Comparing income tax systems
•
What persons are subject to the country’s
taxing jurisdiction?
–
–
•
Most every country asserts taxing jurisdiction over
its “residents”
The United States also taxes its “citizens”
On what income are those persons taxed and
on what income are they exempt?
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What income is taxed and what is not?
•
The U.S. exempts, among many other things:
–
–
–
–
–
–
State and local bond interest
Certain employer-provided benefits,
Certain health benefits and life insurance proceeds
Certain compensation and benefits of members of the armed forces
Certain gains from the sale of a principal residence
Other income, to the extent tax on that income is offset by credits, including
EITC and credits for, among other things, certain expenditures relating to:
•
•
•
–
•
Certain dependent care services, adoption, and education
Certain retirement plans
Certain business investments
Many other exemptions and credits
Foreign countries have their own exemption
lists
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Treatment of foreign source income
•
No country taxes all foreign source income
•
No country exempts all foreign source income
•
All countries tax some foreign source income
and refrain from taxing some foreign source
income
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How the U.S. eliminates tax on foreign source
income
•
•
Exemption:
•
We exclude or exempt foreign earned income of individuals up to
certain limits
Deferral:
•
We defer taxation of foreign active business income earned by
U.S. individuals or corporations, as long as they earn the income
through a non-U.S. corporation.
•
•
Even “passive” income is eligible for this deferral if it is subject to
foreign taxes at rates close to the U.S. rates.
•
This deferral lasts until the money is returned for use in the U.S.
Credit:
•
For income not subject to exemption or deferral, we provide a
dollar-for-dollar credit against U.S. taxes for foreign taxes on that
income.
•
The credit is subject to limitations designed to reduce the credits
that can offset U.S. tax on U.S. source income
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The international tax debate
•
Much of the debate concerns the extent to which one or
another of these three regimes should apply and, in the case
of deferral and credit, what the scope of deferral should be
and how the credit should operate:
–
–
–
•
Exemption from the tax base
Inclusion in the tax base with credit for foreign taxes
Deferral with anti-deferral rules
Other countries use different mixes of exemptions, deferrals
and credits to achieve the politically desired results in their
jurisdictions.
–
–
–
–
France, Canada and Germany use exemptions more than credits
The US, UK and Japan use credits more than exemptions.
All six use anti-deferral rules.
See Ault, Comparative Income Taxation, A Structural Analysis (Kluwer, 1997)
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Territorial vs. U.S. systems: treatment of foreign sales income,
without application of FSC/ETI rules
Plant
Plant
Sales
Sales
Sales
Domestic Manufacturing
and Domestic Sales Activity
•In general, both the U.S. and territorial
systems would tax the income derived
from goods where manufacturing and
sales activity was domestic, whether
sold for domestic or foreign
consumption. (US tax treatment
actually would generally be more 13
favorable if foreign consumption.)
Territorial vs. U.S. systems: treatment of foreign sales income,
without application of FSC/ETI rules
Parent Co
•Both the U.S. and territorial
systems would mitigate
taxation (through deferral or
exemption) of the income
derived from goods
manufactured and sold
abroad. Territorial systems
continue this treatment even
after profit repatriation
Goods
Manufactured
and Sold Abroad
Parent
Co
Plant
Plant
Sales
Sales
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Territorial vs. U.S. systems: treatment of foreign sales income,
without application of FSC/ETI rules
Plant
Other
Jurisdiction
Sale
Co
Plant
Plant
Sale
Co
Goods Manufactured Locally & Sold Abroad
•U.S. taxes the sales commissions earned by Sale Co. (assuming
inapplicability of FSC/ETI and 2002 Thomas Bill), unless Sale Co.
is in the destination country, in which case that income is deferred.
•Some EU countries exempt the sales commissions earned by
Sale Co., but
•If sales activity occurs in a high-tax jurisdiction, there is no
tax benefit
•If sale is from a tax haven
•Arm’s length pricing should prevent allocation of any
significant income to the tax haven
•Also, foreign CFC rules may tax any income that is
allocated to the haven
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VAT vs. income tax: impact on trade/exports
• VAT not preferable to income tax in terms of
impact on trade/exports
• See M. Feldstein & P. Krugman, International
Trade Effects of Value Added Taxation, in Taxation
in the Global Economy, Razin and Slemrod, eds.
(U.Chi. 1990)
– Conclusion is independent of reasons relating
to VAT complexity and evasion potential
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