OECD 50TH ANNIVERSARY CHALLENGES IN DESIGNING COMPETITIVE TAX SYSTEMS Paris, 30 June 2011 What is a Competitive Tax System? Statements about the importance of tax systems being ‘competitive’ are often made by business, politicians, lobbyists and other commentators, but what does this term mean? Introduction there are likely to be strong links between the competitiveness of its firms and the overall In everyday usage ‘competitive’ is a relative levels of productivity and living standards that concept. When applied to a business, it would the country is able to sustain. Individual firms mean that the firm in question is able to may then be ‘competitive’ internationally (in produce its output at the same or lower cost the sense of having a cost or other advantage than other firms in the same line of business, relative to their foreign rivals, given the or that it has some other advantage over them exchange rate, etc); and if a firm is not such as the quality of its product. In most competitive, then national output and income industries a competitive firm would (as a result are likely to be higher if the resources it would of its cost or other advantages over its rivals) have used are redeployed to another line of be able to earn returns in excess of its cost of business where profit opportunities are better. capital. Most of the drivers of the competitiveness of It is more difficult conceptually to apply the firms lie within the domestic economy. Thus term ‘competitive’ to an economy as a whole the World Economic Forum, for instance, in its rather than a particular business. An economy Global Competitiveness Report defines is made up of many different firms (plus ‘competitiveness’ as ‘the set of institutions, extensive public sector provision of services). policies and factors that determine the level of Moreover the structure of its production and productivity of a country’. The level of the pattern of its trade will depend on its productivity in turn sets the sustainable level comparative advantage relative to other of living standards. The Global economies.1 Specialisation in line with Competitiveness Report weights together data comparative advantage increases production pertinent to 12 ‘pillars of competitiveness’: efficiency and raises living standards. institutions, infrastructure, macroeconomic environment, health and primary education, For a typical advanced economy (where higher education and training, goods market natural resources and primary products make efficiency, labour market efficiency, financial up a relatively small part of domestic output) market development, technological readiness, market size, business sophistication and innovation. 1 Even if its firms operate with higher levels of productivity than their foreign rivals, an There are likely to be significant overlaps and economy cannot have a competitive advantage interactions between these ‘pillars’ and views in everything, but will specialise where that competitive advantage is greatest. The higher may differ on precisely how they translate into overall levels of productivity translate (via a increased production efficiency and growth higher real exchange rate) into improved terms potential. However, one approach to examining of trade and higher living standards. the impact of tax on ‘competitiveness’ is to Challenges in Designing Competitive Tax Systems consider how tax policy and administration wealth in the economy) has a strong bearing on impact on the various ‘pillars’ and hence competitiveness and growth. Investment decisions productivity, etc. In practice, most taxes (not just for instance will be influenced by property rights, the corporate income tax) can have an impact on attitudes to markets and levels of trust. Tax policy competitiveness, as Section B below indicates. In and administration can contribute to a competitive practice, the underlying themes arising from economy in a number of ways under this pillar, taking a ‘competitiveness’ perspective are very including: similar to those explored in OECD work on Tax and Economic Growth (OECD 2010a) and the • Raising tax revenues in a way that is broadly Tax Policy Brief on Tax Policy Reform and Fiscal accepted as fair is more likely to achieve high Consolidation (OECD 2010b). levels of (largely) voluntary compliance • Good administration that is effective in However, in considering how tax policy can help deterring evasion reinforces social cohesion to generate economic growth and prosperity, each and ensures no unfair advantage accrues to country’s tax system cannot be considered in businesses that evade tax isolation. In open economies where capital is mobile across boundaries and multinational • Similarly, tax administration that is not open enterprises play an increasing role in international to corruption and that implements tax law trade and investment, tax regimes and tax rates consistently and impartially make the tax can potentially have a significant influence on regime predictable and reduce the extent to decisions about the location of production and which it might discourage investment investment. Section C accordingly explores • Efficiency in tax administration reduces the notions of ‘international tax competitiveness’ and amount of an economy’s resources that have how they interact with other desiderata for tax to be devoted to revenue collection regimes: raising sufficient revenues, fairness, • Low compliance costs and burdens on economic efficiency, etc. Section D discusses business reduce the time that taxpayers have further some of the problems of measuring to spend on tax compliance – time and effort international tax ‘competitiveness’. that could otherwise be spent on creating income and wealth Section E then sets out a few concluding • observations on the implications for tax policy Tax policy making that is evidence-based and and the role that common principles (e.g. the transparent, with publication of the revenue OECD Model) and economic cooperation can forgone from tax expenditures and periodic potentially play. reviews of their cost-effectiveness, estimates of the revenue effects of tax measures proposed in the budget, etc. Pillars of competitiveness: The Impact of Tax Policy and Another important institutional factor for a Administration country’s competitiveness is corporate governance: having businesses that are run The following paragraphs focus on the ‘pillars’ honestly and follow strong ethical practices in identified in the Global Competitiveness Report their dealings with government on tax matters. that are most likely to be directly affected by tax policy and/ or administration. Macroeconomic environment Institutions A core objective of tax policy must be to raise sufficient tax revenues to finance public A sound and fair legal and administrative expenditure while maintaining sustainable budget framework (within which individuals, firms and deficits and public debt ratios. Correspondingly, governments interact to generate income and any tax cuts have to be ‘paid for’. The overall economic impact of a tax reform package and of Challenges in Designing Competitive Tax Systems its financing hence need to be considered Corporate) Income Tax bases by reducing tax together. expenditures would allow lower marginal tax rates; and the distortionary effects of these taxes In addition, the macroeconomic environment depends primarily on marginal rates. (The influences the extent to which the tax regime international dimension to government decisions reduces economic efficiency and growth about what to tax and the design of tax regimes is prospects. Low and stable inflation rates for discussed further in Section C.) instance reduce the distortionary effects on saving and investment of conventional income taxes A significant exception to the general rule that based on historic cost accounting. Stability of the taxes should distort market prices as little as macroeconomic environment also enables possible can arise where those prices do not stability in tax rates and regimes; and where the reflect costs (such as environmental damage) or tax consequences of business decisions and/ or benefits (such as spillovers from one firm’s R&D household savings’ choices are predictable the tax to other firms). In such cases a well-designed tax regime should lead to less distortion of the market to ‘correct externalities’ would improve economic signals to businesses and households that guide efficiency and incentives. their saving and investment decisions. Labour market efficiency Higher education and training On average in OECD countries revenues from While primary and secondary education is personal income tax (PIT) and social security generally compulsory and state funded, higher contributions (SSCs) make up about half of total education, vocational and on-the-job training revenues. This implies that tax rates can be high usually involve more private sector choice and and have potentially significant disincentive finance. Tax regimes thus need to be designed so effects. The PIT is also the tax that is most closely that they do not distort such choices and, tailored to reflect ability to pay and it plays a moreover, take account of the various market significant role in the redistribution of gross (pre- imperfections and spillovers that often arise in this tax) incomes. Governments thus have to make area. important judgments about the trade-offs between efficiency and fairness. Both can be important for Good market efficiency competitiveness. Social cohesion associated with widely-held