In a globalised and digitalised economy, the mobility of capital and labour is increasing. This promotes global tax competition: in the case of corporate income taxation, a race to the bottom can still be observed today. Contrary to this trend, the effective average tax burden of a highly qualified employee (net income 100,000 euros) is noticeably stagnating, while top statutory tax rates for high-income earners are rising. In the future, however, the taxation of highly qualified, mobile workers could become more important due to the massive digitalisation boost caused by the coronavirus pandemic. These are key findings of a study conducted by ZEW Mannheim together with the University of Mannheim and the University of Kiel.
In order to analyse the attractiveness of a tax location for internationally operating companies, the researchers not only examined the development of corporate taxes, but also took a closer look at the tax conditions for highly qualified employees in 26 OECD countries over the last decade. “The effective average tax burden on corporate investments continues to be on a downward trend,” says ZEW Research Associate Christoph Spengel. There are major differences between the countries studied. In France, for example, the effective average tax burden of companies is 34.7 per cent – the highest value in Europe in 2019. In comparison, Germany ranks third among the EU Member States considered with almost 29 per cent. “Overall, it can be observed that the downward trend and the accompanying tax competition for corporate investments has slowed down in recent years,” says Spengel.
Tax incentives have also been shown to influence domestic and cross-border migration of highly skilled workers. If the tax burden on highly skilled labour increases, this can also have an indirect impact on employers. Countries that impose above-average taxes on highly skilled workers become less attractive as an employment location for international companies. ZEW researcher Daniela Steinbrenner explains that these differences can be immense, using the example of an unmarried and childless employee who has a disposable income of 100,000 euros after taxes and duties: “In 2019, Russia levied an effective average tax rate on highly skilled labour of 16.3 per cent, while this was 59.5 per cent in Belgium. In other words, employers in Russia had to pay 119,474 euros in 2019, while Belgian employers paid 246,914 euros – more than double – to provide the same disposable income,” Steinbrenner said. Important drivers for the differences in the tax burden are, on the one hand, the statutory personal income tax rate and, on the other hand, the social security contributions in the specific countries. Overall, the ZEW researchers observed that the average effective tax burden on highly qualified professionals has remained rather constant in recent years.
When combining both indicators, four clear strategies can be identified
To determine the overall attractiveness of countries from a tax perspective and their scope for future tax competition, the researchers combined both indicators – effective average tax burden on companies and on highly qualified workers. As before, both indicators show great differences between the countries. These regional differences have the potential to significantly influence the geographical distribution of (innovative) companies and highly skilled labour, especially in an integrated region like the European Union. Overall, four tax strategies could be identified among the 26 OECD countries studied: The eastern EU Member States tend to pursue a traditional low-tax policy – Russia and Switzerland also fall into this category. Belgium, France, Italy and Spain, on the other hand, have an above-average effective tax burden for companies and highly qualified workers. The northern EU Member States under consideration, as well as Ireland and Slovenia, are characterised by a below-average effective tax burden on mobile capital income, while highly qualified labour is taxed at an above-average rate there. In the fourth strategy, pursued by India, Japan and the USA, the tax burden is reversed: Corporations are taxed above average and highly qualified workers below average.
Leonie Fischer, co-author of the study, concludes that this puts central and western EU countries under high competitive pressure: “In order not to lose their attractiveness, countries like France, Italy and Germany in particular need to reduce the tax burden.” Germany has failed to implement major tax reforms in recent years and has thus become less appealing for investment in capital and labour.
Pandemic-related budget gaps and the global minimum tax could slow down this trend
“It remains to be seen whether the race to the bottom in corporate taxation will continue,” says Fischer. In any case, the pandemic makes this scenario less likely. Furthermore, according to Fischer, it is still unclear to what extent the global minimum tax rate of 15 per cent recently adopted by OECD countries will prevent international corporations from shifting their profits to tax havens. The concrete effects of the minimum tax cannot yet be fully determined. “Against the background of increasing restrictions on corporate tax planning and the transition to a knowledge-based economy, the taxation of labour could become more important in terms of tax competition in the future,” Fischer says. Already today, some EU countries, especially those with above-average tax rates for employees, offer tax incentives for highly qualified foreign workers in order to become more attractive in the competition for internationally mobile specialist and management staff. However, providing such incentives may lead to tax competition between EU countries.