The Benefits of Good Tax Policy


The Benefits of Good Tax Policy

Dec 16th, 2006 4 min read

Former McKenna Senior Fellow in Political Economy

Daniel is a former McKenna Senior Fellow in Political Economy.

International bureaucracies usually disdain free-market policies. So it's remarkable to see the World Bank issuing a new report, Paying Taxes: The Global Picture, that unambiguously endorses low tax rates, simple tax systems and even the Laffer Curve.

The report, co-published with PriceWaterhouseCoopers, ranks business tax regimes in 175 nations. The Maldives, a small and obscure island nation ranks first, but other nations to earn top-10 rankings are more familiar, including Ireland, Singapore, Hong Kong and Switzerland. The United States, unfortunately, ranks 63rd, trailing countries such as Syria, Uganda and Mongolia.

America's tax rate is too high according to the report, but the biggest obstacle to U.S. competitiveness is tax complexity. With 5,100 pages of "primary tax legislation," the burden of red tape is exceeded by only four other nations.

America should radically reform the tax treatment of business, but the real story of the report is that the World Bank has embraced free-market tax policy. Among the key findings:

--High tax rates and complicated tax regimes hurt growth.

"Overall growth is also higher with lower taxes and better collection. And with tax incentives aligned to encourage work, more firms and more jobs are created. One study shows a cut of one percentage point in corporate tax rates is associated with up to a 3.7 percent increase in the number of firms and up to 1.1 percent higher employment."

--High tax rates and complicated tax regimes encourage tax evasion.

"Complicated tax systems can lead to high evasion, even when rates are low. ... A better way to meet revenue targets is to encourage tax compliance by keeping rates moderate."

--High tax rates can reduce tax revenue.

"High tax rates do not always lead to high tax revenues. Between 1982 and 1999, the average corporate income tax rate worldwide fell from 46 percent to 33 percent, while corporate income tax collection rose from 2.1 percent to 2.4 percent of national income. … Russia's … corporate tax rates fell from 35 percent to 24 percent, and a simplified tax scheme lowered rates for small business. Yet tax revenue increased -- by an annual average of 14 percent over the next three years. … Albania's corporate tax revenue rose 21 percent after the rate was cut, while in Moldova it jumped 28 percent and in Latvia, 37 percent.

In Romania, budget revenues grew 8 percent in real terms in the first quarter of 2005 relative to the same period in 2004, despite the new flat tax."

--Low-tax systems reduce corruption.

"Simplifying the tax regime by reducing tax rates and eliminating exemptions is the main way to reduce corruption in tax administration. Georgia -- which introduced major reductions in tax rates and simplifications to the tax system in 2004 -- has seen a drastic fall in perceived corruption of tax officials. In 2005 only 11 percent of surveyed businesses reported that bribery was frequent, down from 44 percent in 2002. That was the sharpest drop in perceived corruption among the 27 transition economies. Romania, another major reformer in 2004, and Slovakia, which introduced large tax reforms in 2003, also saw falls in perceived corruption: from 14 percent to 8 percent of surveyed businesses and from 11 percent to 5 percent, respectively."

None of these statements are shocking. Ever since the Reagan tax cuts triggered a global shift toward lower tax rates, the evidence in favor of better tax policy has become overwhelming. But the international bureaucracies have been hold-outs. Indeed, the International Monetary Fund recently published a sloppy -- and quickly discredited -- paper attacking the flat tax. The Organization for Economic Cooperation and Development may be even worse. This Paris-based bureaucracy actually has an anti-tax competition project that tries to penalize nations with low tax rates. The United Nations, meanwhile, has a crazy idea for global taxes.

This is why the World Bank report is newsworthy. For all intents and purposes, the World Bank has broken ranks with the other international organizations and decided to accept real-world evidence about the benefits of low tax rates and fundamental tax reform. It even endorsed Laffer Curve analysis because of the overwhelming evidence that low tax rates result in more taxable income.

That may sound like common sense, but congressional Republicans managed to hold power for 12 years without incorporating the Laffer Curve into revenue-estimating models. Who would have thought that the World Bank would wind up with better views on tax policy than the Party of Ronald Reagan?

Daniel J. Mitchell is the McKenna senior fellow in Political Economy at The Heritage Foundation.

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