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Taxes in this context are all income taxes including surcharges and state and municipality taxes, as well as payroll taxes paid by the company. Social security contributions are part of the tax burden inasmuch as the employee does not earn a specific, individual benefit by paying them. According to the basic idea of competition, there is little risk of unemployment for the kind of qualified employees considered in this study. Hence we define contributions to unemployment insurance, and by a similar reasoning also contributions to accident insurance, as taxes. On the other hand, we consider health insurance contributions not to be taxes since they are deemed to provide a genuine insurance.
Contributions to public pension schemes qualify partly as taxes. The first pillar of old-age insurance is usually organised as a pay as you go system involving redistribution between generations and between high and low earning workers. Inasmuch contribution payments do not result in actual fair pension entitlements, they constitute an implicit tax rather than an insurance premium. To account for this implicit tax, we compute entitlements earned by the highly qualified employee according to the legislation currently in force and offset against contributions.
Our model distinguishes between three kinds of compensation: (1) cash compensation, (2) contributions to old-age provisions, and (3) benefits in kind. These components are taxable in different periods. Cash compensation and benefits in kind are taxable income in the year of payment. Contributions to old-age provisions are either excluded from taxable income and thus pension benefits are subject to taxation, or contributions are paid out of taxed income implying that pensions are non-taxable income during retirement. Our model explicitly deals with the timing of tax and pension payments by using an inter-temporal approach.
The base case represents the IBC Taxation Index for highly skilled manpower. Here, we consider an employee demanding a disposable income of € 100,000. The total remuneration paid by the employer in order to meet the employee’s demand consists of 75% cash compensation, 20% old-age contributions, and 5% benefits in kind. The employee is single and has no other income. The resulting effective tax burdens form four groups (see Table 3): The first group is with the Swiss cantons Schwyz, Zug, and Nidwalden reveal the lowest tax burdens of less than 30%. The second group with moderate tax burdens between 30% and 40% consists of the other cantons analysed, the United States, Poland, Luxembourg, and the United Kingdom.
High tax burdens with effective tax rates between 40% and 50% occur in Ireland, Slovakia, Austria, the Netherlands, Czech Republic, Hungary, Germany, France, and Italy. Slovenia, Sweden, Belgium, and Finland display the highest effective tax rates with more than 50%.
To illustrate these differences, it is instructive to translate back the EATRs into the total remuneration required in each location so as to provide the employee with a disposable income of € 100,000. To achieve this, a company has to spend € 134,574 in Schwyz, € 161,740 in Massachusetts, and € 230,415 in Finland. Thus, taxes interfere heavily in the international competition for talent.
The most important tax drivers influencing the effective tax rates on highly skilled labour are the top tax rate of the personal income tax and the amount of charges paid within the contributions to social security.
Regarding the top tax rates (including state/cantonal income taxes and surcharges), the Swiss cantons Zug, Schwyz, and Nidwalden again form a group with the lowest top tax rate. They display top tax rates (including cantonal and municipal income taxes) of less than 30%. The second group with top tax rates between 30% and 40% is formed by the Czech Republic, the Swiss Canton of St. Gall, Luxembourg, and Slovakia. Top tax rate of at least 50% apply in Austria, Slovenia, Germany, Finland, the Netherlands, Belgium, and Sweden. The remaining countries levy taxes of between 40% and 50% at the top.
This ranking is widely reflected in the effective tax rates. However, the corresponding incomes from which on the top tax rates apply also are an important factor. In the Czech Republic and in Hungary, tax payers with incomes of € 10,000 and of € 5,000, respectively, already achieve the top tax rates of 32% and 40%. Despite comparably low tax rates, those two countries find themselves in the last third in the ranking. Austria and the Netherlands with top tax rates of 50% and more display lower EATRs due to a higher progressivity in their tax tables and capped social security contributions. Especially for the United States and Switzerland, where the top tax rates often apply only for incomes exceeding € 200,000 and more, the EATRs for a disposable income of € 100,000 are far below the top tax rates.
Regarding the charges payable on a highly qualified employee’s income, the most important impact is the existence or absence of income ceilings from which on no further social security contributions are payable. Only in Austria, Germany, Luxembourg, the Netherlands, Slovakia, and the United States income ceilings exist for all branches of social security for both the employee and the employer. In particular, a low ceiling of € 9,300 applies in Slovakia; the Netherlands have ceilings of around € 30,000. However, the contribution rates are comparably high with more than 40% of gross income. Belgium, Switzerland, the Czech Republic, Finland, and Slovenia do not apply any income ceiling for social insurance contributions. So, the total contribution rate is payable on all income. While Switzerland therefore has a comparably low total contribution rate of less than 15% Slovenia and Belgium levy contributions at rates of around 40%. This results in high EATRs for Slovenia and Belgium. Combined with high top tax rates, the EATRs amount to over 50%. Belgium is on the second-to-last rank;
Slovenia ranks fourth-to-last.
The model allows evaluating the effects of a large number of different economic and personal circumstances. For example, all regions grant tax relief for families in the form of child benefits or special tax schedules depending on marital status and the number of children. The results of the model show that families in Germany, Ireland, the USA, France, and Switzerland enjoy a particularly strong reduction of their tax burden relative to singles (see Elschner and Schwager, 2004 and 2005).
While any variation obviously affects the calculated EATRs, sensitivity analyses show that the ranking of EATRs is quite robust to changes in specific assumptions of the model. In all cases Zug, Schwyz, and Nidwalden have the lowest tax rates, usually followed by the remaining Swiss cantons, the United States, Poland, Luxembourg, and the United Kingdom. Slovenia, Sweden, Belgium, and Finland change ranks among each other but most of the time remain at the high end of the scale. The new EU Member States are not inevitably attractive countries from the tax perspective if one looks at the taxation of highly qualified employees.
In contrast to the tax burden on companies they rather show a moderate or even high tax burden on skilled manpower.
4 Tax Policy Strategies: Explanations and Implications
In this section, we provide a synthesis of the findings about the effective tax burdens of both companies and highly skilled manpower. In the first subsection, we aim at identifying tax policy strategies pursued by the countries analysed. In the second subsection, we discuss several hypotheses which might explain the diversity found among these strategies. While this discussion necessarily remains speculative without a thorough empirical analysis, it will nevertheless present some insights into the political motives and economic circumstances which may have caused the levels of taxation found in our study. This is important since any policy advice to be derived from our figures should take into account the likely political aims and the special situation of each country. The discussion of political implications is the purpose of the final subsection.
4.1 A synthesis of both indicators
Fig. 2 provides a synthesis of the two indicators for the effective tax burden of companies and on highly qualified employees. For five Swiss cantons and the other countries, this figure displays the EATR at the corporate level together with the EATR of a single-earner employee obtaining a disposable income of € 100,000 in 2003. Due to a number of conceptual differences, we cannot compare the absolute values of the IBC Taxation Indexes for companies and for highly qualified employees. Especially, both concepts of effective tax burdens do not permit straightforward conclusions on distributional issues. Nevertheless, we can compare the rankings and the relative differences in effective tax burdens between both indicators.
For this purpose, we index the effective tax burdens of all countries and the Swiss cantons relative to the average of the included Swiss cantons and the other countries. A canton or country with an index number 100 for the taxation of companies (highly skilled employees) thus has an EATR for companies (highly skilled employees) which equals the average of all cantons and countries considered. The vertical (horizontal) distance between an observation and the axes shows how much lower or higher a location’s effective tax burden is compared to the average in the case of companies (manpower).
It is striking that effective tax burdens appear to be closely correlated for a number of locations. Especially for Swiss cantons, we find a low level of effective tax burdens of companies and a low tax burden on highly skilled workers. Other regions that impose large corporate tax burdens also impose large tax burdens on comparatively high personal incomes, especially Germany, France, and Italy. Thus, the Swiss cantons follow a clear low tax strategy with respect to both companies and highly skilled manpower while the other three countries mentioned can be characterized as high-tax countries in both respects. Also Austria, the Netherlands, the United Kingdom, Luxemburg, and Poland display a point on or somewhat above a hypothetical diagonal in Figure 2, indicating a similar ranking in both indicators. The level of taxation is at an intermediate level in both respects for these countries.
There is a group of countries which tax highly qualified employees quite heavily while taxing companies only moderately. Especially Hungary and Slovenia have low tax burdens for companies but highly skilled employees suffer a comparatively high tax burden there. This holds also for Sweden and Finland, which both have dual income tax systems with low tax rates on capital and high tax rates on employment income. Although less clear cut, also Belgium and, with a lower overall level of tax burden, Slovakia and the Czech Republic, can be associated to this group. The most pronounced example for this group obviously is Ireland, which almost matches the most favourable Swiss location in terms of company tax burden while imposing an effective tax rate on skilled manpower which is close to the mean of the regions considered. The tax policy strategy chosen by these countries apparently consists of selectively reducing the tax burden on companies while keeping labour income taxation at relatively high levels.
Finally, the United States (Massachusetts) differs remarkably from all other countries analysed. There, the tax burden on companies is among the highest of all regions considered, while qualified employees are taxed quite moderately. Thus, the strategy of the United States consists of very moderate taxation of high earners combined with a substantial tax on company income.
4.2 Why do countries choose different tax policy strategies?
We group the potential determinants of the tax policies chosen by different countries into three categories. The first two of these, political institutions and preferences for redistribution and equality, essentially determine the amount of government revenues required. The third category, position in the processes of globalisation and growth, mainly explains strategies in company taxation.