New research covering 86 countries, including Canada, has confirmed that low corporate tax rates can help to give a country a significant competitive advantage over economic rivals and are connected with higher-than-average economic growth.
But the advantage tends to be short term and has to be backed up with a good legal and economic infrastructure and targeted incentives if countries are to attract long-term private sector investment.
This conclusion comes from a study by KPMG International, which analyses international movements in corporate tax rates for the past 14 years, drawing on the annual surveys the organization has conducted since 1993.
The findings point to the economic growth enjoyed over this period by countries like Ireland, Norway, Sweden, and Denmark and draws a parallel between this success and a favourable corporate tax regime.
The outstanding example has been Ireland, which has consistently pursued policies designed to attract new investment over the past 15 years. Its headline corporate tax rate has fallen in stages from 40 per cent in 1993 to 12.5 per cent today, giving it the lowest corporate tax rate of any developed country.
At its peak, the Irish economy enjoyed annual growth rates of up to 12 per cent, although this has recently slowed to around 2.5 per cent due to strong competition on tax rates and incentives for inward investment from Eastern European countries like Poland and Hungary.
The Scandinavian countries, Norway, Sweden, and Denmark, have also enjoyed high growth rates while cutting corporate tax. Each of these countries was among the first to take radical action to cut taxes and reorganize their taxation systems in the late 1980s and early 1990s. The effect has been to help keep these countries among the world’s top 10 when measured by economic growth for the past decade.
Canada has followed the trend to cut corporate tax rates, reducing a representative combined federal/provincial rate from 45 per cent to 34 per cent between 1993 and 2006. This change results in a drop of 11 percentage points or about 25 per cent. Canada’s current corporate tax rate is slightly lower than the G7 average of 36.5 per cent.
The main exception to the trend is the U.S., which has maintained high levels of growth with a consistently high corporate tax rate of 40 per cent. Despite its high taxes, the sheer economic power of the U.S. market has preserved its attraction for multinational companies.
But even here, the effectiveness of reducing tax rates has been evident. For example, the American Jobs Creation Act of 2004, which reduced repatriation taxes from 35 per cent to 5.3 per cent for one year, caused U.S. companies to repatriate approximately US $300 billion during 2005, according to JP Morgan Chase.
A single reduction in taxes may not be enough by itself to ensure economic success. Once a major industrialized economy cuts its rates, others seem compelled to do the same, in a process of international tax competition that continues and intensifies over time.
But given the intense global competition for tax revenue, it may make sense for governments to follow the example of the commercial sector and consider strategies other than simple price cuts to attract customers. It does not have to be a race to the bottom.
This would recognize a subtle but important shift in the relationship between large multinational corporate taxpayers and national governments. As advances in technology mean that corporations can site their operations virtually anywhere, tax becomes a price that they have to pay to make use of the goods and services that a country can provide.
“Governments have an opportunity to attract inward investment not just through low taxation, but through astute global marketing of the benefits of placing operations in their countries,” said David Denley, tax partner of KPMG. “Strategies being pursued include market share strategies (such as enforcement of transfer pricing rules) and diversification of income (a shift in the balance between direct and indirect taxes).”
“There is also better communication of government strategic policy for collecting taxes and spending the revenues. By actively explaining to investors the benefits arising from their social policies, governments can make it easier for corporations to persuade shareholders and others that a particular decision was financially sensible, socially responsible and capable of producing the sustainable benefits that investors are looking for.”
Since 1993, KPMG firms have published an annual analysis of corporate tax rates around the world. In the initial survey, the rates from 23 countries were examined. Now, in 2006, the list stands at 86 countries.
The survey has recorded a consistent and dramatic reduction in corporate tax rates over that 14-year period. This reduction began in the mid-1980s in the United Kingdom when the government of Margaret Thatcher lowered the corporate tax rate from 52 per cent to
35 per cent between 1982 and 1986, forcing other countries to follow suit.
When Ireland joined the European Union in 1973, its GDP was 60 per cent of the European average. In 2006, its GDP stands at 110 per cent of the European average, and the country will, for the first time, pay more to the EU than it receives in grants and aid.
Denmark reduced its statutory tax rate from 50 per cent to 30 per cent in 1987, with an actual rate of 28 per cent. Sweden followed in 1992 when it reduced the tax rate from 51 per cent to 25 per cent, with a slight rise to 26 per cent today. Norway heavily reformed its tax system in 1992, implemented a flat tax system, and lowered corporate tax rate from 52 to 28 percent, which is still the actual rate.
KPMG is a global network of professional firms providing audit, tax, and advisory services. KPMG operates in 144 countries and has more than 104,000 professionals working in member firms around the world.
The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss cooperative. KPMG International provides no client services.