The Urgent Need for a Reduction in Japan's Corporation Tax Rate
- Most Countries Have a Rate of 20-30% -
May 31st, 2007
One of the pillars of Japan's growth strategy is the active use of the growth potential of overseas economies. The government has also published plans to double direct investment in Japan. But can this goal be achieved, given that many countries have reduced their corporation tax rates in recent years? Among European countries in particular, the competition to reduce tax rates is intensifying. Within Europe, countries that have either reduced their tax rate in the last few years or plan to do so in the next few years, can be grouped as follows:
(i) Countries with rates of just under 30%: Germany, the United Kingdom and Spain, large countries which have populations of several tens of millions. Spain will be reducing its corporation tax rate by 2.5% in 2007 and again in 2008, bringing the rate down from its current level of 35% to 30%. Germany will reduce its federal corporation tax rate from 25% to 15% in 2008, bringing the effective rate of corporate taxation (including local taxes on companies) down from its current level of 39.9% to 29.9%. The United Kingdom will also be cutting its rate by 2% in 2008, from 30% to 28%.
(ii) Countries with rates in the region of 25%: Netherlands, Finland, Denmark, and other medium-sized countries. Portugal reduced its rate to 27.5% in 2004; Finland and Austria reduced theirs respectively to 26% and 25% in 2005. The Czech Republic cut its rate to 24% in 2006; Greece, Denmark and the Netherlands will be cutting theirs respectively to 25%, 25% and 25.5% in 2007.
(iii) Countries with rates of 20% or less: countries that joined the EU in 2004 and candidates for admission to the EU. Poland and Slovakia both cut their rates to 19% in 2004. Romania cut its rate to 16% in 2005; Turkey cut its rate to 20% in 2006. Bulgaria will cut its rate to 10% in 2007; Estonia will cut its rate to 20% in 2009.
A survey of recent trends reveals that countries that have seen a worsening capital outflow since 2004, have implemented major reductions in their corporation tax rate in the last few years, or plan to do so in the next few years. The largest reduction, as compared to GDP, will be in the Netherlands, which is to cut its corporation tax rate in 2007, from 34.5% to 25.5%. The second largest cut will be in Denmark (from 30% to 25% in 2007), the third largest in Germany (federal corporation tax rate to be cut from 25% to 15% in 2008). Spain, in 6th place after Sweden and Canada, will cut its rate from 35% to 30% in 2008.
Although the capital outflow from the developed nations has seen an overall acceleration since the mid-1990s, there has been no serious outflow from Japan, the United States, Germany, Italy or Canada, which have the five highest rates of corporation tax. In light of this fact, some take the view that there is little urgency for these countries to implement reductions in their corporation tax rates, even though their rates are the highest in the world. However, as noted above, the capital outflow from Germany has been accelerating in recent years. The flow of domestic and foreign capital out of Japan has also accelerated in recent years. The net outflow in direct investment has gone from a level of around ¥3 trillion to ¥4.7 trillion in 2005 and ¥6.6 trillion in 2006.
The trend in Japan is changing, with mergers and acquisitions becoming more commonplace and since the beginning of 2007 there has been a surge in mergers and acquisitions involving foreign companies. As long as direct investment in Japan continues to grow, even if led by foreign companies, it can be expected to bring benefits. However, there is still a risk of capital outflow. The trend among major Swedish companies is often referred to as a case in point. In conjunction with business expansion and globalization, Swedish companies are transferring overseas not only their production bases but also their holding companies and supervisory organizations, and, mergers with major foreign companies are prompting an increasing number of Swedish companies to move their headquarters overseas. In addition to ease of access to major financial markets and ease of recruitment of skilled human resources, it appears that they are motivated by factors relating to taxation, including lighter tax burdens on revenue from overseas business and personal incomes, and lower rates of corporation tax.
However, some observers feel that the situation in Germany has been greatly influenced by the expansion of the EU and that the United States would be a better model. Some point out that, although the effective rate of corporate taxation is virtually the same as in Japan and higher than in many other countries, the inflow and outflow of capital balance out and the United States continues to achieve steady economic growth, and on this basis argue that there is no urgency for Japan to reduce its corporation tax rate.
However, while the effective rates of corporate taxation are virtually the same, the tax burdens in the United States and Japan are very different. As compared with GDP, the corporate tax burden in the United States is only between 50% and 80% of that on companies in Japan. Moreover, the effective rate of taxation in the United States is computed on the basis of figures for California and may well be higher than the actual average for the country. An analysis of tax systems reveals that States fall into three groups: those that do not impose income tax on corporations, those that apply a uniform tax rate and those that apply different tax rates according to the level of income. Even among states applying a uniform tax rate, rates vary considerably, from 9.99% in Pennsylvania to 4% in Kansas. It is therefore useful to compare tax burdens as a ratio of GDP. On this basis, California's corporation tax burden is 0.47%, and ranks 6th highest in the United States. An examination of the relationship of tax burden to rise or fall in the number of persons in employment reveals that, in general, in States where the corporation tax burden is light, the number of persons in employment has risen sharply, whereas in States where it is heavy, the number of persons in employment has seen little growth or has fallen. A total of 9 states have cut their corporation tax rates in recent years, the largest reductions having been made in Kansas (from 7.35% to 4%) and Connecticut (from 10.5% to 7.5%). In all these States, the number of persons in employment had peaked and begun to fall.
In terms of both tax rate and tax burden, Japan's corporation tax system is by far the world's harshest. Moreover, there are already signs that the outflow of domestic and foreign companies from Japan is accelerating. Looking to the future, it is inevitable that globalization will continue and that an increasing number of companies in search of better business conditions will turn overseas when looking for the optimum business location. Under these conditions, a particularly high corporation tax rate tends to exacerbate the outflow of domestic and foreign capital and can easily have severe negative effects. It is a matter of urgency that Japan should bring its corporation tax rate down to less than 30%, as Germany and the United Kingdom will be doing in 2008.
Corporation tax is an important source of revenue. For this reason, a major reduction in the corporation tax rate would lead to a severe revenue shortfall and some have criticized the idea as unrealistic. However, putting off the reduction of the corporation tax rate would be highly likely to bring economic stagnation in the medium-to-long term, and could only be described as a short-sighted decision. On the assumption that reducing the corporation tax rate is the right thing to do, there is an urgent need for a new, integrated approach to the reform of revenue and expenditure, from scratch, including further reductions in expenditure and new devices and systemic reform on the revenue side. There is also a need for a review of the role of local taxation. The proportion of local taxation revenue generated by corporation tax is generally lower in other countries than in Japan, where it is just over 20%. There are 10 countries, among them the United Kingdom and France, where local governments do not levy corporation tax. In these countries, because local taxes tend to amplify the differences in tax revenue between regions, corporate income tax is usually a national tax. It is a matter of urgency that Japan should not simply cut its corporation tax rate but should review its corporation tax system as part of a radical reform of its entire taxation system.
For more information on the content of this report, please contact Hidehiko Fujii, the Japan Research Institute, Limited.