0
www.taxfreedomday.be
Tax Freedom Day® 2013
Comprehensive reforms vs.
a low flat corporate income tax rate
In the first six...
Contents
Executive summary...................................................................................................
© PwC 2013	 PwC Tax Freedom Day® 2013	 1
Executive summary
In the first few years of our study, Tax
Freedom Day fell on ei...
2	 PwC Tax Freedom Day® 2013	 © PwC 2013
We therefore asked Professor Moesen
of the KUL to again shed some light on
the qu...
© PwC 2013	 PwC Tax Freedom Day® 2013	 3
Assuming, however, that
comprehensive reform might not be
(immediately) achievabl...
4	 PwC Tax Freedom Day® 2013	 © PwC 2013
Tax Freedom Day is the symbolic
date on which the average taxpayer
stops working ...
© PwC 2013	 PwC Tax Freedom Day® 2013	 5
Tax Freedom Day is based on an
average applied to all citizens of a
country and i...
6	 PwC Tax Freedom Day® 2013	 © PwC 2013
The price of our
collective comfort
Consider a morning in the life of a
standard ...
© PwC 2013	 PwC Tax Freedom Day® 2013	 7
15.06
NO
04.07
SE
27.06
DK
04.06
DE
07.06
IT
13.06
GR
13.04
CY
19.06
FR
30.05
UK
...
8	 PwC Tax Freedom Day® 2013	 © PwC 2013
Abstract
Neo-institutional economics holds that
institutional quality is a key fa...
© PwC 2013	 PwC Tax Freedom Day® 2013	 9
1. 	Civic capital and economic
performance
Why do some countries show a
prominent...
10	 PwC Tax Freedom Day® 2013	 © PwC 2013
•	 To what extent is the judiciary
independent from influence by
members of gove...
© PwC 2013	 PwC Tax Freedom Day® 2013	 11
As a first approach we will concentrate
on the variables with a strong
correlati...
12	 PwC Tax Freedom Day® 2013	 © PwC 2013
Government effectiveness is
considered to be an instrumental
component of civil ...
© PwC 2013	 PwC Tax Freedom Day® 2013	 13
The Economist recently ran a cover
story on its weekly magazine claiming
that “I...
14	 PwC Tax Freedom Day® 2013	 © PwC 2013
The Nordics still benefit from a most
generous welfare system. Nevertheless
they...
© PwC 2013	 PwC Tax Freedom Day® 2013	 15
For pragmatic purposes the question
arises: how can we foster government
effecti...
16	 PwC Tax Freedom Day® 2013	 © PwC 2013
It is sad to say but in Belgium it is often
the government which appoints the
me...
© PwC 2013	 PwC Tax Freedom Day® 2013	 17
6. Conclusion and policy implications
Civic capital creates a
climate of trust w...
18	 PwC Tax Freedom Day® 2013	 © PwC 2013
Appendix
Table 1
Underlying data
Country
Civic
capital
Government
expenditure
Go...
© PwC 2013	 PwC Tax Freedom Day® 2013	 19
Sources
Global economic competitiveness indicator: normalised value between 1 an...
20	 PwC Tax Freedom Day® 2013	 © PwC 2013
I.	Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....
© PwC 2013	 PwC Tax Freedom Day® 2013	 21
We refer to section I of last year’s study
for the business case behind this
ref...
22	 PwC Tax Freedom Day® 2013	 © PwC 2013
3.	 It is especially relevant to review
VAT as it is a virtually totally
outsour...
© PwC 2013	 PwC Tax Freedom Day® 2013	 23
III. Corporate taxation
A.	Corporate taxation in
Belgium
Corporate income taxes ...
24	 PwC Tax Freedom Day® 2013	 © PwC 2013
The number of active coordination
centres over the period 1999 to 2006
are depic...
© PwC 2013	 PwC Tax Freedom Day® 2013	 25
3. Overlapping with this second
period (from the early ’90s to date):
“EU and in...
26	 PwC Tax Freedom Day® 2013	 © PwC 2013
Figure 3
Capital/share premium (full chart of accounts)
– in million EUR
Source:...
© PwC 2013	 PwC Tax Freedom Day® 2013	 27
5. Now and going forward: “how to
(re)develop our system to further
enhance grow...
28	 PwC Tax Freedom Day® 2013	 © PwC 2013
There were similar results for our
country in the study by Professor
Hylke Vande...
© PwC 2013	 PwC Tax Freedom Day® 2013	 29
E.	Impact on the design of the
corporate tax regime of the
future?
Summarising a...
30	 PwC Tax Freedom Day® 2013	 © PwC 2013
The abolition option (combined with
integration into personal income
taxes) was ...
© PwC 2013	 PwC Tax Freedom Day® 2013	 31
The more logical question to ask
therefore seems to be: how can we
marry the adv...
32	 PwC Tax Freedom Day® 2013	 © PwC 2013
The idea for a low flat corporate
income tax (apart from borrowing the
term flat...
© PwC 2013	 PwC Tax Freedom Day® 2013	 33
Both Cyprus and Ireland have an
“ordinary profit tax system”, with
profit being ...
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
PWC - Final tax freedom day 2013 report - June 2013
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Transcript of "PWC - Final tax freedom day 2013 report - June 2013"

  1. 1. www.taxfreedomday.be Tax Freedom Day® 2013 Comprehensive reforms vs. a low flat corporate income tax rate In the first six years of our study, Tax Freedom Day® fell on either 8 or 10 June but last year we saw a marked increase in the overall tax burden. This shunted Tax Freedom Day® all the way along to 14 June - the most significant slide in 30 years. Last year’s trend is now confirmed: with an overall tax burden of 44.9% of GDP, Tax Freedom Day® 2013 will fall on 14.06.2013 (44,9% overall tax burden of GDP) June 2013 Executive summary p1 / Tax Freedom Day® – what is it? p4 / Value for tax money: the relevance of civic capital p8 / Tax Freedom Day®: comprehensive reforms versus a low (flat) corporate income tax rate? p20 / Previous Tax Freedom Day® publications p44
  2. 2. Contents Executive summary.................................................................................................................................1 1. Tax Freedom Day® – what is it? ......................................................................................................4 2. Value for tax money: the relevance of civic capital ....................................................................8 3. Tax Freedom Day: comprehensive reforms vs. a low (flat) corporate income tax rate? .....................................................................................20 4. Previous Tax Freedom Day® publications ..................................................................................44
  3. 3. © PwC 2013 PwC Tax Freedom Day® 2013 1 Executive summary In the first few years of our study, Tax Freedom Day fell on either 8 or 10 June. However, last year, we saw a clear worsening in the overall tax burden, with Tax Freedom Day taking an additional four days to arrive – moving back to 14 June – the first such slump in 30 years. Last year’s “backward trend” is now confirmed. With an overall tax burden of 44.9% of GDP (compared to a full 45% last year), Tax Freedom Day 2013 will again fall on 14 June (the extremely small drop in the total tax burden not being enough to shift the date in the calendar). A tax burden of almost 45% of GDP and 14 June as Tax Freedom Day again ranks us as having one of the highest tax burdens among our neighbours. However, for the first time since we started our study, France is now “overtaking” us, with a total tax burden of 46.3% (and Tax Freedom Day falling on 19 June in 2013, which would seem to be the highest burden they have ever had). That said, compared to our neighbours one can see that most countries are generally moving up the calendar versus last year (the Netherlands, 27 May versus 23 May; Luxembourg, 21 May versus 20 May; and Germany 4 June versus 3 June). Only the UK is able to hold steady (at 30 May for the last four years). The fact that our Tax Freedom Day remains 14 June should obviously not really come as any surprise, as the government’s decisions to increase taxes in December 2011 are now exacting their full toll and our GDP (which is still suffering from the effects of the financial crisis) has clearly not been able to outgrow the government’s tax increases. Tax Freedom Day® For the eighth year in a row, we have calculated Tax Freedom Day® – the day when the average inhabitant of the country stops working to pay tax and starts working for themselves. As we demonstrated last year, we do get a lot back for this tax burden in terms of public programmes via schools, roads, administration of justice, police and fire departments and redistribution via our social security system. However, the sheer magnitude of the tax burden, although already questioned in earlier Tax Freedom Day studies, now even more clearly invites the question of whether the payback in terms of a competitive economy or efficient government is commensurate with the level of this high burden.
  4. 4. 2 PwC Tax Freedom Day® 2013 © PwC 2013 We therefore asked Professor Moesen of the KUL to again shed some light on the question of the effectiveness of our government in light of the revenues raised through the taxes we have to suffer. He first of all returned to the World Economic Forum’s “Global Economic Competitiveness Indicator”, which was already referred to in his analysis for our Tax Freedom Day study in 2008. The Global Economic Competitiveness Indicator is a composite index published annually by the World Economic Forum, distilling out economic performance and institutional quality of a nation based on data from 140 countries and 110 indicators. Based on this and other data from the World Bank for government effectiveness and taking into account budget size, Professor Moesen again concludes (as in 2008) that government effectiveness is NOT enhanced by solely allocating more budgetary resources to the public sector. The conventional wisdom that a bigger budget automatically increases government effectiveness is thus a fallacy. The impact is that the increases in our tax burden last year and this year will not automatically translate into a bigger payback for the general public. To shed further light on the mechanics of how to enhance government effectiveness and economic performance, Professor Moesen has taken the detailed data and also compared Belgium to another country that has roughly the same budgetary envelope but whose government effectiveness is clearly higher – Sweden. Looking at these details, one sees that both Belgium and Sweden rank fourth in terms of government expenditure but, for government effectiveness, Sweden is in third position, while we slump to 11th place. Turning then to another indicator that Professor Moesen referred to in last year’s analysis (“civic capital”) this relative gap even appears to be widening (with Sweden taking third place, while Belgium only makes it to 13th place). Civic capital is defined as the persistent, shared beliefs that help a group overcome the free rider problem in the pursuit of activities with social value. The basic idea is that citizens who share cultural values based on respect and solidarity demonstrate higher standards of civic behaviour and require more accountability and integrity from policymakers and public servants. The importance of greater civic capital is that it leads to better economic performance and is a measure of a nation’s institutional quality, as can be seen from the differences between Sweden and Belgium. Professor Moesen therefore concludes that, apart from raising taxes to increase budget resources, our policymakers should also be tackling deficiencies in policymaking and public administration, as this would increase civic capital, which would in turn correlate directly with increased economic prosperity. The flip side of the coin of creating economic prosperity is clearly how to adapt one’s tax system to best sustain economic growth, as growth is in the end the best motor for any recovery or wealth creation. Last year, we thus looked at two major reviews of tax systems around us (the UK’s Mirrlees Review and the Dutch “Continuiteit and Vernieuwing” report) and outlined several options that could be looked at to carry out a “comprehensive reform” of our own tax system. It is important in this respect to note that these reflections are actually still entirely valid and could thus still form the basis for such comprehensive reforms.1 1 For an overview of these reflections and options, see the Tax Freedom Day report 2012 – http://www.pwc.be/TFD2012, and the tax section in particular, pp. 18–42.
  5. 5. © PwC 2013 PwC Tax Freedom Day® 2013 3 Assuming, however, that comprehensive reform might not be (immediately) achievable, we this year contrast the more comprehensive reform with a more “singular (but perhaps more politically drastic) reform” focusing solely on corporate income tax, which, as already shown by the OECD in 1997-1998, is the tax that most distorts economic growth. A number of studies have shown that (i) the effective corporate income tax rate can have a severe adverse impact on aggregate investment, FDI and entrepreneurial activity, while (ii) it correlates negatively to growth and positively to the size of the informal economy. We therefore wondered what “optimal low flat corporate income tax rate” would be low enough not to distort the economy, but still generate maximum tax revenue for the State. Given the specific situation of our corporate income tax system compared to those of the rest of the EU, evolving as it has since its inception in 1962, it appears that this optimal low flat corporate income tax rate would be around 3% to 4% on a basis differing as little as possible from our current tax base, but still eventually allowing for simplification of various facets of the system, thus also widening the tax base and the scope of various earn- backs. Frank Dierckx Managing Partner PwC Tax Consultants The specific situation of our country (it has developed high corporate income tax rates and also a special scheme to attract finance companies) suggests that the second alternative, followed since 2006 (the notional interest deduction regime), is far better suited to our country than the ordinary corporate income tax system. 2 The first option (for corporate income tax) is to stick to a simple “ordinary profit income tax system”, such as we had for many years and as is known in many other countries. The system is obviously widely known and therefore understandable, but is not the most optimal, which therefore immediately leads to further options. 1 Considering our Tax Freedom Day studies over the last two years and starting out from our present corporate income tax system (and extrapolating to the entire tax system), we can distinguish the following paths along which to pursue tax reform: A third alternative, to reap as many positive economic effects as possible, would be to abolish corporate income taxes altogether as they have a very adverse effect on economic growth. 3 However, this third alternative would also mean the total loss of corporate income tax revenue, which invites a fourth alternative, which is to introduce a “low flat corporate income tax” at the optimal rate for our country (3 to 4%), thus still raising as much revenue as possible but reaping the economic benefits of ensuring that corporate income tax no longer causes any significant economic disruption. 4 Fifthly and finally, it would also be possible (even in conjunction with the above suggestions) to go back to a more comprehensive tax reform as discussed in last year’s Tax Freedom Day study. 5
  6. 6. 4 PwC Tax Freedom Day® 2013 © PwC 2013 Tax Freedom Day is the symbolic date on which the average taxpayer stops working for the state treasury and begins earning for himself. It relates to the total taxes paid by the average citizen as a percentage of their total income, and is calculated by dividing the total tax revenue of general government by the nation’s gross domestic product (GDP). The Belgian result of 44.9% for 2013 is converted into days of the year starting with 1 January. Put differently, Tax Freedom Day is a measure of the overall tax burden borne by the citizens of a specific country in a particular year. All taxes, direct and indirect, that are levied by any level of government are taken into account (i.e. federal, regional and local). Contributions to the social security system are also included. These taxes constitute nearly all general government revenue. Direct taxes include personal income tax, corporate income tax and property tax. Value added tax and excise on petrol, tobacco, alcohol, etc. are considered indirect taxes. Government revenues from user fees are not included (for example, entry fees for public swimming pools). Dividends received from public enterprises (such as Belgacom) are also excluded. The same is true for proceeds from the sale of government property (e.g. public buildings). 1. Tax Freedom Day® – what is it? On Friday 14 June, Belgian citizens will have a good reason to be happy: it will be Tax Freedom Day. Symbolically, from then on, all income that the average taxpayer earns can be spent entirely on purely private expenditure. Tax Freedom Day falls on 14 June this year, according to our calculation as based on the latest authoritative government data on taxes and income provided by the Federal Planning Agency. Figure 1 Tax freedom day in Belgium and some neighbouring countries in 2009, 2010, 2011, 2012 and 2013, based on estimate data* Country 2009 2010 2011 2012 2013 Slovakia 27 April 20 April 20 April 10 April 12 April Cyprus 30 April 28 April 1 May 13 April USA 13 April 9 April 12 April 17 April 18 April Hungary 2 June 18 May 9 May 17 May 20 May Luxemburg 14 May 16 May 10 May 20 May 21 May The Netherlands 24 May 19 May 23 May 23 May 27 May United Kingdom 14 May 30 May 30 May 30 May 30 May Germany 8 June 27 May 28 May 3 June 4 June Italy 10 June 6 June 5 June 8 June 7 June Austria 1 June 2 June 2 June 2 June 9 June Greece 20 May 25 May 30 May 7 June 13 June Belgium 8 June 8 June 10 June 14 June 14 June Norway 16 June 17 June 16 June 17 June 15 June France 11 June 31 May 6 June 12 June 19 June Denmark 25 June 25 June 20 June 20 June 27 June Sweden 5 July 12 July 2 July 30 June 4 July * Calculated by dividing the total tax revenue of general government by a nation’s gross domestic product. Figures are based on estimate data.
  7. 7. © PwC 2013 PwC Tax Freedom Day® 2013 5 Tax Freedom Day is based on an average applied to all citizens of a country and is not limited to the working population. The aim is thus not to give the precise impact of all taxes on a typical Belgian worker but rather to evaluate the tax burden of the country. Behind the tax burden Adult Belgians are familiar with the brown envelope in the mailbox announcing the personal income tax bill. Indeed, this is a very visible tax form, which needs to be filed and audited. The same applies to Tax-on- Web. There are less obvious taxes, such as VAT, which is already included in consumer prices in any shop. Also, social security contributions are withheld at source before an employee gets his take-home pay. Figure 2 Tax-to-GDP ratio (incl. SSC), 2013 (figures are based on estimate data) - in % Conceptually and statistically, the exact calculation of Tax Freedom Day is a matter open to debate. Several of the more important points are worth mentioning in this context. For instance, should income transfers from the government to its citizens be considered as “negative taxes” and thus be excluded from the tax burden? It is often claimed that, over an average lifetime, about three quarters of social security contributions are returned to a typical citizen in the form of pension, child benefits, unemployment benefits, sickness pay, etc. within the framework of a collective welfare system. Critics are also justifiably reluctant to interpret Tax Freedom Day as the split between the number of days typical Belgian citizens work for the government, and the number of days they work for themselves. Instead, critics view taxes in a civil society as the price to be paid for public services such as law and order, education, health, maintenance of public infrastructure, etc. 0 10 20 30 40 50 60 Hungary Sweden Slovakia 27,67 29,40 USA Luxembourg 38,33 UK 40,82 Italy 43,08 Greece 44,75 Norway 45,20 Denmark 48,60 Cyprus 27,90 38,08 The Netherlands 39,90 Germany 42,10 Austria 43,56 Belgium 44,90 France 46,30 50,30 Figure 3 Sources of revenue (as percentage of overall revenue) Source: BNB – Belgostat – Institut des Comptes Nationaux 29% 7% 29% 27% 8% Direct taxes on households Direct taxes on companies Indirect taxes Social security Non-tax revenues In figure 3 below, the major sources of government revenues are listed. Three categories are of substantial importance: direct taxes on households, indirect taxes and social security contributions. Each category represents roughly one quarter to one third of total tax revenues (shares are somewhat rounded). Direct taxes on business count for 7%. Non-tax revenues (fees, dividends from public enterprises, etc.) provide the remaining 8%. Putting technical considerations aside, the announcement of Tax Freedom Day always provides a focal point to stimulate reflection on the functioning of the state, and on Belgium’s place in an international framework.
  8. 8. 6 PwC Tax Freedom Day® 2013 © PwC 2013 The price of our collective comfort Consider a morning in the life of a standard Belgian family. Parents and kids shower with water supplied by a local public company. Breakfast includes products inspected by the Federal Agency for Safety of the Food Chain. The children walk to the local public school. The mother has an appointment at the hospital for a medical check-up, which is almost entirely financed by public money. She takes the bus, run by a regional company, with a ticket that is heavily subsidised. The husband drives by car to his office in town. He uses a highway and a bridge, no toll is paid. He holds a university degree which took him four years of study to obtain. On average, a university student places a burden of about EUR 12,500 per academic year on public resources. The tuition which he paid only covers a minor fraction of this real cost. The other day, he had a chat at the office with a foreign colleague. His colleague told him that, in his home country, university education is mostly a private matter. In fact, his parents had to take out a second mortgage on their house to finance his studies. What would life be like in a society without government? There would be no system of courts to administer justice. National defence would be disorganised without regular armed forces. How would police and fire protection be provided to the public? What about support for the disabled, poor, sick, elderly, etc.? Taxes generate revenues, which are intended to finance public programmes. The raison d’être of a state is the provision of public services, as broadly defined. But which levels of government are the big spenders in Belgium? Figure 4 reveals the role of the federal government, which absorbs 25,7% of total public expenditure. The social security system is dominant here, as it directs about 42,6% of total expenditure flow. Consecutive state reforms have assigned significant spending power, about 24,9%, to the regional level (encompassing the regions and the communities). Local government, with 5,3%, is a smaller player, but municipalities and provinces are the partners that stand closest to the population. Table 1 Composition of expenditure (as % of total expenditure) Salaries of civil servants (including army, police, teachers, etc.) 23% Other operating costs 7% Income transfers to households 50% Subsidies to business 5% Income transfers to EU, abroad, etc. 3% Interest on public debt 6% Investments 6% 100% Another classification criterion is the economic nature of categories of expenditure. Table 1 summarises the major categories of expenditure. As already mentioned, the social security system operates as a large redistribution mechanism from the active to the retired, from people who hold a job to the unemployed, from the healthy to the sick. Together with the other layers of government, about 50% of total outlays are directed as income and support to households, but it is the beneficiary who ultimately decides how the money is actually spent. To give a crude example: parents may spend money received as child benefit on travel. As shown in table 1 salaries of civil servants (including the army, police, teachers, etc.) together with other operating costs amount to 30%, which is usually labelled as government consumption. Government investments in buildings and public infrastructure are nowadays at a fairly low level, at 6%. In fact, the interest bill on the public debt is also 6%, the same as public investment. Figure 4 Expenditure by level of government (as % of total expenditure in 2011) 25,7% 1,5% 24,9% 5,3% 42,6% Federal government EU Institutions Regional government Local government Social security system Source: Taxation trends in the European Union 2013 - European Commission Services
  9. 9. © PwC 2013 PwC Tax Freedom Day® 2013 7 15.06 NO 04.07 SE 27.06 DK 04.06 DE 07.06 IT 13.06 GR 13.04 CY 19.06 FR 30.05 UK 21.05 LU 27.05 NL 09.06 AT 12.04 SK 20.05 HU 14.06 BE Tax Freedom Day 2013 in Europe Tax Freedom Day is the symbolic date on which the average taxpayer stops working for the state treasury and begins earning for himself. It relates to total tax paid by the average citizen as a percentage of their total income. * Calculated by dividing the total tax revenue of general government by a nation’s gross domestic product. Figures are based on estimate data.
  10. 10. 8 PwC Tax Freedom Day® 2013 © PwC 2013 Abstract Neo-institutional economics holds that institutional quality is a key factor for explaining observed differences in prosperity and poverty across countries. Decisions by economic agents and citizens are embedded in a set of values, norms, formal and informal codes of conduct, habits, etc. that shape the civic capital of a society. This study contributes to the growing body of empirical research that investigates the positive relationship between institutional quality and economic performance. However, in contrast to most other worldwide research, we limit our examination to 21 mature industrial economies. Economic performance is measured by the global economic competitiveness indicator and civic capital is proxied by institutional quality; both composite indicators are supplied yearly by the World Economic Forum. Our main focus is on government effectiveness (data from the World Bank) as a strategic component of civic capital. Surprisingly it is shown that no correlation whatsoever exists between government effectiveness and general government expenditures as a share of GDP (OECD data). On the other hand meaningful clusters of countries can be identified taking into account differences in the level of civic capital with the Nordic countries as champions. At the instrumental level our paper explores how government effectiveness and also civic capital can be fostered. Value for tax money: the relevance of civic capital Wim Moesen Faculty of Business and Economics, KU Leuven, Belgium Kristof De Witte Top Institute for Evidence-Based Education Research, Maastricht University, the Netherlands Thanks to Mark Camilleri for helpful comments.
  11. 11. © PwC 2013 PwC Tax Freedom Day® 2013 9 1. Civic capital and economic performance Why do some countries show a prominent and persistent track-record of economic prosperity while others cannot, or only to a lesser extent? This was and still is a fundamental question of political economy. Standard growth theory identifies the accumulation of physical capital, investment in human capital and (endogenous) technological progress as driving forces behind aggregate production (R. Barro, 1996). But then the question remains: why do some countries invest more in skills, innovation and equipment than others? Recent research investigates the ‘deep determinants’ of output growth, such as institutions, international trade and geography. In a stimulating paper D. Rodrik et al. (2002) have claimed that the quality of institutions ‘trumps’ everything else. The title of their study is outspoken and challenging: “Institutions rule: the primacy of institutions over geography and integration in economic development”. A recent best-seller in this area is the book by D. Acemoglu and J. Robinson: “Why nations fail: the origin of power, prosperity and poverty” (2012). Institutional economics hypothesises that differences in economic prosperity are mainly due to differences in the quality of institutions. Institutions range from formal constraints (constitutions, laws, rules, etc.) to informal codes of conduct (moral values, norms of behaviour, conventions, attitudes, etc.). Institutions guide human interactions. In economic life good institutions facilitate complex transactions, specialisation and flexibility while reducing “transaction costs” in the sense of the costs of running the economic system. Transaction costs are the economic equivalent of friction in physical systems. Loosely put, like a lubricant, good institutions grease the wheels of the economic system by “saving” on transaction costs. In this paper we focus on civic capital and government effectiveness. Civic capital can be viewed as a container concept encompassing the quality of institutions. A related concept is social (or societal) capital which also has become popular in economics since the influential publications of R. Putnam (1993) and F. Fukuyama (1995). In our view civic capital addresses at least three vital dimensions: 1. Is there a legitimate government which has the support of a democratic majority and which is able to make adequate decisions? 2. Is there a civil service which has the competence and integrity to operationally implement the decisions in the field, thereby delivering value for tax money? 3. At the end of the day, are the norms and values of the citizens such that they are willing to cooperate with the government decisions and their administrative monitoring? We view government effectiveness as a principal generator of trust within a society and thus as a driving force for economic prosperity. Citizens who are convinced that they get value for their tax money from the public administration, army, police, judicial system, schools, hospitals, etc. are more willing to engage in interpersonal or mutual trust, and vice versa. It takes time and effort to build up such a virtuous circle of public and private trust; flagrant inefficiencies, corruption and clientelism can destroy it (W. Moesen and L. Cherchye, 2001). 2. Data description As a first step we want to investigate empirically whether higher levels of civic capital correlate with better economic performance. For this examination we need first a variable which adequately represents civic capital and another variable for economic performance. As noted before, civic capital shapes the legal and administrative framework in which individuals interact to generate wealth. For empirical purposes, it boils down to the institutional quality of a country. In our own research, we favour the institutional quality data taken from the World Economic Forum (WEF). Each year, the WEF publishes a global economic competitiveness report of some 140 countries, which has established a reputation as the most comprehensive assessment of its kind. It contains publicly available but also private survey data covering some 110 single indicators. These are then grouped into 12 pillars which support economic performance. The first pillar refers to the institutional quality of each country. It is a composite indicator that captures several characteristics. We list 10 of them: • Are property rights, including financial assets, well protected? • Is there diversion of public funds to companies, groups and/or individuals due to corruption? • What is the level of public trust in the ethical standards of politicians? • Is it common for firms to make undocumented extra payments or bribes connected with (a) imports and exports; (b) public utilities; (c) annual tax payment; (d) awarding of public contracts and licences; (e) obtaining favourable judicial decisions?
  12. 12. 10 PwC Tax Freedom Day® 2013 © PwC 2013 • To what extent is the judiciary independent from influence by members of government, citizens or business? • Do government officials show favouritism to well-connected businesses and individuals when deciding upon policies and contracts? • How would you rate the composition of public spending in terms of efficiency? • How burdensome is it for business to comply with governmental administrative requirements (e.g. permits, regulations and reporting)? • Are police services reliable in enforcing law and order? • Is government policymaking transparent? After a normalisation of the original data and an appropriate weighting scheme, the composite indicator ranges between a value of 1 and 7, whereby a higher numerical value represents a higher level of civic capital. We limit our data set to 21 countries, all mature democratic industrialised OECD members. The set covers the 15 Carolingian core countries of the European Union plus comparable countries such as Australia, Canada, Japan, New Zealand, Norway and the United States. We consider government effectiveness as a major component of civic capital. Representative data are borrowed from the World Bank. Each year D. Kaufmann and his team publish a ranking for some 200 countries within the project “Governance Matters”. The government effectiveness indicator measures the quality of public services, the quality of the civil service and its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to its stated policies. After aggregation each country gets a numerical value between -2.5 and 2.5. Both composite indicators are reported in table A of the appendix. In a production function approach one would expect that a larger budget size, i.e. more public resources, would lead to greater government effectiveness. Data for general government expenditures, as a percentage of gross domestic product (GDP), are reported by the OECD. These expenditures cover all levels of government: federal, regional, local and also the social security system. The relative size of government is also listed in table A. Finally a variable for economic performance is still required. The usual suspects are GDP per capita or real growth over a defined period of time. But we prefer the global economic competitiveness indicator which is updated yearly by the WEF. Conceptually the global economic competitiveness indicator is meant to reveal the relative success of a country in achieving economic performance. Internationally these rankings of the WEF serve as benchmarks for national policymakers and stakeholders. Also here a higher value of the composite indicator is associated with a higher economic performance, as reported in table A. 3. Empirical findings It may be instructive to start the empirical exercise with an examination of the pairwise correlations between civic capital, global competitiveness, government effectiveness and general government expenditures. These correlations are reported in table 1. Civic capital Government effectiveness Global competitiveness General government expenditures Civic capital 1 Government effectiveness 0.94 * 1 Global competitiveness 0.83 * 0.82 * 1 General government expenditures -0.14 -0.005 -0.13 1 Table 1 Pairwise correlations * denotes significant at 5% level
  13. 13. © PwC 2013 PwC Tax Freedom Day® 2013 11 As a first approach we will concentrate on the variables with a strong correlation. Later on we will elaborate on the absence of any correlation, such as between general government expenditures and government effectiveness. At an intuitive level this is an odd finding. As the sample covers only 21 observations it may be less meaningful to run multiple regressions rather than the simple bivariate regressions. Despite the fact that the bivariate analyses should be interpreted with sufficient caution (i.e. they ignore endogeneity issues arising from unobserved heterogeneity, measurement errors or reverse causality), they may be instructive. Figure 1 displays the linear relationship between civic capital and global competitiveness. As expected the coefficient of civic capital is statistically significant and the R2 is 0.68. Although correlations do not per se imply causal relationships, we believe that the arguments in section 1 rationalise the transmission mechanism in a similar vein as E. Hanushek and L. Woessman (2011). We may thus conclude that in mature economies a higher level of civic capital does contribute to better economic performance. We note that the peripheral countries Greece, Italy, Spain and Portugal both show a low civic capital and lesser economic prosperity. In figure 2 we focus on government effectiveness as the right hand variable and global competitiveness as the left hand variable. As reported the regression shows a significant positive relationship. Greater government effectiveness is thus a trump card to increase the economic competitiveness of a country. Figure 1 Relationship between civic capital and global competitiveness Competiveness = 2.51 (t-value = 6.23) + 0.51 civic capital (t-value = 6.47); R² = 0.68 6 5.5 5 4.5 4 3.5 4 4.5 5 5.5 6 Civic capital Competitiveness(WEF) GR IT PT ES AUAT BE CADK FI FR DE JA LU NL NZ NO SW CH UKUS Figure 2 Relationship between government effectiveness and competitiveness Competiveness = 3.94 (t-value = 19.45) + 0.77 effectiveness (t-value = 6.18); R² = 0.66 6 5.5 5 4.5 4 0.5 1 1.5 2 2.5 Competitiveness(WEF) Government effectiveness AUAT BE CA DK FI FR DE GR IT JA LU NL NZ NO PT ES SW CH UKUS
  14. 14. 12 PwC Tax Freedom Day® 2013 © PwC 2013 Government effectiveness is considered to be an instrumental component of civil capital. Both concepts result in a composite indicator capturing several single items. Some of these underlying dimensions may be common in both aggregated numerical indicators. But the scope of civic capital is larger than that of government effectiveness. One may therefore expect that there is a strong correlation between government effectiveness, constructed by the World Bank (Washington) and civic capital, put forward by the World Economic Forum (Geneva). This close relationship is reported in figure 3. 4. An inconvenient puzzle: the relationship between general government expenditure and government effectiveness In a production function approach it is assumed that greater resources (input) will lead to greater outcome (output). Eventually there may be diminishing returns but the basic relationship should at least be positive. Figure 4 shows that in the present study this is not the case when general government expenditure is related to government effectiveness. Economists feel uneasy with this remarkable finding. In fact the bivariate correlation is -0.005 and no meaningful regression line can be drawn in the scatter diagram. One may be tempted to discard the diagram totally. But interestingly some clusters of countries can be identified. The Nordic countries Finland, Denmark and Sweden often cluster at the top of league tables. Also in figure 5 they show excellent government effectiveness, together with a huge budget size well above 50% of GDP. Figure 3 Relationship between government effectiveness and civic capital Civic capital = 2.87 (t-value = 14.79) + 1.45 effectiveness (t-value =12.11); R² = 0.89 6 5.5 5 4.5 3.5 4 0.5 1 1.5 2 2.5 Civiccapital Government effectiveness AU AT BE CA DK FI FR DE GR IT JA LU NL NZ NO PTES SWCH UK US Figure 4 Relationship between government expenditure and government effectiveness Civic capital = 5.85 (t-value =4.73) – 0.02 civic capital (t-value =-0.60); R² = 0.01 2.5 2 1.5 0.5 1 35 40 45 50 55 60 Governementeffectiveness General government expenditure
  15. 15. © PwC 2013 PwC Tax Freedom Day® 2013 13 The Economist recently ran a cover story on its weekly magazine claiming that “If you had to be reborn anywhere in the world as a person with average talent and income, you would want to be a Viking” (The Economist, February 2-8, 2013). Apparently these Nordic countries succeed in providing value for tax money with the support of their population. A second cluster gathers countries such as Switzerland, New Zealand, Canada, Australia, Luxemburg, the US and Japan. These market oriented economies have a public sector representing between 35% and 45% of their GDP. The levels of government effectiveness show a substantial variation, but on average they are still prominent. Citizens of these countries usually perceive the quality of the smaller basket of public services to be in line with their lower taxes. Spain, Portugal, Greece and Italy form a third cluster. Ironically these countries are often labelled the “Club Med” countries. The size of the public sector lies somewhere between 45% and 50% of GDP. Unfortunately these governments perform poorly and the people loudly complain about this deficiency. In the eurozone they are considered to be peripheral countries with a significant sovereign debt problem. Finally there is a fourth cluster with the Netherlands, Norway, Belgium, Austria, Germany, the U.K. and France. These countries have public sectors which represent between 45% and 55% of their GDP. These social market economies provide a larger basket of public services, when compared with the more capitalistic second cluster. Their public resources and consequently tax levels are also higher. On average the government effectiveness scores just a little below the second cluster. Surely there is some heterogeneity in the cluster albeit more in the size of the budget than in public sector performance. Figure 5 Groups of countries and the relationship between government expenditure and government effectiveness 2.5 2 1.5 0.5 1 35 40 45 50 55 60 Governementeffectiveness General government expenditure AU AT BE CA DK FI FR DE GR IT JA LU NL NZ NO PT ES SW CH UK US All the same, when we regress government effectiveness in function of the share of government expenditure for the full 21 countries of the sample, no statistical correlation whatsoever can be detected. Other characteristics, apart from the endowment with public resources must shape the outcome in the effectiveness of governments. Which factors are relevant? As a case in point we will examine in some more detail Belgium and Sweden. Both happen to have the same budget size, i.e. 53.1% of GDP. They are both in 4th place in the ranking of government expenditure. But there is a huge difference in government effectiveness: Sweden moves ahead to 3rd place while Belgium falls back to the 11th place in the ranking. In terms of civic capital the relative gap is even wider: 3rd place for Sweden and 13th place for Belgium. In terms of the competitiveness of the economy the distance is also disappointing for Belgium: 13th in the ranking compared to 4th for Sweden. Could it be that the Nordics show more professionalism in each phase of the policy cycle: agenda setting, preparation ex ante, formulation, implementation and evaluation ex post? Or is the “culture” of the public administration “superior” and the “DNA” of public servants more “adequate”? Surely the basic idea is that citizens who share cultural values based on respect and solidarity show higher standards of civic behaviour. They require more accountability and integrity from policymakers and are less tolerant of quests for personal gain and privilege by their elected representatives and public servants. This boils down to a higher civic capital in terms of transparency, trust, achievement and accountability, all habits which reduce transaction costs and enhance performance both in the public and private sector.
  16. 16. 14 PwC Tax Freedom Day® 2013 © PwC 2013 The Nordics still benefit from a most generous welfare system. Nevertheless they succeed in balancing their budgets. Take again Sweden as an example. Government spending as a percentage of GDP has been reduced by 10 percentage points since the mid- nineties. At the same time the level of public debt has decreased from 85% to 50% of GDP. Sweden passed a sweeping pension reform. Controlling public spending is difficult everywhere, and Sweden demonstrates that a pragmatic approach surely helps when the focus is on results rather than ideology. An interesting example of such pragmatism is the introduction of a voucher system in education. Since the reform, parents have the choice of sending their children to any school they like, enabling voluntary organisations to run ‘free’ schools with public funding. In fact such a school system has already been operating in Belgium for more than half a century. Two principles are applied. First there is an underpricing of education which is viewed as a merit good with individual benefits but also with positive external effects for society as a whole. Underpricing means that there is a small entrance fee just to avoid potential misuse. But the bulk of the funding comes from public means. The solidarity between citizens is such that they are willing to pay via taxes for affordable schooling for all. A second principle is that of “voting with one’s feet”. Parents have freedom of choice between several competing suppliers from either regional, provincial or municipal government, and also from voluntary organisations. In Belgium these non-profit schools are historically mostly the offspring of religious congregations. These free schools are dominant in terms of pupils and students, and enjoy equitable funding just like the public schools. These two principles are also applied in the healthcare sector in Belgium. The freedom of choice together with collective funding puts an upward pressure on the performance of the service providers. If they do not deliver value for tax money these institutions will lose their pupils and patients, who are free to go elsewhere. The results are encouraging: according to the WEF, Belgium ranks second after Finland in the area of primary education and health. Maybe the Belgian experience has inspired Sweden, now ranked 7th after its move to the voucher system? 5. How to enhance government effectiveness? In the previous sections it was shown that civic capital and government effectiveness contribute positively to economic prosperity also in mature industrialised economics. As a next step, one would conjecture that a larger budget size thus would per se increase government effectiveness and hence economic performance. Surprisingly this is not at all confirmed by a simple regression analysis. Values and norms and the habits of the heart differ greatly among countries also in mature economies.
  17. 17. © PwC 2013 PwC Tax Freedom Day® 2013 15 For pragmatic purposes the question arises: how can we foster government effectiveness/civic capital and ultimately economic success? It is quite evident that one cannot upgrade civic capital simply by decree. On the other hand, it is rewarding to reflect on piecemeal steps to enhance government effectiveness. In figure 6 we regress government effectiveness against transparency of government policy. Here too a statistically significant positive relationship is confirmed. From the standard cycle of the five phases of policymaking in section 4 we learn that a more transparent procedure and content of policymaking raises the effectiveness of government. Let us again compare Sweden which holds 4th position and Belgium which ranks 17th on this aspect. A case in point is fiscal policy. Sweden requires a balanced budget for local government, a tiny surplus for general government and a ceiling for central government expenditure. These are clear constraints but difficult to implement in the field. In order to mitigate the problem, the spending ceiling is set at least three years in advance in order to impose forward-looking behaviour. The small budget surplus target is more problematic to evaluate. Is this a backward-looking exercise focused on actual net lending or is it (partly) forward-looking? Are the outcomes to be adjusted for cyclical fluctuations of individual years or a larger time period? Since 2007 a system for monitoring the government budget has been installed. In this the Fiscal Policy Council plays a pivotal role. It consists of independent (mostly academic) economists (European Economic Advisory Group, 2012). There are special provisions to guarantee the autonomy of the council; for instance the council itself proposes its members to the government. Figure 6 Transparency of government policies correlates strongly to government effectiveness Effectiveness = -1.13 (t-value = -2.89) + 0.54 transparency (t-value = 6.91); R² = 0.72 2.5 2 1.5 0.5 1 3 4 5 6 Governementeffectiveness Transparency of government policies AU AT BE CA DK FI FR DE GRIT JA LU NL NZ NO PT ES SW CH UK US
  18. 18. 16 PwC Tax Freedom Day® 2013 © PwC 2013 It is sad to say but in Belgium it is often the government which appoints the members of any evaluation committee. The preoccupation is an almost mathematical assignment of the seats to the different political parties and a subordinate concern for professionalism and integrity. This observation brings us to figure 7 where government effectiveness is convincingly regressed against the absence of favouritism in the decisions of the government. Sweden excels, and is ranked in second position whereas Belgium is ranked in an unfortunate fourteenth place. Quite a lot of work remains to be done in Belgium in this area. As a third ingredient, we examine empirically the impact of the independence of the judiciary on government effectiveness. In figure 8 we observe an even stronger positive correlation. Here Belgium is lagging in 13th place compared to Sweden at in more central 7th place. For this item there is a top cluster which contains 13 countries with more or less the same score for independence of the judiciary. We note that Greece again figures at the bottom. Figure 7 (Inverse of) Favouritism in the decisions of the government correlates strongly to government effectiveness Effectiveness = -0.43 (t-value = -1.58) + 0.47 favouritism (t-value = 7.37); R² = 0.74 2.5 2 1.5 0.5 1 32 4 5 6 Governementeffectiveness Inverse of favouritism in the decisions of the government AU AT BE CA DK FI FR DE GRIT JA LU NL NZ NO PT ES SW CH UK US Figure 8 Judicial independence correlates strongly to government effectiveness Effectiveness = -0.72 (t-value = -2.78) + 0.41 independence (t-value = 8.89); R² = 0.80 2.5 2 1.5 0.5 1 43 5 6 7 Governementeffectiveness Judicial independence AU AT BE CA DK FI FR DE GR IT JA LU NL NZ NO PT ES SW CH UK US
  19. 19. © PwC 2013 PwC Tax Freedom Day® 2013 17 6. Conclusion and policy implications Civic capital creates a climate of trust which reduces transaction costs, i.e. the cost of running an economic system. As such, civic capital acts as an economic asset of a country. This paper logically demonstrates and empirically verifies a positive relationship between civic capital and economic prosperity, also when the regression analysis is applied to a smaller specific sample consisting only of mature industrialised economies. 1 But the tricky question remains: is civic capital a given endowment for a country or can it be “engineered”? We have shown that government effectiveness acts as a strategic component of civic capital. Reasonably one would surmise that government effectiveness is enhanced by allocating more budgetary means to the public sector. Surprisingly, for our sample of 21 OECD countries no correlation could be found. The conventional wisdom that more budgetary resources will automatically increase government effectiveness simply does not hold true. Other factors convincingly come into play such as the quality and transparency of government decision making itself, the capacity and integrity of the public services to implement these policies and the willingness of the citizenry to conform to the legitimate prescriptions. 2 On all these dimensions the Nordic countries perform best. As a case in point, we have compared Sweden and Belgium in greater detail. Both countries share the same size budget as a percentage of GDP, but the difference in civic capital is substantial. Hopefully policymakers and the public administration are interested in learning from better practices elsewhere. Such attitude stands in sharp contrast with the usual lament for more tax money rather than an eagerness to tackle the manifest deficiencies in policymaking and the public administration. Alternatively the Nordic countries also prove that high levels of public spending and taxation are sustainable in their prosperous economies, provided that the government delivers value for tax money. 3 Finally, the mere fact that decency pays on the aggregate may inspire citizens at large to increasingly engage in civic behaviour (W. Moesen and L. Cherchye, 1999). All efforts in this respect should be encouraged. 4
  20. 20. 18 PwC Tax Freedom Day® 2013 © PwC 2013 Appendix Table 1 Underlying data Country Civic capital Government expenditure Government effectiveness Global competitiveness value rank value rank value rank value rank Switzerland (CH) 5.75 3 33.7 21 1.89 5 5.72 1 Finland (FI) 6.03 2 55.1 3 2.25 1 5.55 2 Sweden (SW) 5.73 4 53.1 4 1.96 3 5.53 3 Netherlands (NE) 5.72 5 51.2 7 1.79 7 5.5 4 Germany (DE) 5.31 11 46.7 12 1.53 14 5.48 5 United States (US) 4.59 17 42.3 17 1.41 15 5.47 6 United Kingdom (UK) 5.41 9 51 8 1.55 13 5.45 7 Japan (JA) 5.13 13 40.7 19 1.35 17 5.4 8 Denmark (DK) 5.4 10 58.2 1 2.17 2 5.29 9 Canada (CA) 5.52 8 43.8 15 1.85 6 5.27 10 Norway (NO) 5.66 6 46 13 1.76 8 5.27 11 Austria (AT) 5.04 14 53 6 1.66 12 5.22 12 Belgium (BE) 5 15 53.1 4 1.67 11 5.21 13 Australia (AU) 5.27 12 36.3 20 1.74 9 5.12 14 France (FR) 4.83 16 56.2 2 1.36 16 5.11 15 New Zealand (NZ) 6.06 1 43 16 1.93 4 5.09 16 Luxembourg (LU) 5.6 7 41.2 18 1.73 10 5.09 17 Spain (ES) 4.25 19 45 14 1.02 18 4.6 18 Italy (IT) 3.56 20 50.6 10 0.45 21 4.46 19 Portugal (PT) 4.28 18 50.7 9 0.97 19 4.4 20 Greece (GR) 3.37 21 49.5 11 0.48 20 3.86 21
  21. 21. © PwC 2013 PwC Tax Freedom Day® 2013 19 Sources Global economic competitiveness indicator: normalised value between 1 and 7, World Economic Forum, 2012 Civic capital: institutional quality, normalised value between 1 and 7, World Economic Forum, 2012 Government effectiveness: normalised value between -2.5 and 2.5, World Bank, 2011 General government expenditure: as percentage of GDP, OECD, 2010 References Acemoglu, D., & Robinson, J. (2012). “Why nations fail: the origins of power, prosperity, and poverty”, Crown Business. Barro, R. J. (1996). “Determinants of economic growth: a cross-country empirical study” (No. w5698), National Bureau of Economic Research. Hanushek, E. A., & Woessmann, L. (2011). “How much do educational outcomes matter in OECD countries?”, Economic Policy, 26(67), 427-491. European Economic Advisory group (2012), “Report on the European Economy”, CGS-IFO. Fukuyama, R. (1995), “Trust: the social virtues and the creation of prosperity”, Free Press. Moesen, W., & Cherchye, L. (1999), “It pays to be decent: on the relationship between micro-societal values and the macroeconomic performance of nations”, 1-33. Moesen, W., & Cherchye, L. (2001), “Trust in the public sector and economic performance: strengths and weaknesses of Belgium Inc.”, 1-22. Putnam, R. (1993), “Making democracy work”, Princeton University press Rodrik, D., Subramanian, A., & Trebbi, F. (2002), “Institutions rule: the primacy of institutions over geography and integration in economic development”, (No. w9305), National Bureau of Economic Research. © PwC 2013 PwC Tax Freedom Day® 2013 19
  22. 22. 20 PwC Tax Freedom Day® 2013 © PwC 2013 I. Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 II. A comprehensive reform?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 A. Personal income tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 B. VAT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 C. Corporate income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 D. Other taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 III. Corporate taxation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 A. Corporate taxation in Belgium. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 B. Corporate tax revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 C. Impact of corporate income tax on investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 D. The race to the bottom. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 E. Impact on the design of the corporate tax regime of the future?. . . . . . . . . . . . . . . . . . . . . . . . . 29 IV. Abolishing corporate income tax vs. a low (flat) corporate income tax rate for Belgium?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 A. Why do we tax corporations?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 B. A flat tax? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 C. Corporate income tax rates in the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 D. A low (flat) corporate income tax for Belgium?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 1. A discordant tax situation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 2. The optimal tax?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 3. The cost of the tax?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 a) General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 b) Simplifying and compensatory measures?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 c) Final and transitional aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 V. Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 I. Background Looking at some profound reflections that have been done in the UK2 and the Netherlands3 , our 2012 Tax Freedom Day study already took a look at how to potentially approach a more comprehensive reform of the total tax system.4 3. Tax Freedom Day: comprehensive reforms vs. a low (flat) corporate income tax rate? 2 “Dimensions of Tax Design – The Mirrlees Review”, Institute for Fiscal Studies, 2010 (“The Mirrlees Review” or “the UK report”). 3 “Continuïteit en Vernieuwing – Een visie op het belastingstelsel”, studiecommissie belastingstelsel, (Ministerie van Financiën) (2009-2010) (“The Dutch report”). 4 See “Tax Freedom Day 2012”, http://www.pwc.be/TFD2012, pages 18 et seq.
  23. 23. © PwC 2013 PwC Tax Freedom Day® 2013 21 We refer to section I of last year’s study for the business case behind this reform5 and would just like to summarise here the reflections and conclusions on which it was based6 : 1. In all likelihood, much can already be done within our current tax regime. 2. An enlargement of the tax base coupled with a reduction in taxation is likely to be beneficial. 3. Solidarity should be a third governing principle, but this should be organised at a lower cost, given how progressive taxation can actually be counterproductive. 4. Taxation can also be used to foster/ stimulate certain behaviours, as can be seen in the area of climate change (or “green”) taxation, for instance. This should nevertheless take into account the law of diminishing returns and the fact that states must bundle their efforts to achieve certain effects. 5. Any change should also take into account possible harmful effects on GDP growth, as explained by the OECD. These reflections are still valid and they could thus yet form the basis for such more comprehensive reform or, if this is not immediately possible, for a piecemeal shift of the tax system. Therefore, in section II, we first revisit the main findings from last year’s study. On the other hand, if a more comprehensive reform (of various taxes) is not possible, it might be reviewed what changes could be envisaged that might “best” sustain economic growth, as growth would, in the end, be the best motor for any recovery or wealth creation. It may thus be useful to recall7 that, in 1997-1998, the OECD already researched what stimuli foster economic growth while maintaining tax receipts.8 The study analysed the link (from 1971 to 2004) between the tax structures of 21 OECD countries and growth in their GDP. It did not look so much at levels of taxation but focused more on the impact of changes in tax systems. It concluded that taxes obviously always have a distorting effect. It also concluded that, if changes are needed, the following taxes have the least negative impact on GDP growth: 1. Immovable property taxes (least negative impact); 2. Indirect taxes; 3. Personal taxes; and, finally, 4. Corporate income taxes (most negative impact). Therefore, this year, and especially in light of the above study, we would like to compare and contrast our reflections from last year with a more focused possible reform, looking solely at corporate income tax, which is most detrimental to economic growth. II. A comprehensive reform? Taking the above into account and in order to enable our comparison, we obviously need to refer to last year’s study9 , but to briefly summarise it, we just repeat here the governing principles and conclusions for a more comprehensive reform: A. Personal income tax 1. The top rate should probably not be changed as top rate increases are more symbolic than effective. 2. The tax base should be enlarged as much as possible, allowing a reduction in rates. 3. The focus should lie more on increasing the tax-exempt bracket (or lump-sum deduction for earned income expenses), rather than just reducing rates across the board. 4. To achieve this, it is essential to do as thorough a review as possible of all deductions, the underlying tenet being that they should be abolished and only explicitly retained where there exists a clear business case and rationale. B. VAT 1. As VAT is less harmful to GDP growth than direct tax, it should be reviewed whether the VAT base and revenues can be enlarged, while reducing the direct tax base and revenues. 2. Because taxes on labour are especially high in our country, any movement should be oriented towards reducing tax on jobs and personal income tax in general (especially for lower-income households). 5 Idem. 6 Idem, p. 30. 7 Idem. p. 25. 8 C. Heady, A. Johansson, J. Arnold, B. Brusand and L. Vartia, “Tax and Economic Growth” (2009), University of Kent; see also Jens Arnold: “Do tax structures affect aggregate economic growth? Empirical evidence from a panel of OECD countries” (OECD 2008) ECO/WKP (2008) 51 – 14 October 2008. 9 See “Tax Freedom Day 2012”, http://www.pwc.be/TFD2012, pp. 18 et seq.
  24. 24. 22 PwC Tax Freedom Day® 2013 © PwC 2013 3. It is especially relevant to review VAT as it is a virtually totally outsourced tax, which requires fewer civil servants to administer than direct taxation. Its administrative cost should thus also be lower. 4. The main factor in any reform should focus on enlarging the tax base by either: (i) abolishing certain exemptions; (ii) moving certain products and services to a higher rate bracket; or, more drastically, (iii) reviewing the UK proposal to abolish all zero and reduced rates and subject all goods and services to the standard tax rate. 5. In the case of the last option, this should also be coupled with a review of how to redirect the enhanced revenues (in particular) to lower-income households via increased tax-exempt brackets or lump-sum deductions for earned income. C. Corporate income tax 1. The OECD has determined that corporate income taxation is the tax most detrimental to GDP growth, and care should be taken – especially in the open economy we have – in how this tax is integrated into our system. In addition, we should focus in particular on attracting foreign investment, as that enlarges the tax base and in the end allows the government to lower other taxes. 2. Our notional interest deduction regime is thus actually a good system, despite all the criticism that has been levelled at it. 3. An alternative is to opt for a real flat tax, but then with a concomitantly real low rate. This option could potentially be very costly and it would be essential to review the entire system to see which deductions could be done away with to compensate. Here, too, the rate should be carefully set to attract as much foreign investment as possible. D. Other taxes 1. Reviewing whether/which environmental taxes could be appropriate both to enlarge the tax base and to steer certain behaviour. 2. Seeking to augment the involvement of private savings in helping fund the state’s financial needs and thus to also achieve greater liquidity and hence lower the interest rate at which the government funds its borrowing. 3. Reviewing whether other indirect taxes could be used to rebalance the overall tax burden. However, as it is already so high, it should also be very carefully reviewed whether adding other taxes is still viable, as the total burden could become utterly unacceptable.
  25. 25. © PwC 2013 PwC Tax Freedom Day® 2013 23 III. Corporate taxation A. Corporate taxation in Belgium Corporate income taxes appeared in our country in 1962 as a “traditional profits tax” (i.e. a tax which is supposed to tax revenues minus costs as shown in company accounts)10 . Since its inception, the tax has been subjected to many amendments and reforms (which have often made the system no longer really a “profit tax” (consider disallowed expenses under sec. 198 ITC or accelerated depreciation under sec. 64 ITC, under which goods can be depreciated faster than their useful life, the “economic exemptions” in secs. 67 to 80 ITC, the various corporation tax “deductions from taxable profit” (secs. 202 to 205 ITC) or even special inventory valuation rules under the accounting valuation rules). The reforms have sometimes also been more of a playground for politicians rather than being real reforms. The interested reader may want to review the descriptive article by Dirk Deschrijver tracing the corporate income tax reforms in Belgium since 1988, also including some references to the system before that period.11 By stepping back from these various reforms, which all may have been important or at least had important impacts, one can probably see the following five major periods (some of which do nonetheless overlap) or trends in this respect. 1. The first 20 years (from 1962 to 1982): “introduction and development” of the system In this first period, corporate taxes were introduced and developed. The initial rate was 30% in 1962, which did not really change until the early ’70s, when it gradually increased (to 48% in 1982). At the same time, the higher rates were coupled with special incentives to promote certain investments or industries. It was possible, for instance, to charge depreciation “at will” or even “depreciation up to 110%” of the acquisition value of goods12 . At the same time, the system was further refined in the sense that certain loopholes allowing abuse of some of the underlying principles were closed (for example, the abolition of “option companies”, whereby a company held by an individual shareholder could opt to be treated as transparent, allowing him to use corporate depreciation of immovables to be set against his own personal income tax13 , which, especially with the previously mentioned “depreciation at will”, resulted in serious distortions which the system had never intended). Similarly (but actually only at a later stage, in 1989) the “subject to tax condition” was introduced into the participation exemption (secs. 202-203 ITC) to ensure that only dividends received from companies that had actually paid underlying tax could give rise to double taxation relief.14 2. The second period of 20 years (from 1983 to 2003): the “coordination centre” age The early ’80s was the period of “special company incentives” (e.g. “reconversion companies”16 , “employment zones”17 and, especially, “coordination centres”)18 . The last of these were a very big motor for our economy and actually survived for more than 20 years due to the fact that Europe explicitly confirmed on two occasions that they did not infringe the EU state aid rules. That period was thus marked by a clear strategic view that the country wanted to attract headquarters and finance companies. And it was extremely successful, and was fully supported throughout this long period by all governments (which unfortunately can’t always be said for later reforms). Some of the figures demonstrate their importance: coordination centre status was applied for by over 400 multinationals, around 350 of which were licensed. Discounting those that were licensed but did not formally establish a coordination centre and those that were only here for a short time, around 280 coordination centres ultimately operated under the regime at some point. At the peak of its success, there were 263 in existence. These included a cross-section of the largest US-based multinationals as well as a significant number of UK, Dutch, Scandinavian and Belgian groups. 10 Act of 20 November 1962, official gazette 1 December 1962. 11 See Dirk Deschrijver, “Hervorming van de Belgische Vennootschapsbelasting in de periode 1988-2012, Is this the real life? Is this just fantasy?” in TRV 2013, p. 24. 12 Brought in by section 2 of the Act of 29 November 1977 introducing temporary tax exemptions to promote private investments, official gazette 9 December 1977. Also see practice note Ci.RH.421/296.056 of 31 January 1978, Bull. Bel., no. 560, pp. 405-421. 13 Repealed by the Act of 4 August 1986. 14 Act of 22 December 1989, official gazette 29 December 1989. 15 Years refer to assessment years. 16 Introduced by sec. 50 of Recovery Promotion Act of 31 July 1984; see also practice note Ci.RH.421/369.893 of 30 October 1991. 17 Introduced by Royal Decree no. 118 of 23 December 1982 on employment zones, Bull. Bel., no. 614. See also practice note Ci.RH.421/368.883 of 31 July 1987, Bull. Bel., no. 664, and practice note Ci.RH.421/439.244 of 29 November 1993, Bull. Bel., no. 733. 18 Royal Decree no. 187 of 30 December 1982 on coordination centres. Table 1 Historical Belgian standard corporate income tax rates15 1962-1974 1974-1975 1976-1982 1983-1987 1988-1990 1991 1992-2003 2004-date 30% 42% 48% 45% 43% 41% 39% 33%
  26. 26. 24 PwC Tax Freedom Day® 2013 © PwC 2013 The number of active coordination centres over the period 1999 to 2006 are depicted in figure 1. From an employment perspective, there was a large and steady increase in workforce numbers, from 1,968 in 1987 to 7,964 in 1992, peaking at 9,958 in 2002. Counting indirect employment as well, coordination centres were responsible for employing some 18,000 to 20,00019 people. This is illustrated in figure 2. 19 Of which approximately 50% were directly employed by coordination centres. The other 50% were in indirect employment. 20 Memorandum of Understanding to the bill introducing the NID, Doc. 51/1778/004, p. 13. Figure 2 Number of employees (direct) in coordination centres Source: M. P. Styczen, “SNF Working Paper No 31/2010 - Financial Centers in Belgium: A comprehensive case study of multinationals’ financial centers in Belgium”, Institute for Research in Economics and Business Administration, Bergen, 2010. 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 1968 1987 2963 1989 5601 1990 7964 1992 8139 1994 7991 1996 8227 1998 9058 2000 9958 2002 9402 2003 Figure 1 Active coordination centres Source: Finance and Budget Committee of the Belgian Parliament 0 50 100 150 200 250 300 243 1999 263 2000 243 2001 230 2002 215 2003 213 2004 177 2005/2006 During the period 1991-1999, total coordination centre share capital rose from EUR 250 million to EUR 70.5 billion. Direct foreign investment in coordination centres increased from EUR 160 million in 1987 to around EUR 4 billion in 2000, representing 45% of total foreign investment in Belgium (as opposed to 25% in the late 1980s and early 1990s).20
  27. 27. © PwC 2013 PwC Tax Freedom Day® 2013 25 3. Overlapping with this second period (from the early ’90s to date): “EU and international developments” period Although not resulting in a single reform, the next period to mention (which brings us to the present day) is one that saw all of the EU (and also other international) developments. The prime examples are (i) introduction of the Parent-Subsidiary Directive21 , the Mergers Directive”22 , development of the case law of the EU Court of Justice on the “fundamental freedoms”23 and the EU Code of Conduct on Harmful Tax Competition24 . These developments have had (and are having) a profound influence on our tax system as they actually reduce the “tax sovereignty” of the countries subject to them, and the attendant rules and principles must be taken on board in designing a tax system (small or large). The growing importance of the EU Court of Justice is demonstrated by the following table, which summarises the numbers of judgments from 1960 to 15 April 2013.25 4. From 2003-2006 to 2013: the “notional interest deduction” period Although the European Commission had ruled several times that coordination centres were not in breach of state aid rules, in 2003, it suddenly announced that they were.26 Thus, it’s against this background that introduction of the notional interest deduction (in 2006) has to be viewed: (i) firstly, it was politically difficult to reduce the standard rate at that time because some saw that as a gift for businesses; (ii) secondly, even a “normal” reduction in the standard rate would not have stemmed the flow of finance companies out of the country (since these vehicles had ample alternatives for achieving a “low”-tax status in other countries); and 21 Directive of 23 July 1990, O.J. 20 August 1990, L225. 22 Idem. 23 See arts. 49, 56 and 63 TFEU. 24 See Ecofin council meeting of 1 December 1997, no. C 2/1 - O.J. 1 of 6 May 1998. 25 http://ec.europa.eu/taxation_customs/resources/documents/common/infringements/case_law/court_cases_direct_taxation_en.pdf. 26 For a historic overview of the system and the Commission’s involvement, see Decision of EU Commission of 17 February 2003, C 2003/757/EC. Table 2 Judgements in the area of direct taxation 1960-1995 1996-2000 2000-2005 2005-2013 19 38 70 180 (iii) finally, a more drastic reduction – especially if not coupled with a complicated review of the entire system – would have cost too much (e.g. halving the rate – which still wouldn’t have been enough to keep the finance centres here – would easily have cost EUR 5 or 6 billion (before earn-back effects)). Apparently, these reasons were not, however, enough to garner the same support as had been given to coordination centres and the regime has pretty much been under attack since its inception. As a result, it’s already been changed so many times that it’s arguable that it has lost most of its initial attraction (which would herald the dawn of a fifth period, discussed below).
  28. 28. 26 PwC Tax Freedom Day® 2013 © PwC 2013 Figure 3 Capital/share premium (full chart of accounts) – in million EUR Source: National Bank of Belgium - Central Balance Sheet Office 431.748 2005 734.436 2008 302.688 Difference 70,11% 800.000 600.000 400.000 200.000 0 Figure 4 Capital/share premium (abridged chart of accounts) – in million EUR Source: National Bank of Belgium - Central Balance Sheet Office 2005 2008 34.391 48.427 14.036 Difference 40,81%50.000 40.000 30.000 20.000 10.000 0 Figure 5 Solvency ratio Source: National Bank of Belgium - Central Balance Sheet Office 0,6 0,5 0,4 0,3 0,2 0,1 0 Full chart Abridged chart 0,5 0,36 0,53 0,4 0,03 0,04 Difference 6% 11% This is – to say the least – surprising if one takes an objective view of the NID. Despite the severe crisis we had in 2008, companies’ equity has continued to increase, making them less vulnerable to distortions in the global economic environment. Detailed figures27 for 2008 compared to 2005 reveal the following: • The capital structure is rising overall (+ 68%) but is doing so most robustly for entities filing a full chart of accounts (+ 70%). And, even in companies with an abridged chart of accounts (SMEs), the capital base has increased by about 41%. Thus, SMEs are also clearly benefiting from the measure, countering the fallacy that only large companies benefit. • The significant increase in the capital structure of Belgian-based companies resulted in an improved solvency ratio: 0.50 (full chart of accounts)/0.36 (abridged chart of accounts) in 2005 compared to 0.53 (full chart of accounts)/0.40 (abridged chart of accounts) in 2008. This represents an increase of 6% for large entities and no less than 11% for SMEs. 27 Annual accounts of enterprises – Globalisations – Group PU450 (all enterprises – abstract of statutory accounts from banks and insurance companies – Nacebel Codes 0*+1*+2*+3*+4*+5*+6*+7*+8*+9*-99*). The 2008 figures are compared to those for 2005.
  29. 29. © PwC 2013 PwC Tax Freedom Day® 2013 27 5. Now and going forward: “how to (re)develop our system to further enhance growth” As the notional interest deduction regime has been subject to so much criticism28 , now is probably the time to ask, and answer, how we want to (re) develop our corporate income tax system in order to restore Belgium in today’s highly competitive world to the attractiveness it boasted in the coordination centre period, when we were highly successful at attracting foreign investment and headquarters companies. The further question here is whether this should be done by focusing on headquarters companies and “foreign investment” only, or if it can also be done by adapting our system so that other businesses (including local ones) are also able to thrive. B. Corporate tax revenues While their relative importance varies from country to country, the recent OECD Report on “Base Erosion and Profit Shifting”29 again confirmed that, across the OECD, corporate income tax raises average revenue of around 3% of GDP, or about 10% of total tax revenues. In terms of trends, the unweighted average tax on corporate income as a percentage of total taxation in OECD countries was 8.8% in 1965, dropped to 7.6% in 1975, and then consistently increased over the years until 2007, when the reported average ratio was 10.6%. Starting in 2008, probably due to the economic downturn, the ratio fell to 10% in 2008, and 8.4% in 2009; it subsequently rose to 8.6% in 2010.30 28 For an overview of these criticisms, but also of the responses, see http://www.pwc.be/TFD2012, pp. 14 et seq. 29 OECD (2013) Addressing Base Erosion and Profit Shifting. 30 Idem. 31 Idem. Figure 6 Taxes on corporate income as a percentage of GDP - OECD unweighted average Source: OECD (2012), Revenue Statistics 1965-2011 1965 1975 1985 1990 1995 2000 2007 2008 2009 2010 2011 4,5% 4% 3,5% 3% 3% 2,5% 2% 1,5% 1% 0,5% 0% Moreover, it is also important to note that the cuts in tax rates introduced by these reforms (see also III D) have not led to a fall in the corporate tax burden (measured by the corporate tax-to- GDP ratio). Actually, revenues from corporate income taxes as a share of GDP have increased over time, with the unweighted average revenue from tax on corporate income as a percentage of GDP going up from 2.2% in 1965 to 3.8% in 2007. This positive trend reversed in 2008 and 2009 due to the financial crisis, when the average ratio dropped to 3.5% (2008) and 2.8% (2009). However, it did recover slightly in 2010, to 2.9%.31 This can also be demonstrated by figure 6 above.
  30. 30. 28 PwC Tax Freedom Day® 2013 © PwC 2013 There were similar results for our country in the study by Professor Hylke Vandenbussche and Karen Crabbé of the KUL, who reviewed the development of standard and effective tax rates in Europe versus Belgium38 . In that study, the effective tax rate of large companies in Belgium was compared to that of similar companies across Europe. It showed that when Belgium lowered its standard rate from 40.17% to 33.99% in 2002 (and thus fell to 8th place in the ranking of highest tax rates), it actually stayed the third-highest (effectively)-taxed country with an effective tax burden that was still some 7.1% above the 2004 European average. This was despite a substantial rate reduction39 coupled with a widening of the tax base. It is also obvious that the race to the bottom is not yet over. A clear example here is the UK, which will be wooing businesses with one of the lowest corporation tax rates in the western world in 2015. The cut to 20% is the third in a row, the rate having dropped from 28% to 24% in April, and set to fall from 24% to 21% in 2014. With one of Europe’s biggest economies making such statement, we may be seeing the start of even bigger drops in corporate income tax rates across Europe. This also holds true for our country, where a similar result emerges - see table 3 above. C. Impact of corporate income tax on investments Apart from the aforementioned OECD study on “harmful and less harmful taxes for economic growth”32 (concluding that corporate income taxes have the most negative impact on economic growth), special reference should also be made to a number of other studies that not only support this, but have even calculated the negative impact of corporate income tax, plus two studies that have calculated the “optimal corporate income tax rate” (see below). The first study in this respect was done by the National Bureau of Economic Research in the USA in 2009 by five staff members of the World Bank and Harvard University33 . It shows that, based on data from 85 countries in 2004, the effective corporate tax rate has a serious adverse impact on aggregate investment, FDI and entrepreneurial activity. The study also showed that a 10% increase in the effective corporate tax rate reduces the aggregate investment-to-GDP ratio by two percentage points. Corporate tax rates are also negatively correlated to growth and positively correlated to the size of the informal economy.34 Obviously, conversely, this means that a 10% drop in the corporate income tax rate could result in a 2% increase in GDP. These results are also borne out by an earlier study by Lee and Gordon in 2004.35 D. The race to the bottom It is obviously against this backdrop that one has to see the drop in corporate income tax rates that has been witnessed in recent years and that (notwithstanding) has not resulted in a drop in attendant revenues. The most extensive study in this respect is probably that by Devereux, Griffith and Klemm in 2002, which looked at tax bases and revenues in advanced economies from 1960 to 199936 , which was further supplemented by another study by Abbas, Klemm, Bedi and Park.37 The studies showed that: (i) while standard rates have dropped; (ii) the revenue raised from corporate income tax has actually risen; (iii) as tax bases have broadened; and (iv) This all results in stable, or even higher, tax revenues at the lower effective tax rates charged on the larger tax bases. Table 3 Corporate tax revenue in Belgium, % of GDP, 1990-2011 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2,0 2,0 1,5 2,0 2,2 2,3 2,7 2,8 3,4 3,2 3,2 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 3,1 3,0 2,9 3,1 3,3 3,5 3,5 3,3 2,5 2,7 3,0 32 See Tax Freedom Day 2012, p. 25, http://www.pwc.be/TFD2012. 33 See Djankov, Ganser, McLiesh, Ramalho and Shleifer, “The effect of corporate taxes on investment and entrepreneurship”, Working Paper 13756, National Bureau of Economic Research. 34 Idem. 35 Lee and Gordon, “Tax Structure and Economic Growth” in Journal of Public Economics, 2005, vol. 89, issues 5-6, pp. 1027-1043. 36 Devereux, Griffith and Klemm (2002), “Corporate Income Tax Reforms and International Tax Competition”, Economic Policy, Vol. 17(35), pp. 451-495. 37 Abbas, Klemm, Bedi and Park: “A Partial Race to the Bottom: Corporate Tax Developments in Emerging and Developing Economies”, in IMF Working Paper WP/12/28. 38 Taxation Trends in the European Union, Data for the EU Members States, Iceland and Norway – European Commission Taxation and Customs Union – 2013 Edition (http:// ec.europa.eu/taxtrends). 39 Prof. Hylke Vandenbussche and Karen Crabbé: “Vennootschapsbelasting: de positie van België in het verruimde Europa”, KUL Leuven, April 2005. Source: Eurostat
  31. 31. © PwC 2013 PwC Tax Freedom Day® 2013 29 E. Impact on the design of the corporate tax regime of the future? Summarising all of this: 1. As corporate income taxes have a detrimental impact on economic growth and wealth creation40 , countries have primarily reacted by offering special incentives (for example our depreciation “at will” or, later, our coordination centres), but have also had to increase tax rates to stem the fall in overall revenues. 2. These special incentives then gradually had to be abolished, either because some groups benefited too much from the incentives compared to others (arguments of equality or discrimination) or because the incentives eventually fell afoul of formal EU rules (generally also inspired by principles of non- discrimination and equality). However, in a reaction to stay ahead of other countries in attracting investments, nations then started to reduce corporate tax rates, at the same time increasing the tax base (disallowed expenses, thin-capitalisation rules, etc.). 3. Other countries chose to drop their rate radically (e.g. the 12.5% rate in Ireland), and so increase foreign investment in one fell swoop using a low standard rate. 4. Although successful, further competition and integration in Europe resulted in even these low rates being overtaken by other countries (e.g. the 10% rate in Cyprus). 5. Belgium, on the other hand, retained a more discordant system with, on the one hand, one of the highest standard corporation tax rates (in Europe, virtually only France and Malta still have higher standard rates) and, on the other hand, a special regime for coordination centres, which conferred a virtually total exemption. It had been given explicit approval by the EU institutions on several occasions, as a result of which the system was nurtured since not only did it bear the EU seal of approval but it also had a big impact on attracting finance companies.41 6. The EU, on the other hand (and despite having decided the opposite several times) eventually ruled that our coordination centre regime was contrary to the state aid rules and had to be repealed. 40 See I and footnote 7. 41 For an impact analysis of this, see, for instance: Forum 187, “Economic and Financial Analysis of Coordination Centers”, December 1999, and M. P. Styczen, “SNF Working Paper No 31/2010 - Financial Centers in Belgium: A comprehensive case study of multinationals’ financial centers in Belgium”, Institute for Research in Economics and Business Administration, Bergen, 2010. 42 R. Boadway and N. Bruce, “A general proposition on the design of a neutral business tax”, Journal of Public Economics 24 (1984), 231-239, especially 234; M. Gammie & the IFS Capital Taxes Group, “Equity for Companies: A corporation tax for the 1990s”, Institute for Fiscal Studies 1991, especially section 2, pp. 19 et seq. 43 For a summary of these criticisms, plus a few responses, see http://www.pwc.be/TFD2012. 7. Thus, it’s against this background that the introduction of the notional interest deduction has to be viewed (see also III A, above – 4th period). 8. The notional interest deduction, moreover, had the advantage of actually introducing a so-called “neutral profits tax” as the costs of both outside and internal finance (by way of equity) are placed on the same plane (there’s a deduction for both).42 9. However, despite the above advantages, the notional interest deduction did not get the same political support as the old coordination centres had: if fact, worse still, it has been subject to attack from a number of quarters.43 10. As a result, the system has already been changed several times and it is questionable how secure its future is, bearing in mind the fact that we still face the challenge of having a discordant system of a high standard rate coupled with having attracted finance centres that still benefit from a relatively low effective tax rate (which we certainly do not want to lose).
  32. 32. 30 PwC Tax Freedom Day® 2013 © PwC 2013 The abolition option (combined with integration into personal income taxes) was in fact just recently raised by Professor Decoster of the KUL52 , who cited reasons more or less in line with those mentioned above: (i) why do we tax companies at all (they don’t really bear the cost of it, as they pass it on in lower wages, lower shareholder value and more costly products)? (ii) corporate income tax is detrimental to economic growth; and (iii) a 10% drop in corporate tax revenues would raise GDP growth by some 2%. That said, the option of entirely abolishing corporate income taxes forgets the basic reason cited by the Institute of Fiscal Studies of why we do tax companies: because we can. IV. Abolishing corporate income tax versus a low (flat) corporate income tax rate for Belgium? A. Why do we tax corporations? This, at first sight remarkable, question was posed back in 1991 by the authoritative British Institute for Fiscal Studies in its study on the corporation tax of the future, which led to the proposed “allowance for corporate equity” (of which our notional interest deduction is an instance).44 Actually, the more we look at this from a purely rational point of view, the less obvious it is why we do in fact tax corporations45 : 1. Firstly, personal income tax is paid by the company’s workforce, who take money out of the business in the form of salary. 2. Secondly, the capital providers likewise pay personal income tax on the money they draw out of the company in the form of interest, dividends and capital gains. 3. Finally, it is ultimately not the company itself that bears the brunt of corporation tax: rather, that is shifted onto its customers (in the price of the goods and services it sells), its staff (in lower pay) or its capital providers, which have to suffer a lower return on their investment. The more logical reasons why we tax companies (as already propounded by both the Institute of Fiscal Studies46 and in the 1966 Carter Report in Canada)47 therefore seem to be: 1. Because we can48 – in other words, as the Institute for Fiscal Studies has said, with the right corporation tax, it’s possible to raise revenue for the state without having to sacrifice too much in terms of economic efficiency49 ; 2. In order to avoid individuals hiding behind companies (for instance, see the controversy surrounding “management companies”); and 3. Because governments want to tax “non-residents” who invest in the country (but don’t vote here)50 and force them to contribute to its social welfare. On the other hand, given how corporate taxes in and of themselves have a detrimental effect, reference can also be made to a number of studies showing that the optimum rate for corporation tax is actually “equal to nil”51 , which is one reason why the abolition of corporate income tax is even advocated. 44 “Equity for Companies: A corporation tax for the 1990s”, Institute for Fiscal Studies, April 1991 (“IFS 1991”), section 1.2.1, p. 8.41 For an impact analysis of this, see, for instance: Forum 187, “Economic and Financial Analysis of Coordination Centers”, December 1999, and M. P. Styczen, “SNF Working Paper No 31/2010 - Financial Centers in Belgium: A comprehensive case study of multinationals’ financial centers in Belgium”, Institute for Research in Economics and Business Administration, Bergen, 2010. 45 Idem. 46 Idem. 47 Royal Commission on Taxation Report (Carter Report), Canada, 1966. 48 IFS 1991, section 1.2.6, p. 9. 49 Idem. 50 See also Huizinga and Nielsen, “Capital income and profit taxation with foreign ownership of firms”, Journal of International Economics (1977), 412, 149-165 (cited in the Mirrlees Review, p. 928). 51 See e.g. K. Judd, “Redistributive taxation in a simple perfect foresight model”, Journal of Public Economics (1985), 28, 59-83; and Chamley: “Optimal taxation of capital income in general equilibrium with infinite lives”, Econometrica (1986), 54, 607-622. 52 A. Decoster, “Vrijdenken over een belastinghervorming”, De Gids op Maatschappelijk Gebied, no. 4, 2013; pp. 5 et seq., esp. 20.
  33. 33. © PwC 2013 PwC Tax Freedom Day® 2013 31 The more logical question to ask therefore seems to be: how can we marry the advantages of abolishing corporate income taxes (i.e. achieving increased GDP growth), with the opportunity that is created to raise taxes (without resulting in investors taking flight out of the country) by maintaining a (low-rate) corporate income tax? In other words, assuming we wanted to depart from an “ordinary corporate income tax based on net profits” (as in most countries) but with a relatively high rate, or from the “neutral business tax system”, again with a relatively high rate (as our notional interest deduction system was (on its inception): 1. What optimal “low” corporate income tax rate would be low enough not to distort the economy; but 2. Would still generate maximum tax revenue for the state? Answering this question takes us through further analysis of the following points, which we discuss in the ensuing sections: 1. How do you structure a low (flat-rate) corporate income tax so that it’s attractive? (IV B.) 2. What, especially in light of the race to the bottom (see III D, above), are other countries doing to compete in attracting investments? (IV C.) 3. What other features (of the country itself, or other aspects in general) also have to be taken on board to bring the tax most optimally close to zero (distorting the economy as little as possible), but to nevertheless keep it above zero (in order to still raise revenue)? (IV D.) At the same time, it should also be noted that, before even considering such a tax, it would also be necessary not only to consider its potential cost, on the one hand (IV D(3)), but also, on the other hand, to take on board any other aspects that could hamper its introduction (IV D(3)(c)). Indeed, it may very well be that, while such a tax might be seen as appropriate (as it could eliminate any economic distortion and be good for creating wealth (cf. the discussion at OECD level on “harmful taxes”), other aspects such as the accounting impact could be detrimental and mean that in the end the tax is abandoned (or form an issue needing special attention). B. A flat tax? The concept of “flat taxes” is most associated with a proposal initially formulated in 1981 by Robert E. Hall and Alvin Rabushka53 , two senior fellows at the Hoover Institute in California. Although the proposal probably inspired most of the flat tax ideas that have emerged since54 , it is not really the kind of tax that would be needed to achieve the goal above (see IV A). If we look at the various flat taxes that have been put forward since that proposal55 , even those that have made an appearance in our country56 have generally integrated income and corporate income tax and provided for a single flat tax for both of them (as in the Hall/Rabushka proposal). 53 Hall and Rabushka, The Flat Tax, second edition 1995, The Hoover Institute Press, no. 423. 54 For a summary of some of those proposals, see Keen, Kim and Varsano, “The “Flat Tax(es)”: Principles and Evidence”, in IMF Working Paper, WP/06/218; see also Ivanova, Keen and Klemm, “The Russian Flat Tax Reform” in IMF Working Paper, WP/05/16. 55 Idem. 56 Niemegeers & Pompen, “Vlaktaks, rechtvaardig en doeltreffend”, Roularta Books (2008); or “De LDD Vlaktaks”, http://www.ldd.be/nl/vlaktaks-922.htm. 57 See also footnotes 63 and 64. 58 Idem. 59 For a sample return, see D. Mitchell, “Flat tax or sales tax? A win-win choice for America”, The Thomas A. Roe Institute for Economic Policy Studies, no. 1134, p. 5. This combined flat tax (which also, and indeed especially, focuses on personal income taxes – which generally bring in more revenue than corporate income tax) is generally the reason why such proposals have been either criticised as a pipe dream and unaffordable57 or been dismissed as nonsense.58 What’s important, however, is that what we’re looking at here and what would be needed to achieve our stated goal (of virtually abolishing corporate income taxes but still keeping a vestige at a very low standard rate in order to maximise revenues without distorting the economy excessively) would therefore not really fit the model of a Hall/Rabushka flat tax. That said, it should still bear one of the main features of the proposal: i.e. as far as possible, it should be a “simple” tax. For that reason, the Hall/Rabushka proposal (being “simple”) has even been called the “postcard” tax, as the return would fit on a postcard59 , although, in the end, even if it were enacted, it’s still questionable how very simple it would be. Although purporting to be simple, it actually seeks to replace the entire income tax system (personal and corporate) with a flat tax, more a modified form of VAT than a tax on income, while all we’re asking here is how corporate income tax can be adjusted to almost achieve both the benefits of not having it (which would be simple) and still raising money out of it (hence the need to keep something).
  34. 34. 32 PwC Tax Freedom Day® 2013 © PwC 2013 The idea for a low flat corporate income tax (apart from borrowing the term flat tax from the Hall/Rabushka concept) would therefore rather be to: 1. keep as much of the current system as possible and thus retain a corporate income tax; but 2. simplify it by abolishing certain exemptions and special regimes (unless imposed or truly essential considering the country’s international position (also mitigating revenue loss as much as possible); and 3. set a standard rate that is as close to zero as possible (to minimise economic distortions) but nonetheless high enough to still raise as much income for the state as feasible (so that the benefits of a special rule or incentive can de facto still be enjoyed in future or at least that the headline rate is set so that the future impact is constant). C. Corporate income tax rates in the EU Under III D above, we pointed to the race to the bottom which has been going on for a number of years (without, for that matter, apparently impacting corporate income tax revenues). In order to find the optimal (low) corporate income tax rate, specific focus needs to be placed on rates in the EU as such, with a sharp eye being kept on (a) our neighbours and (b) those countries that currently have the lowest rates (as we would also obviously want to dip deeper than those rates to attract as much investment to our country as possible). Figure 7 above shows: • with some exceptions, our neighbours have rates ranging from 10% to 25% (more the current average rates in the EU); • though countries like Ireland and Cyprus (both 12.5%) have gone for a low rate. Further, it’s important to note that both our neighbours (with even higher rates) and countries like Cyprus and Ireland (with low rates) apply these rates to a “normal” profit system. In both Ireland and Cyprus, taxable income is based on the profits shown in company accounts. More specifically, this clearly demonstrates that a low tax rate can go hand-in-hand with tax incentives aimed at attracting foreign investors without adversely impacting corporate income tax revenues. Figure 7 Adjusted 2012 top statutory tax rate on corporate income Source: OECD (2012), Revenue Statistics 1965-2011 33,99 10 19 25 29,8 21 12,5 26 30 36,1 27,5 10 15 15 29,2 20,6 35 25 25 19 31,5 16 17 23 24,5 22 24 0 5 10 15 20 25 30 35 40 BE BG CZ DK DE EE IE EL ES FR IT CY LV LT LU HU MT NL AT PL PT RO SI SK FI SE UK
  35. 35. © PwC 2013 PwC Tax Freedom Day® 2013 33 Both Cyprus and Ireland have an “ordinary profit tax system”, with profit being based on annual accounts in which all expenses, including asset depreciation plus interest charges, are fully deductible. Cyprus also has a 100% participation exemption for dividends and capital gains on shares. Moreover, neither Cyprus nor Ireland charges withholding tax on dividends paid out of resident companies. The 100% participation exemption on dividends and capital gains are two measures that we, too, have advocated in the past as a means to attract yet more foreign capital to our country.60 Considering these factors, it would appear that the optimal upper ceiling would still need to be lower than Cyprus and Ireland’s 12.5%, even under a normal profit system like our current corporate income tax system (in other words, if we really want to be competitive, we should avoid doing away with too many facets of our current system, as the Irish and Cypriot regimes would then become/ remain more attractive – see, however, IV D(3), for the cost of such a system and certain adjustments that would be desirable, albeit the regime would do best to keep as many of its features as possible). D. A low (flat) corporate income tax for Belgium? 1. A discordant tax situation As discussed in III E, we actually have a discordant system at present with, on the one hand, one of the highest standard corporate tax rates in Europe and, on the other hand, a low rate for finance companies (currently benefiting from the notional interest deduction). Moreover, if one looks at the effective tax rate of the old coordination centres at the time the regime was repealed (and replaced by the notional interest deduction), we see that it switched from 0.5% (still under the coordination centre regime) to 3.7% (in 2008 under the notional interest deduction).61 Obviously, with the recent drops in notional interest deduction rates, a vast number of finance companies’ effective tax rates have increased significantly. This has resulted in a number of overseas- headquartered multinationals withdrawing their finance activities from Belgium. Moreover, finance companies can also qualify for comparable lower rates abroad, which means that the optimal rate for a finance company should be between 3% and 4%. Clearly (because there are many available alternatives), any tax regime with an effective tax rate over this rate of around 3 to 4% will inevitably result in finance companies leaving the country, something that should be avoided as they are very important62 and even seem to have had the effect of sustaining corporate income tax revenues during the last crisis.63 60 See e.g. Tax Freedom Day Report 2012, http://www.pwc.be/TFD2012, pp. 38-39. 61 Forum 187 – Annual Report 2006 and information extracted from the annual accounts of all companies involved (i.e. 67 section annual accounts vs. profit before tax). 62 See, for instance: Forum 187, “Economic and Financial Analysis of Coordination Centers”, December 1999, and M. P. Styczen, “SNF Working Paper No 31/2010 - Financial Centers in Belgium: A comprehensive case study of multinationals’ financial centers in Belgium”, Institute for Research in Economics and Business Administration, Bergen, 2010. 63 C. Valenduc, “Imposition des revenus du travail, du capital et de la consommation : évolutions récentes”: SPF Finance, Documentation Sheet, Q3 2011, p. 15, 51-53. Figure 8 Effective tax rates of the old coordination centres Source: Forum 187 - Annual Report 2006 and information extracted from the annual accounts of all companies involved 0,53% 2,01% 3,69% 3,03% 2,17% 0,0% 1,0% 2,0% 3,0% 4,0% 2005 2006 2007 2008 2009
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