Statistics are a lot like sausages. They can be fun to consume, but the more you look into how they are made, the more you are put off consuming them. A breath of fresh air, in that regard, has been the Doing Business statistics, which are based on countable, real-world processes and which are, in that respect, a much better set of figures to give to policymakers worried about competitiveness than better known but more abstract competitiveness rankings.
Evaluating a country’s tax system
The start of the new year has seen the release of Paying Taxes 2010, a joint publication of the World Bank (and its International Finance Corporation) and PriceWaterhouseCoopers. The Paying Taxes report, through the Ease of Paying Taxes index, is a key input into the annual Doing Business rankings. That index, though, is again a summary statistic based on a three measures of the tax system, across three key areas of business, giving nine statistics for each country in total.
Two of the measures are purely efficiency measures, namely the number of payments required and the number of hours it takes to make those payments. The third measure, the effective tax rate paid (in percent) has the potential to be more ideologically controversial, but is still a relevant metric for attractiveness to business, it’s fair to say. The three areas of taxation examined are corporate profits, labour and ‘other taxes’ (generally VAT or consumption tax).
In each country, the figures are based on a case study company, which – for those interested in such things – is a domestic flower-pot manufacturer and retailer. This was chosen, because it involved both manufacture and retail as well as some technology, and because it’s a global understood business. It’s important to note, then, that the measure is free of two types of distortions that are often important in the tax system, firstly industry-specific incentives and reliefs, and secondly incentives designed to attract foreign direct investment.
The results make interesting reading for those curious about the economic world around them. I’m sure if I asked people to choose between Mauritius and Mauritania, in terms of paying taxes, not many would have a strong opinion. However, in Mauritius, which ranks 12th in the world, there are only seven tax payments to be made, taking 161 hours in total, with a total tax rate of 23%. In Mauritania, which ranks in the bottom ten (175th, to be exact), there are 38 separate payments to be made, taking almost 700 hours and resulting in a tax rate of 86%.
Revisiting the EU’s 2010 goals
While the index can be used to generate that sort of economic trivia, it can illuminate bigger issues, for example challenges facing the EU in meetings its objectives under the Lisbon ‘Growth & Jobs’ strategy. Under that strategy, the EU hoped to be “by 2010, the most competitive and the most dynamic knowledge-based economy in the world”. Naturally, with something as broad an ambition as that, it’s hard to definitively say whether it’s a failure or not, but – at least in the realm of making it easy for domestic enterprise – the EU has lots of work to do.
There are 42 developed countries in the Paying Taxes report, of which 26 are EU member states. Despite that numerical advantage over non-EU developed countries, only one EU country – Ireland – features in the Paying Taxes top 10, compared to three non-EU countries (Hong Kong, Singapore and New Zealand). Seven EU countries, including Austria and Italy, feature outside the top 100, compared to just two non-EU countries (Japan and Mexico, included by virtue of its OECD membership, if you’re wondering).
Across all nine measures, developed countries from outside the EU score consistently better on average than their EU counterparts. The average number of payments is 13.5 outside the EU, compared to 18 in the European bloc, while the number of hours required is over 230 in the EU, compared to 195 elsewhere. Lastly, the total tax rate is higher in the EU at 44.5%, compared to 37.5% in other developed countries.
Reform labour taxes, not corporate taxes
The partial exception is when it comes to corporation taxes. In that area of taxation, EU countries require on average 1.9 payments, compared to 1.4, a small enough difference, which is actually overturned when looking at the number of hours required to complete those payments (EU: 42; non-EU: 80). Most surprising is the gap in the tax rate paid on corporate profits. The average in the EU, for the case study firm, is 12.4%, compared to 20.5% in other developed countries. (Small digression: Ireland’s marginal corporate tax rate is often cited in the EU as excessively low, at 12.5%. However, its effective rate – 11.9% – places it right in the middle of the EU rankings, behind countries like France and Belgium.)
Averages hide variation, by their very nature, and ten of the EU member states do score well in the Paying Taxes report (well meaning in the global Top 50). Therefore, it makes sense to look at the EU’s leaders and laggards and compare them with other developed countries, to see where strengths and weaknesses are. The graphs below show each of the three aspects of business regulation efficiency in the Paying Taxes report, across the top EU countries in the Paying Taxes index, other developed countries and other EU countries.
In terms of numbers of payments required, the EU’s best are in line with the rest of the developed world. The rest of the EU, however, remains hugely inefficient by comparison, apart from payments on profits. The second graph shows the numbers of hours required to pay taxes. Again, the top EU countries have very efficient systems of regulation, in international comparison. In fact, when it comes to paying taxes on profits, the EU is very efficient compared to other countries. But in the area of labour, i.e. hiring and paying workers, the bulk of the EU is very inefficient. Whereas in leading developed countries, it takes less than 60 hours to complete labour tax payments, in the majority of the EU, it takes over twice as long on average.
The final area the report looks at is the actual percentage rates charged by area. Here again, when it comes to profits, the EU is very competitive, in the sense of low rates charged, compared to other developed countries, on average; likewise ‘other taxes’ (where the EU enjoys a relatively standard VAT system across countries). However, taxes charged on labour are significantly higher than in other developed countries.
There is an important lesson here. While it’s important to be attractive to capital in a world of globally mobile capital and foreign direct investment, it’s equally important to be attractive for labour. For firms to produce, they require not only capital but also labour. Modern technology-based capital increasingly requires skilled labour to get the most out of it. Trying to build the world’s most competitive economy with one pillar will not work.