SMARTER TAXES SURVEY: A global tour of policies that work
The Economist: The Ideas Economy
By Roger Martin
Tax arguments tend to revolve around level: They’re either too high or too low. As these arguments quickly deteriorate into ideology – high is left and low is right—we generally get nowhere useful.
Part of that is because, economically, high/low is a less consequential dimension than smart/dumb. The question should be: Is our tax structure smartly structured? And the answer for America is definitive; it has one of the dumbest tax structures in the developed world.
What makes a tax structure smart or dumb? Put simply, a dumb tax structure discourages activities that generate prosperity (and with it a big tax base) and encourages activities that do not. A smart tax structure does the opposite.
Since the prosperity and the size of the tax base of an economy is driven by the capacity of its corporations to invest in creating high-productivity and therefore high-paying jobs, a smart tax structure provides minimal discouragement to corporate investment. The higher the tax burden on corporate investment, the lower the incremental investment in becoming more competitive and productive, the fewer high-paying jobs create and a smaller the tax base in turn. The smaller the tax base, the higher the tax rates needed to raise a given level of revenue.
Americans feel pleased that relative to other developed countries, taxation is low – and indeed they are correct. As the chart shows, America has the fourth-lowest tax receipts as a percentage of gross domestic product (GDP) of any OECD country. Collectively, the various levels of government in the USA collect revenues equal to 26% of GDP compared to 35% across the OECD.
However, its discouragement of corporate investment is among the highest in the developed world. Only four countries (France, Japan, Korea and Spain) have appreciably higher taxation of business investment than the US’s 27%.
So even though the US has a low level of taxation overall, it takes a large bite from corporate investment. That is a watermark of a dumb tax system. And it stems from a category error in logic. Progressive taxation philosophy, as applied in America, holds that poor people should pay low taxes, middle class people should pay medium taxes, rich people should pay high taxes and, since corporations are like really rich people, they should pay really high taxes. But corporations aren’t people. They are legally-constructed entities whose primary economic purpose is to create high-paying jobs (by, of course, providing useful goods or services). If they succeed, one by-product is for them to be in a position to pay dividends to their shareholders – who are taxed on those dividends.
Countries like Denmark and the Netherlands have a profoundly different – and smarter – taxation philosophy. They keep their taxation of corporate investment very low (18% and 16% respectively) in order to encourage corporations to invest, and if a high-earning citizen wants to enjoy life in Belgium or Denmark, the government will tax them relatively highly for that pleasure.
France, on the other hand, recycles 43% of its economy through the tax system and imposes the highest taxation on business investment in the developed world at 34%.
The chart begs the question: How do the countries with low taxation of corporate investment fund themselves? The answer is, with the smartest tax vehicle on the planet—the value-added tax (VAT). A VAT is a tax on consumption – i.e. it makes consumption more expensive than would otherwise be the case. Rather than discouraging the production of future growth and prosperity, VAT discourages the consumption of current prosperity. In a world increasingly concerned with sustainability, the VAT looks even smarter.
Every other OECD country has a national VAT tax, at an average of 18%. America is conspicuous with zero national VAT. This is great for the relative competitiveness of the rest of the world, but it does the US no favors.
There is a simple and straightforward solution to the current situation: America could eliminate all corporate income taxation by instituting a modest VAT. The US Treasury department and other economists pin the VAT required at between 5 and 8.5 percent—still one of the lowest VAT jurisdictions in the developed world.
In one fell swoop, that would convert America from having one of the dumbest tax structures in the developed world to perhaps the smartest. And the impact on investment and innovation would be profound.
A best-selling author, Roger Martin is Dean of the Rotman School of Management at the University of Toronto as well as Chairman of the Institute for Competitiveness & Prosperity. He is also a senior adviser to CEOs of large global companies. In 2007, BusinessWeek named him one of the ten most influential business professors in the world, and in 2009, The Times (of London) named him thirty-second on its list of the top fifty management thinkers in the world. His newest book, Fixing the Game will be published by Harvard Business School Press in May 2011.
