8.2 - The tax burden of companies

Tax competition is often part of political debates and takes on an important role in the political agendas of all countries. The tax burden of companies and highly skilled personnel is an important cost factor when deciding where to set up a company. Regional policies should strive to maintain and improve the competitiveness and general conditions that attract innovative companies. The tax burden is the most important driving factor towards localisation as it is totally decided on a political level. A low tax burden not only attracts new companies and encourages the existing ones to stay, but also affects a company's competitiveness at an international level. Ceteris paribus, a low tax burden allows companies to charge lower prices and possibly to obtain a larger market share. This should have a positive effect on regional economic growth. Undoubtedly a government needs tax revenues to create infrastructure and provide public services. However, at any given level of infrastructure and public services, lower taxes should foster economic growth. In recent times many countries - especially Eastern European ones - have adopted aggressive policies to reduce the tax burden of companies, but they were not the only ones. Many other European countries have also reduced it in the last few decades. Companies are not only subject to direct taxation, but also have to take on part of the tax burden of their employees. In an economy based on knowledge, human resources are always more important whilst being more mobile - especially skilled ones. When choosing where to set up business, it is essential for a company - particularly a multinational one - to take into account both its own effective tax burden and that of its highly skilled employees. For these employees net disposable income (Note 1) is relevant. Firms competing to secure the best staff have to offset differences in direct taxation and social insurance among countries. Moreover, part of the tax revenues from a multinational can be transferred together with profits from one country to another. The tax burden of highly skilled personnel becomes more relevant in the choice of a place where to set up a new branch and create new jobs.
Taxation cannot be easily placed within policies for promoting the economy. Laws on taxation are so complex that an international comparison of tax burden is very difficult. Here the most recent data available are provided based on laws in force in January 2005. Regions that compete with the Veneto and are particularly interesting for tax burden benchmarking are compared. Unfortunately, not all tax systems enable us to calculate regional data. Consequently, for some regions the corresponding national data are used instead. The areas compared are the following: Baden-Württemberg, Bayern, Rhône-Alpes, Spain, London, Ireland, the Swiss cantons Zug, Ticino and Genève, Austria, Finland, Denmark, and Slovenia.

Top  The tax burden of highly skilled personnel

It is to be noted first of all that the basic BAK tax index (Note 2) (Note 3) is the tax burden of a single person with a € 100,000 income and that in most European countries income taxation is mainly handled at national level - differences at regional level are minimal and will be overlooked in this paper.
Among the countries compared only Switzerland has a clearly federal fiscal policy. Its taxation law is federal, but cantons act independently when they devise a yearly taxation multiplier - to multiply the federal rate. The countries we compare here have different taxation systems - different degrees of progressive taxation, different maximum tax rates, different family rebates and different national health services. The real tax rate aims to make the different kinds of income taxation comparable.
In Italy, personal income taxation is established at national level. Local taxes are levied on income, but they are fixed surcharges compared to national taxation - a similar system is used in Denmark and other Scandinavian countries. A peculiarity of Italian taxation is IRAP - regional tax on production activities - that is levied on the company's added value. As personnel costs are not deductible, IRAP is a tax on salary and should be taken into account when the tax burden of highly skilled personnel is analysed. The IRAP tax rate is established by the central government - 4¼ percent - and regions are entitled to adjust it by one percentage point.
With an effective tax burden of almost 45 percent, Italy is at a disadvantage in the search for highly skilled personnel when compared to most European countries in this analysis. Taxation levels similar to those of Italy can be found in France, while in Germany and Ireland they are slightly lower - approx. 41-42 percent. The tax burden in Spain and Great Britain is about 40 percent too.
The lowest tax burden is to be found in Switzerland - led by the Zug Canton with an effective tax burden of 25 percent. Among the other European countries only Austria can compete with Swiss cantons. The highest burden is to be found in Finland and Slovenia with rates equal to 56 and 52 percent respectively. Among the countries compared, the tax burden of highly skilled personnel varies considerably: it is lowest in the Zug Canton - 25 percent - and twice as much in Finland - 56 percent. In other words, an employer in Zug spends € 132,800 to grant their employee a disposable income equal to €100,000, whereas in Finland an employer needs to spend € 229,900. In Italy, for a disposable income equal to € 100,000, an employer spends € 180,500 (Figure 8.2.1).
The tax burden has three main sources: income tax rates, tax base and social contributions. In some countries a disposable income level equal to € 100,000 falls within the income bracket with the highest tax rate while in other countries tax rate scales go beyond this. The tax base varies considerably with reference to deductions, especially in the case of social contributions. This is relevant for high income levels. The burden of social contributions in the effective tax burden depends on contribution levels and on a ceiling for social contributions - if any - as these are lower for high incomes.
If maximum tax rates are compared with the BAK index, one can see that in many countries, including Italy, Ireland and Great Britain, the two figures are not very different - less than 1.5 percentage points. This means that in those countries the maximum tax rate is quickly attained and the burden of social contributions has no impact. This is also the case in Austria and Denmark, but there social contributions can be almost completely deducted and the BAK index is definitely lower than the maximum tax rate laid down by law. In Finland the burden of social contributions is so heavy that the BAK index is 5 percentage points higher than the maximum tax rate. In Finland social contributions do not have an upper limit for the highest incomes.
The tax burden of highly skilled personnel is not the only determinant of a region's economic success. For example, there is a huge difference in the economic performance of Finland and Slovenia, though they both have high tax burdens. In Finland, other localisation factors make setting up new companies easier - especially innovative and high tech companies. In Slovenia the taxation of medium-high income personnel is among the highest in Europe. This makes Slovenia much less attractive for innovative and high tech companies where this kind of staff plays an essential role (Figure 8.2.2)
In many European countries attempts are made to reduce the tax burden in order to improve competitiveness at international level. Between 2003 and 2005 Germany exhibited the sharpest reduction in tax burden (-5.8 percentage points). In 2004 in Germany the maximum tax rate was reduced and the taxation of pensions was reformed. Second comes Italy with a five percentage point reduction of the real tax burden in two years. Ticino and Austria too reduced their tax burden of highly skilled personnel by over three percentage points.
In Ireland and Great Britain, however, the tax burden has clearly increased. In Ireland this is due to the introduction, in 2004, of social contribution payments on company cars. Whereas in Great Britain, tax brackets were increased and the social insurance system was reformed, increasing the contributions made by employees. Moreover, in Great Britain employers and employees have paid an additional 1 percent tax on gross salaries since 2004.
On the one hand, an almost linear pattern of tax burden can be noticed in Italy and Germany. On the other hand, there is progressive taxation in Switzerland and Nordic countries, especially for tax brackets lower than € 200,000 (Figure 8.2.3).

Top  Company tax systems

When comparing tax systems in the different areas, the average tax burden, the cost of capital, and the marginal tax burden were calculated. The main results for company taxation can be drawn from the effective average tax rate (EATR), a measure of the real tax burden on a profitable investment, thus indicating how attractive a region is for a company that deciding where to set up. A second range of results concerns the effective marginal tax rate (EMTR), i.e. the tax burden on investments whose returns are barely enough to be worthwhile for a company. These are the last profitable investments before after-tax revenues are equal to zero. In theory, the lower the marginal tax burden in a region, the higher the level of profitable investment, and hence the greater the competitiveness of companies investing in the region.
A low tax burden attracts new companies to a region, provides incentives to stay and leads existing companies to invest further. As a matter of fact, some Eastern European countries have used an aggressive strategy to this end, thus reaching the lowest tax burdens in the whole of Europe - the most striking example is Slovakia.
Unlike personal income taxation, company taxation varies in the different regions of one and the same country. In Germany every municipality can adjust the trade tax multiplier. In Switzerland, companies are taxed on the basis of the federal system. Besides a national tax equal to 8.5 percent, the federal system includes canton and municipal taxes, which vary on the basis of the laws in each canton and municipal decisions. In theory, some degree of tax independence does exist in Italy too, as national laws on the regional tax on production activities (IRAP) - set at 4.5 percent - enables regions to adjust the rate by one percentage point. In practice, in 2005 no region exercised this right.
In almost all the countries included in the comparison, capital tax and real estate tax are decided on a regional and local level. Capital tax or property tax are only to be found in France and Switzerland, whereas they were abolished in the United States. A real estate tax - a special type of capital tax - is to be found in all European countries , except for Slovenia. This tax varies on a regional level. In most cases it is about 0.3 percent and is over 1 percent in Great Britain only. Moreover, real estate taxes can be deducted from the tax base of the company profit tax.

The average tax burden

An effective average tax rate (EATR) of companies is analysed in the regions compared. This corresponds to the BAK index of companies' tax burden. (Note 4). (Figure 8.2.4)
As is the case with taxation of highly skilled personnel, there are huge differences in the taxation of companies among the countries compared. If a company makes an investment with a 20 percent return before tax in Dublin or in the Zug Canton, it has an effective average tax burden equal to 14 percent, while in France, Spain and Germany it is as high as 35 percent. The advantage of Dublin and Zug comes from the low tax rate on profits. Moreover, in the case of Zug, the tax base is particularly favourable. The Ticino canton should also be considered as a region where taxation of investment is advantageous for companies.
With a tax burden almost equal to 31 percent the Veneto - like the other Italian regions, with minimal differences - is among the regions with a medium-high tax burden. However, the regions with the heaviest taxation are the French, the German and the Spanish ones. In Spain and Germany the high tax rate comes from the tax rate on profits, which includes both national and local taxation. The drawbacks in France are the relatively high taxes on capital and real estate, while the tax on profits is lower than in Italy.
In Slovenia, the tax burden of companies is about 10 percentage points lower than that of the Veneto. This makes Slovenia very competitive for Italian companies. The reason for this advantage lies in the very favourable depreciation conditions. Thus the high tax rate set by law does not come into force. If all incentives to investments in Slovenia were taken into account, the tax burden would decrease even further.
Finland and Denmark, with tax burdens falling within the average of the regions included in the comparison, have fiscal policies for companies that are more economically favourable compared to those for highly skilled personnel, where they rank at the bottom. (Figure 8.2.5)
Although most regions have not exhibited striking changes in company taxation over this period, some interesting cases of change in the fiscal policy can be seen concerning company investment. In general, a downward trend in taxation can be noticed in the different European countries.
Among the regions in our comparison, Austria is the country that has eased its tax burden more consistently, as its effective tax rate has reduced by eight percentage points. In 2005 a reform of the Austrian tax system introduced a flat rate amounting approximately to 25 percent of tax companies' incomes.
In 2005 Finland and Denmark reduced their tax burden by cutting the nominal tax on companies' incomes. Compared to 2003, the effective tax rate was reduced by 2.5 percentage points in Finland and 1.5 percentage points in Denmark. In the Veneto too the tax burden of companies eased somewhat.

Marginal tax burden

Besides the effective average tax burden, the BAK/ZEW model is also used to calculate the marginal effective tax burden that applies to marginal company investment, i.e. to the last profitable investments before an after-tax return equal to zero. The following table shows the different tax rates for a profitable investment (EATR) and a marginal one (EMTR). Even if the marginal tax burden is not as relevant as the average one when a decision is made where to set up a company at international level, it is important as it provides further information on the effective tax burden of companies. Moreover, if a multinational has to decide which of its branches to invest further in, a region with a low marginal rate tends to be more competitive than a region with a high marginal rate (Table 8.2.1).
In terms of tax burden, the Zug Canton - with an effective rate equal to 7.2 percent in 2005 - is the best place for marginal investment too. Slovenia has moved up from the fourth to the second place, thus turning out to be interesting for a company wishing to grow. Dublin - with a 12 percent rate - is relegated to third position.
Among the other regions Copenhagen (Denmark) and Venezia (Veneto) appear to have reached a better position, while Helsinki (Finland) and London are not so advantageous for marginal investment (Figure 8.2.6)
In the comparison of tax burdens for marginal investment, the Veneto - as well as the other Northern Italian regions - gains in the eyes of companies. In general, the negative effect of local, capital and real estate taxes is more relevant than in the case of the average tax burden. As a consequence, France is even less attractive as a place for marginal investment than in the case of the average tax burden. The positive effect of depreciation is more marked than in the case of the average tax burden. This accounts for the better competitive position of Slovenia.
With reference to both effective tax rates - the average and the marginal one - the ranking of regions may vary according to the type of investment. The ranking of regions may vary if the weights of goods that are considered in the investment or the return rate before tax change. Even the choice of mix in the sources of funding can be critical for the effective tax burden depending on taxation of debt and the corresponding interests.

Top  Conclusions on benchmarking

The tax burden of companies, but above all of highly qualified personnel is an important cost factor when choosing where to set up a company. In the previous chapter the Veneto emerged as a country with a medium-high tax burden both of skilled personnel and of companies. In the competition among companies to get highly skilled personnel with a disposable income of € 100,000, Italy ranks tenth out of 13 countries compared. This does not change if one considers an employee with dependents and improves little if a € 200,000 income is considered - 9th place. In the ranking of the average tax burden of companies calculated for a profitable investment, the Veneto ranks tenth out of 14 regions. As to marginal investments, the competitive position of the Veneto in terms of taxation improves a little as it now ranks at 8th place (Figure 8.2.7)
Figure 8.2.7 provides an overview of the level of tax burden and taxation strategies adopted in the regions compared with the Veneto (= 100).
No region in the comparison is in the first quadrant - top right - hence no region has a higher tax burden both in terms of personnel and of companies.
In the second quadrant there is a group of regions whose company tax burden is higher than in the Veneto. These are German, French and Spanish regions. These regions choose a more lenient strategy for personal income taxation - with the exception of France, where the tax burden is practically the same as in Italy. All in all, regions in the second quadrant have an effective tax burden similar to the Veneto. Finland, Denmark and Slovenia pursue an opposite strategy to the regions just mentioned. They levy relatively lower taxes on companies, but they are stricter than Italy and other continental countries as to the incomes of highly skilled personnel. Slovenia - above all - seems to apply two almost contrasting strategies: whereas personnel taxation is among the highest in Europe, the tax burden of companies can compete with that of some of the Swiss cantons and with Austria.
In the third quadrant there are regions with a tax advantage both for companies and for highly skilled personnel. Whilst taxation in London is not very different from that in the Veneto, Dublin has a particularly low taxation for companies, especially in the manufacturing industry.
The real competitors of the Veneto and of Italy in terms of tax burden are the bordering countries of Switzerland and Austria. The tax burden of companies in the Swiss cantons is between 40 and 70 percent that of the Veneto. For companies in the service industry which have a strong demand of highly skilled personnel Switzerland is a viable alternative to Italy. Similar conditions can be found in some Eastern European countries which are not included here - in particular Slovakia, whose tax burden is similar to that of the Zug canton.
Finally, it should be pointed out that taxation is not the only relevant localisation factor in an economy. Empirical studies of the BAK index on economic growth factors show that taxation is only one of the determiners of growth and that tax reduction is not the only strategy to give impetus to the economy. Innovation, a progressive, flexible labour market regulation and easy access to the region are equally important. In 2005 the empirical BAK study on the impact of a number of economic policy tools on productivity growth confirmed in any case that moderate taxation of highly skilled personnel is relevant while the impact of the tax burden of companies is less so. Therefore, it is not advisable to reduce the tax burden of companies to a minimum as a strategy for economic growth but it is important to be competitive in terms of taxation of medium-high earned incomes.

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  1. Income after tax, after payment of social contributions and taxation of earned income.
  2. Processing by BAK in co-operation with the Centre for European economic research, ZEW (Zentrum für Europäische Wirtschaftsforschung) in Mannheim
  3. The effective average tax rate (EATR) is calculated by dividing the difference between the income before tax and disposable income - the tax wedge - by the gross income. The EATR measures how much an employer will have to pay - as a percentage of the gross income - to guarantee a given level of disposable income to a highly skilled employee.
  4. It measures the effective tax burden on a profitable investment with a return before tax equal to 20 percent. The investment is equally spread over the following five types of goods: real estate, intangibles (patents), machinery, securities and inventions. Funding sources are new share capital (10 percent), retained earnings (55 percent) and debt (35 percent). The model includes tax on company profits on capital and real estate. Differences in the ways depreciation of investment and interest on debt are handled are also considered. The model also includes incentives to investment that affect the tax base in most countries. Analysis concerns company taxation as a whole, not shareholders' personal income taxation.

Figure 8.2.1
Tax burden of highly qualified personnel, 2005 (*)
Figure 8.2.2
Variation in percentage of the effective tax rate (*), 2003-2005
Figure 8.2.3
Simulation of the pattern /trend of tax burden as income increases
Figure 8.2.4
Tax burden of companies for profitable investments, 2005
Figure 8.2.5
Variation in percentage of the tax burden of companies for profitable investments, 2005
Table 8.2.1
Effective taxation index for companies (%), 2005
Figure 8.2.6
Tax burden of companies for marginal investments, 2005
Figure 8.2.7
Tax burden of highly skilled personnel (*) and companies, 2005
Chapter 8 in figures
Chapter 8 in figures

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