According to this year’s International Tax Competitiveness Index, Estonia has the most competitive taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. system in the developed world.
Key drivers for Estonia’s high rank are its relatively low corporate tax rate at 21 percent with no double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of dividend income, a nearly flat 21 percent income tax rate, a property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. that only taxes the value of land and not the value of building and structures, and a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. that exempts 100 percent of foreign profits.
Overall, Estonia scores highly in each of the five categories in the index. It ranks first in both corporate taxes and property taxes, second in income taxes, eighth in consumption taxes and eleventh in international tax rules.
Estonia’s Tax Structure
Not only does Estonia have relatively low tax rates, it also provides an example of a neutrally structured tax system that does not discourage saving and investment.
Estonia Has a Neutral Business Tax System
For its corporate tax, it all starts with the correct tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . Estonia allows for full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of capital investment. This means that when business determines its profit, it is able to account for the full cost of capital investment (plant, equipment, structure, etc.) in the year in which it is incurred. Every other OECD country requires that business write off these business investments over multiple years and sometimes not at all.
Additionally, Estonia only taxes distributed profits and at a 21 percent tax rate. This means that if a business in Estonia earns $100 and pays that $100 to its shareholders, the business would be required to pay a tax of $21 on the distributed profit. Instead, if that business decides to reinvest that $100, the business would not have to pay tax on that $100.
Now, this does not mean that the income goes untaxed. Instead, the profit is potentially taxed as at Estonia’s 21 percent capital gains rate. If the business reinvests its $100 profit, it is probable that the value of the business would increase and, with it, the value of a shareholders shares. If a shareholder were then to sell their shares, they would face the 21 percent capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. rate.
Estonia also provides a 100 percent exemption on all foreign earned income.
Estonia has Neutral Property Taxes
Estonia is one of three OECD countries to correctly define their property tax base by only taxing the value of land. This is important because many countries tax both the value of land and any buildings or structures built on top of this information. This, in effect, becomes a tax on capital; if a business builds any new structures or buildings, it will result in a higher property tax bill. Instead, Estonia’s tax system is neutral between land holding and development.
Additionally, Estonia does not levy an estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. , nor any transfer taxes, wealth taxes, or financial transaction taxes as we see in other OECD countries.
Consumption and Individual Taxes
Estonia has a simple, broad-based value-added tax with a 20 percent tax rate, which is slightly above the OECD average. It also has a relatively flat, 21 percent income tax rate, which is half of the OECD average top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. of 42 percent.
Estonia does have an above average tax burden on labor at close to 40 percent and a slightly above average capital gains rate, though the structure of its corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. and its elimination of the double taxation of corporate income mitigates the economic harm of its capital gains tax.
Estonia Provides a Model Example on Business Taxes
Estonia’s tax system—with full expensing, a single layer of taxation on corporations via the 21 percent corporate rate or the 21 percent capital gains rate, the exemption of foreign earned income, and well-structured property taxes—gives it the most competitive tax code in the developed world.
When discussing business tax reform, congress should look to the example set by Estonia. A tax code that correctly defines business income and eliminates all the biases against saving investment would be a boon to U.S. investment and economic growth.
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