Tax burden on capital income: international comparison

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Main conclusions

  • The taxation of capital, both at the personal and corporate level, is the subject of much debate and affects economic growth by reducing incentives to save and invest.
  • It is useful to compare the taxation of capital income from country to country; this is not trivial. Countries have many different tax rates, exemptions, and special rules.
  • We calculate the average tax burden on capital income from aggregate statistics by dividing total capital tax revenue by total capital income. This is an approximation because taxes on household capital income are not observed directly. Our method is well used in the literature but, to our knowledge, has not been used to compare the taxation of capital between countries in recent years.
  • Among the 30 OECD countries for which data are available, the average tax burden on all types of capital income is 29%, with a range of 9% in Lithuania to 50% in Canada. In general, English speaking countries tend to have high capital taxes and Eastern European countries tend to have the lowest capital taxes. Data is from 2018 in most cases.

introduction

The taxation of capital is a complex and controversial issue. Capital taxes include personal income tax and corporation tax as well as property and transaction taxes.

Capital is very mobile. This is especially true for the corporate tax base, as many companies today have a global perspective when making investment decisions. High taxes on profits and capital gains also reduce the returns to entrepreneurship. High capital and corporate tax rates exacerbate the well-known problems caused by the tax system; for example, the incentive for companies to borrow rather than finance investments with equity, since interest is generally deductible. In addition, the taxation of capital gains when they are realized leads to foreclosure effects on the financial and real estate markets.

The result of a textbook in economics — due to the results of models by economists Christophe Chamley (in 1986) and Kenneth Judd (in 1985) —is that capital should not be taxed at all. The taxation of capital distorts the savings decisions of individuals.[1] By lowering the return on savings, taxes on capital penalize those who delay their consumption rather than consuming their income as it is earned. Due to compound interest, the taxation of capital penalizes savings all the more as the savings horizon is long. For long savings horizons, the distortion is very important. This leads to lower savings, lower capital stock and lower GDP. Therefore, not taxing capital is in everyone’s interest, even those who spend all they earn. Chamley-Judd’s result is still debated but remains the benchmark for the academic debate on the taxation of capital.[2]

As the taxation of capital is a much debated and economically important issue, it is useful to compare tax levels between countries. Data on statutory tax rates, as well as effective corporate tax rates calculated from statutory tax rates and various factors determining the corporate tax base, are readily available from international organizations such as the OECD. However, we are not aware of recent comparisons of the average tax burden on all types of capital income calculated from national accounts aggregates.[3]

Results: Average tax burden on capital income

We report the average tax burden on capital income for 30 OECD countries in 2018, or in 2017 in a few cases. The average among countries is 29 percent, with a range of 9 percent in Lithuania to 50 percent in Canada. Eastern European countries, as well as Ireland, have the lowest levels of capital taxation. Many Eastern European countries have flat or nearly flat income taxes and light corporate taxes. For example, the Hungarian corporate tax rate is 9% and Estonia and Latvia only tax distributed profits. English-speaking countries, on the other hand, tend to tax capital relatively heavily.

Denmark has the highest average tax burden on capital income in Europe Comparative study on the taxation of capital income

Methodology

To calculate the average tax pressure on capital income, we use the formula of the economist Enrique Mendoza and his co-authors of their study published in 1994 which is well used in the literature:[4]

Tax burden on capital income Taxation of capital income International comparative study OECD Timbro Tax Foundation

Looking first at the numerator, corporate tax, property tax, and transaction taxes (such as stamp duty) are easily identified. The main challenge is to identify the amount of income tax paid by households. Most countries apply a global income tax, where capital and labor income are taxed together. Mendoza et al. (1994) solve this problem by assuming that the tax rate on capital income is the same as the tax rate on all income. They therefore multiply the average rate of personal income tax by the capital income of households plus the mixed income of businesses run by their owners. This implies that the formula is an approximation, but since we are using the same formula for all countries, the ranking should not be affected much.

Sweden is one of the countries that tax capital and labor income separately. This fact can be used to test the robustness of the formula. When using actual rather than estimated tax revenues, the Swedish capital income tax rate drops by 8 percentage points, implying that Sweden moves up from 5th to 8th place in the ranking of country. Thus, there is some uncertainty in the method, but we still believe it is the most robust and transparent way to compare the average tax burden on capital income between countries.

The denominator is the total operating surplus in the economy, a national accounts term for profits. At the aggregate level, this corresponds to the total income from capital, including the imputed rent of owners. The operating surplus can be declared gross or net, depending on whether depreciation of the capital stock is deducted or not. We use net operating surplus in our calculations because it is conceptually the best definition of capital income: owners of capital care about how much they can keep after spending to replace spent capital. The ranking of countries changes little if we use the gross operating surplus instead.

We calculate tax rates for the 30 OECD countries for which data are available. Data is for 2018 for all countries except Australia, Greece, South Korea and the United States, where data is for 2017.

[1] Christophe Chamley, “Optimal taxation of capital income in general equilibrium with an infinite lifespan”, Econometrics 54: 3 (1986) and Kenneth L. Judd, “Redistributive Taxation in a Simple and Perfect Forecasting Model”, Journal of public economics 28 (1985).

[2] For a recent discussion of Chamley and Judd’s results, see Ludwig Straub and Iván Werning, “Positive Long-Run Capital Taxation: Chamley-Judd Revisited,” American Economic Review 110: 1 (2020), and Varadajan V. Chari, Juan Pablo Nicolini and Pedro Teles, “Optimal capital tax revisited”, Monetary Economics Journal 116 (2020).

[3] See David Carey and Josette Rabesona, “Tax Ratios on Labor and Capital Income and on Consumption”, in Peter Birch Sørensen (eds.), Measuring the tax burden on capital and labor (Cambridge, Mass .: MIT Press, 2004) and Cara McDaniel, “Average tax rates on consumer, investment, labor and capital in the OECD 1950-2003”, Mimeo, Arizona State University, 2007 for older calculations, and Peter Birch Sørensen, “Measuring Taxes on Capital and Labor: An Overview of Methods and Problems,” in Peter Birch Sørensen (ed.), Measuring the tax burden on capital and labor (Cambridge, Mass .: MIT Press, 2004), for a discussion of conceptual issues.

[4] Enreique G. Mendoza, Assaf Razin and Linda L. Tesar, “Effective Tax Rates in Macroeconomics: Cross-National Estimates of Tax Rates on Factor Income and Consumption” Monetary Economics Journal 34: 3 (1994).


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