The Jury Is In

U.S. companies are overtaxed relative to their international competitors.

July 17, 2008
by Charles Swenson, PhD/CPA and Namryoung Lee, PhD/CPA

When it comes to effective corporate income tax rates of publicly-traded companies around the world, we find that "tax havens" and Asia Pacific-based companies have among the lowest effective tax rates, while U.S, Japanese, Russian and Italian-based companies have very high effective rates, compared with their benchmarked counterparts worldwide.

For all firms, taxes are a significant cash drain. In our analysis, firms pay, on average, more than 30 percent of their net income in the form of income taxes. Fortunately, income taxes are a controllable cost. With tax planning, including locating the business in tax-sympathetic countries, firms can manage their taxes and stay competitive with their worldwide counterparts. The results of our study are important for policy purposes. Although many governments advertise low statutory tax rates and advantages to locating a new business in their country, low statutory tax rates themselves are only partly indicative of the tax cost of locating in a country. Instead, effective tax rates (ETRs) are more indicative of the true tax costs. Effective rates take into account differences in the tax base (worldwide versus territorial), differences in incentives and tax credits, etc. Ours is the first study to document such worldwide effective rates.

Effective Tax Rates

Our report shows the ETRs for publicly-traded countries around the world. ETRs are firms' income tax expense divided by their pre-tax incomes for the year. Our data exclude any firms that report negative accounting earnings; effective rates for such firms would be meaningless. Effective rates can provide a glimpse of how firms and entire countries really stack up against one another. Effective tax rates, from firms' financials, are calculated as: ETR = total taxes paid/pretax income. The data are drawn from the Global Compustat database, which contain the financial statements of all publicly-traded firms in the world. To avoid potential year-by-year fluctuations, we report the average of such data from the two years 2006-2007.

The table reports, by country of incorporation, top statutory corporate tax rates and effective corporate tax rates by year for firms in our database. Top statutory rates are those effective for 2007 (Worldwide Tax Summaries (PricewaterhouseCoopers, 2007). Note that only national statutory tax rates are shown; local tax rates (e.g., Swiss Canton taxes) are not added in. Effective rates are the median rates for all publicly-traded companies incorporated (and publicly traded) within that country (because actual tax return data is not publicly available, we use financial statement data. Some caution should be exercised in the interpretation of the data because of varying accounting standards by country. The data are derived from the Global Compustat database). Effective rates can give us a clearer picture of the true tax burden faced by a company than statutory tax rates can because ETRs implicitly take into account varying tax concessions given by countries, whether the country uses a worldwide or territorial tax structure, whether the country has restrictive or liberal rules on income recognition and allowable deductions (expenses), etc. Countries with a small number of observations (less than 10) should be interpreted with extreme caution, since the data may simply show unusual fluctuations for a few companies during this time period.

As we might suspect, the tax-haven countries — the Netherland Antilles, Cayman Islands, Monaco and Panama — have statutory and effective rates at-or-under 10 percent. What is surprising are Australian companies' ETRs of 13 percent, when the country's statutory rate is 30 percent. While many countries' ETRs are below the statutory rates, a few have ETRs higher than the statutory rates. This is because the statutory rate only includes the national income tax rate. In contrast, firms' reported ETRs include national, local and foreign taxes paid. For example, Cayman Island companies have median ETRs of under 10 percent, but this is comprised solely of taxes paid to other countries.

Consistent with our expectations, Pacific Rim Asian countries compare favorably. As noted above, statutory rates are at the national level, and do not include other local or foreign taxes that a firm, located in that country, might also face. Thus, effective rates can conceivably be higher than statutory rates. The following statutory (effective) rates apply: China: 25 percent (20%); Hong Kong: 17.5 percent (14%); Indonesia: 30 percent (31%); Japan: 30 percent (41%); Korea: 25 percent (26%); Malaysia: 27 percent (21%); the Philippines: 35 percent (17%); Singapore: 20 percent (17%); Taiwan: 25 percent (17%); and Thailand 30 percent (17%). The median statutory rates for these countries are 30 percent. It is worth noting that China, Hong Kong, Malaysia, the Philippines and Taiwan have effective rates much lower than their statutory rates. Thus, these countries must have favorable tax climates. One striking result is the very high effective rates in Japan, at 41 percent.

Also consistent with expectations, U.S.-based companies pay an effective rate of approximately 29 percent, three percentage points above the worldwide average of approximately 26 percent. However, a few countries pay even higher effective rates: Argentina, Japan, Italy and Russia. In comparison, median statutory rates for other geographic areas are: South America, 30 percent; Eastern Europe, 35 percent; Central America, 30 percent; the Near East, 36 percent; Africa, 35 percent; North America, 31 percent; Western Europe, 34 percent; all others (excluding the Caribbean), 36 percent. The conclusion is that, on average, the Pacific Rim Asian and tax haven countries offer competitive tax rates and structures.

So what does it all mean from a policy standpoint? As the table shows, firms from different countries, but from the same industries, compete on a global basis, and firms located in lower ETR countries have a clear cost advantage over their competitors located in higher ETR countries. Such advantages can, in the long run, be used to undercut their competitors in terms of price, or invest in additional R&D or plant, among other things.

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Charles Swenson, Ph.D., CPA, MBT, is professor and Leventhal Research Fellow and Namryoung Lee is visiting scholar, both at the Marshall School of Business at the University of Southern California.