Comparative Taxation

Some Basic Points

Philip R. West Steptoe & Johnson LLP Presentation to Congressional Working Group on International Taxation November 8, 2002

What makes one system better than another?

• Economic efficiency: Is it good for the economy?

– This may differ from whether it is good for any particular taxpayer • Simplicity: Can it be complied with and administered?

• Fairness: Are distributional effects politically desirable?

– Businesses, not only individuals, argue for fairness (largely vis-à vis foreign competitors) under the name of “competitiveness” 1

How do we compare tax systems?

• What taxes do the systems use to raise revenue? • What is the balance? – To what extent is revenue raised by each tax element of the system?

• What are the technical rules used to implement each tax?

2

Keep in mind

• Marginal rates alone may tell little – The tax base may be more relevant • What income is included in the tax base?

• What tax deductions, exemptions and credits are available?

• Are tax “holidays” available?

• “Fairness” and “competitiveness” are hard to measure, or even define – “Competitiveness” may be a shorthand way of saying that “taxes on U.S. businesses should be lower, compared to their foreign competitors” – “Fairness” may be a shorthand way of saying that “taxes should be imposed based on ability to pay” – Fairness may be measurable through distributional or incidence analyses, but there does not appear to be any reliable way to compare the effect of tax systems on competitiveness 3

What taxes are used to raise revenue?

• • • • • • – – Income taxes Corporate Individual – Employment taxes

E.g.,

social security taxes – Consumption taxes

E.g.,

state sales taxes, VAT Excise taxes Property taxes User fees and other charges 4

Total tax receipts as a percentage of GDP

– U.S.: 28.9% – OECD average: 37.0% – EU average: 41.3% • Source: OECD in Figures, 2001 5

Comparative tax burdens as a percentage of total collected revenues (Source: OECD in Figures, 2001) Personal income tax plus employee portion of social security Corporate income tax plus employer portion of social security Consumption taxes U.S.

50.7% OECD Average 34.1% 21.2% 23.8% 16.2% 31.3% 6

• •

Office of Management and Budget, Citizen’s Guide to the Federal Budget, 2001

As a percentage of collected revenues, over the past 50 years: • Both corporate income taxes and excise taxes have declined significantly • • Social insurance taxes have grown significantly Individual income taxes have grown slightly “Corporate income taxes have shrunk steadily as a percent of GDP, from 4.5 percent in 1955 to an estimated 1.9 percent in 2001.” 7

•

Comparing income tax systems

• What persons are subject to the country’s taxing jurisdiction?

– – Most every country asserts taxing jurisdiction over its “residents” The United States also taxes its “citizens” On what income are those persons taxed and on what income are they exempt? 8

What income is taxed and what is not?

• • – – – – – – – The U.S. exempts, among many other things: State and local bond interest Certain employer-provided benefits, Certain health benefits and life insurance proceeds Certain compensation and benefits of members of the armed forces Certain gains from the sale of a principal residence • • • Other income, to the extent tax on that income is offset by credits, including EITC and credits for, among other things, certain expenditures relating to: Certain dependent care services, adoption, and education Certain retirement plans Certain business investments Many other exemptions and credits Foreign countries have their own exemption lists 9

Treatment of foreign source income

• No country taxes all foreign source income • No country exempts all foreign source income • All countries tax some foreign source income and refrain from taxing some foreign source income 10

• • • How the U.S. eliminates tax on foreign source income Exemption: • We exclude or

exempt

certain limits foreign earned income of individuals up to Deferral: • We

defer

taxation of foreign active business income earned by U.S. individuals or corporations, as long as they earn the income through a non-U.S. corporation.

• Even “passive” income is eligible for this deferral if it is subject to foreign taxes at rates close to the U.S. rates. • Credit: • This deferral lasts until the money is returned for use in the U.S. For income not subject to exemption or deferral, we provide a dollar-for-dollar

credit

against U.S. taxes for foreign taxes on that income. • The credit is subject to limitations designed to reduce the credits that can offset U.S. tax on U.S. source income 11

The international tax debate

• • – – –

Much of the debate concerns the extent to which one or another of these three regimes should apply and, in the case of deferral and credit, what the scope of deferral should be and how the credit should operate:

Exemption from the tax base Inclusion in the tax base with credit for foreign taxes Deferral with anti-deferral rules – – – –

Other countries use different mixes of exemptions, deferrals and credits to achieve the politically desired results in their jurisdictions.

France, Canada and Germany use exemptions more than credits The US, UK and Japan use credits more than exemptions. All six use anti-deferral rules. See Ault, Comparative Income Taxation, A Structural Analysis (Kluwer, 1997) 12

Territorial vs. U.S. systems: treatment of foreign sales income, without application of FSC/ETI rules Plant Plant Sales Domestic Manufacturing and Domestic Sales Activity •In general, both the U.S. and territorial systems would tax the income derived from goods where manufacturing and sales activity was domestic, whether sold for domestic or foreign consumption. (US tax treatment actually would generally be more favorable if foreign consumption.) 13

Territorial vs. U.S. systems: treatment of foreign sales income, without application of FSC/ETI rules Parent Co Goods Manufactured and Sold Abroad Parent Co •Both the U.S. and territorial systems would mitigate taxation (through deferral or exemption) of the income derived from goods manufactured and sold abroad. Territorial systems continue this treatment even after profit repatriation Plant Sales Plant Sales 14

Territorial vs. U.S. systems: treatment of foreign sales income, without application of FSC/ETI rules Plant Other Jurisdiction Sale Co Sale Co Goods Manufactured Locally & Sold Abroad •U.S. taxes the sales commissions earned by Sale Co. (assuming inapplicability of FSC/ETI and 2002 Thomas Bill), unless Sale Co. is in the destination country, in which case that income is deferred.

•Some EU countries exempt the sales commissions earned by Sale Co., but •If sales activity occurs in a high-tax jurisdiction, there is no tax benefit •If sale is from a tax haven •Arm’s length pricing should prevent allocation of any significant income to the tax haven •Also, foreign CFC rules may tax any income that is allocated to the haven Plant Plant 15

VAT vs. income tax: impact on trade/exports

• VAT not preferable to income tax in terms of impact on trade/exports • See M. Feldstein & P. Krugman,

International Trade Effects of Value Added Taxation

, in Taxation in the Global Economy, Razin and Slemrod, eds. (U.Chi. 1990) – Conclusion is independent of reasons relating to VAT complexity and evasion potential 16