CBO Compares International Corporate Tax Rates

In the United States, the top federal statutory corporate income tax rate (the rate set by law that applies to the highest corporate income tax bracket) has been 35 percent since 1993. Most corporate income is taxed at that rate. With state taxes added in, the top statutory rate is even higher; on average, that combined rate was 39.1 percent in 2012, among the highest in the world (see Summary Table 1).¹

The statutory corporate tax rate is one of many features of the tax system that influence corporate behavior. Companies are likely also to consider other provisions of the tax system -- including tax preferences, surtaxes, and noncorporate taxes -- that affect the amount of taxes they owe. Among the alternative measures of tax rates that account for some of those provisions are the average and effective marginal corporate tax rates.

The average corporate tax rate is a measure of the total amount of corporate taxes that a company pays as a share of its income. The Congressional Budget Office estimates that the U.S. average corporate tax rate for foreign-owned companies incorporated in the United States in 2012 was 29 percent -- about 10 percentage points below the top U.S. statutory corporate tax rate.²

The effective marginal corporate tax rate (in this document, the effective corporate tax rate), is a measure of a corporation's tax burden on returns from a marginal investment (one that is expected to earn just enough, after taxes, to attract investors). CBO estimates that the effective corporate tax rate was 19 percent in the United States in 2012. That rate, the fourth highest among the Group of 20 (G20) countries, was about 20 percentage points below the top U.S. statutory corporate tax rate.³

This chart book is an update and expansion of CBO's 2005 report that examined statutory and effective corporate tax rates for the United States and member countries of the Organisation for Economic Co-operation and Development and the Group of 7 between 1982 and 2003.⁴ This report focuses mainly on the 2012 tax rates in countries that are members of the G20. CBO expanded the analysis to include average tax rates, which were estimated on the basis of information reported for income and taxes paid by corporations in a given year. For both this report and the 2005 report, effective corporate tax rates were derived from simulations based on certain features of the various countries' tax systems.

 

Summary Table 1.

 

Corporate Tax Rates in G20 Countries, From Highest to Lowest, 2012

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 6.]

 

 

 

How Do Different Tax Rates Affect Business Decisions?

All three types of corporate tax rates affect a company's decisions, but each influences a different choice. Because of their broader scope, average and effective corporate tax rates are better indicators of a company's incentives to invest in a particular country than is the statutory corporate tax rate. The average corporate tax rate reflects a country's corporate tax rate schedule, the system's tax preferences for business investments, any surtaxes, and possibilities for tax avoidance or evasion. Companies consider the average corporate tax rate when deciding whether to undertake a large or long-term investment in a particular country. The effective corporate tax rate, which is a measure of the tax on a marginal investment, is more informative for decisions about whether to expand ongoing projects in those countries in which a company already operates. In contrast, businesses focus on the narrower statutory corporate tax rate when they develop legal and accounting strategies to shift income earned in high-tax countries to low-tax jurisdictions -- especially low-tax jurisdictions in which those businesses do not plan to invest and from which they thus expect no benefits from tax preferences for business investments.⁵

Is the U.S. Statutory Corporate Tax Rate Comparable to Rates of Other Countries?

The top statutory corporate tax rate in the United States in 2012 was 10 percentage points higher than the average (weighted by gross domestic product, or GDP) of the top rates in the other G20 countries, CBO estimates. In 2003, Japan, Germany, and the United States had the highest statutory corporate tax rates among G20 countries; by 2012, reductions in Japan's and Germany's top rates had dropped them to second and ninth place, respectively, boosting the United States to the top of the list. The United States also had the highest rate among the 15 countries with GDP above $1 trillion in 2012, according to one survey of 129 jurisdictions.⁶

In countries outside the G20, tax rates varied more widely in 2012. On the one hand, the United Arab Emirates taxed corporate income at rates up to 55 percent. On the other hand, some jurisdictions had rates so low (and in some cases collected no corporate income taxes at all) that they were considered tax havens, attracting companies to relocate income from other countries with higher corporate income tax rates.

How Do Average Corporate Tax Rates Differ by the Country of Incorporation?

A U.S.-owned foreign company is one that is incorporated outside the United States and has more than half of its shares (a controlling interest) owned by a single U.S. taxpayer. About 49,000 U.S.-owned companies were incorporated in G20 countries in 2012. CBO estimates that those companies faced average corporate tax rates in 2012 that were nearly always lower than the top statutory corporate tax rate in the country of incorporation. Two exceptions were Argentina and Indonesia, which had the G20 countries' highest average corporate tax rates for U.S.-owned foreign companies. Average corporate tax rates in the G20 for those businesses ranged from a high of 37 percent in Argentina to a low of 10 percent in the United Kingdom -- the G20 country with the greatest number of U.S.-owned foreign companies in 2012.

In this report, CBO compares average corporate tax rates for U.S.-owned foreign companies with the rates faced by foreign-owned companies incorporated in the United States. Those businesses have more than half of their shares owned by a single foreign taxpayer. If it were possible to calculate, the best measure for comparing new investments in a foreign country with those in the United States would be the average tax rate faced by the U.S.-located affiliates of U.S.-owned foreign companies. That rate, however, cannot be calculated with available information. Instead, the average tax rate faced by foreign-owned companies incorporated in the United States is used as an approximation because both types of companies operate outside of their domestic markets. In 2012, the average tax rate faced by foreign-owned U.S. companies was higher than the average rates that U.S.-owned companies faced in all but two other G20 countries.⁷

Average corporate tax rates were lower in 2012 than they were in 2004 in the United States and eight other G20 countries, CBO estimates.⁸ Top statutory corporate tax rates fell in most G20 countries between those two years, but other changes in the tax system and the economy also affected average corporate tax rates.

How Do Effective Corporate Tax Rates Differ From Top Statutory Corporate Tax Rates?

Two key features of national tax systems cause effective corporate tax rates to differ -- both in magnitude and direction -- from top statutory corporate tax rates: the treatment of depreciation (the loss in value attributable to wear and tear of an asset) and the sources of financing for investments. CBO estimates that, at 18.6 percent, the U.S. effective corporate tax rate in 2012 was more than 20 percentage points lower than the top statutory rate.⁹ Other tax preferences that are part of the U.S. tax code but that are not included in this analysis would lower that rate even more.

The U.S. tax code provides companies with deductions for depreciation (known as cost recovery allowances) that are more generous for equipment than for buildings, although the opposite is true for most other G20 countries. As a result, the U.S. effective corporate rate on investments in equipment was only the 10th highest among G20 countries in 2012, but the effective corporate rate on investments in buildings was 2nd highest among the G20 countries.

Because companies in most countries can deduct interest payments -- but not payments of dividends to shareholders or the capital gains they earn -- from taxable income, effective corporate tax rates on debt-financed investments are lower than are those for equity-financed investments. That difference is greater when there is a high statutory corporate tax rate because the high rate increases the value of the interest deduction.¹⁰ The value of that deduction, in combination with the depreciation schedule, caused the U.S. effective corporate tax rate for debt-financed investments in equipment to be the second lowest among G20 countries in 2012. The U.S. effective corporate tax rate is ranked near the middle for comparable equityfinanced investments. Italy is unique among the G20 countries in that since 2012, its tax system has provided an allowance for corporate equity that permits companies to take a deduction for equity that is similar to the deduction for interest payments.¹¹ That feature is the chief reason that Italy's overall corporate effective tax rate was estimated to be negative in 2012.

CBO estimates that the U.S. effective corporate tax rate overall was essentially unchanged between 2003 and 2012. In 2003, the U.S. rate ranked fifth among those of the G20 countries, and it followed Japan's, Argentina's, Canada's, and Germany's. In 2012, the U.S. rate ranked fourth, and it followed Argentina's, Japan's, and the United Kingdom's. In Italy, largely because of the adoption of the allowance for corporate equity, the effective corporate tax rate declined by 36 percentage points from 2003 to 2012. By that year, Italy's rate, at -23 percent, was by far the lowest among G20 countries and constituted a net government subsidy for corporations' marginal investments.

The estimates of effective corporate tax rates presented in this report reflect differences among the G20 countries only in statutory corporate tax rates and depreciation allowances for buildings and equipment. However, countries also differ in their tax treatment of other sources of income or expenditures (for example, investments in research and experimentation) and in their economic conditions (such as their inflation rates). Appendix B includes estimates that incorporate additional differences among the G20 countries. Accounting for those differences results in estimates for the United States that range from 13 percent (accounting for the tax treatment of investments in research and experimentation) to 19 percent (using the actual U.S. inflation rate in 2012).

How Much Have Tax Rates Changed Since 2012?

The necessary data are not available to estimate average corporate tax rates for a year more recent than 2012. It is possible, however, to examine how statutory and effective corporate tax rates have changed since 2012. Four G20 countries modified their corporate income tax systems after 2012, generally resulting in lower effective tax rates. Japan, South Africa, and the United Kingdom reduced their top statutory corporate tax rates. As of 2015, Japan's top statutory corporate tax rate was 32.1 percent -- 5 percentage points lower than its top rate in 2012. As a result, CBO's estimates of Japan's effective corporate tax rate fell from 21.7 percent in 2012 to 18 percent in 2015. South Africa's top statutory corporate tax rate fell from 34.6 percent in 2012 to 28 percent in 2015, and its estimated effective corporate tax rate fell from 9.0 percent in 2012 to 6.2 percent in 2015. The United Kingdom reduced its top statutory corporate tax rate from 24 percent in 2012 to 20 percent in 2015 but also slightly tightened the tax treatment of depreciation for equipment. On net, those changes led to a reduction in the estimates of effective corporate tax rates from 18.7 percent in 2012 to 15.7 percent in 2015. An increase in a surcharge caused India's top statutory corporate tax rate to rise from 32.5 percent in 2012 to 34.6 percent in 2015. That change led to an increase in the estimates of the effective corporate tax rates from 13.6 percent in 2012 to 15 percent in 2015.

² The average corporate tax rate faced by foreign-owned companies incorporated in the United States is used as a proxy for the measure that a U.S. corporation with operations in several countries would consider when comparing a new investment in a foreign country with a new investment in the United States. See Appendix A for further discussion of CBO's analytical methods.

³ The G20 consists of Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States, and the European Union (a group of 28 countries, including France, Germany, Italy, and the United Kingdom).

⁴ Congressional Budget Office, Corporate Income Tax Rates: International Comparisons (November 2005), www.cbo.gov/publication/17501.

⁵ For a discussion of profit shifting, see Congressional Budget Office, Options for Taxing U.S. Multinational Corporations (January 2013), pp. 14-16, www.cbo.gov/ publication/43764.

⁶ See KPMG International, "Corporate Tax Rates Table" (accessed March 3, 2017), http://tinyurl.com/qbf9wmu.

⁷ The estimates of the average tax rates faced by U.S.-owned foreign companies are not precisely comparable to those faced by foreign-owned U.S. companies. For U.S.-owned foreign companies, data available from tax returns and financial reports show only the worldwide amounts of income and tax liabilities; hence, the average tax rates faced by U.S.-owned foreign companies include income and taxes from all of the countries (possibly including the United States) in which those companies operate. For foreign-owned companies incorporated in the United States, by contrast, the average corporate tax rates were estimated solely from data on U.S. income and taxes.

⁸ No data were available to compute such rates for U.S.-owned foreign companies for 2003.

⁹ CBO's analysis of effective corporate tax rates does not include the effects of expiring tax provisions, such as "bonus depreciation" -- a feature of the tax code that allowed the immediate deduction of expenses from some types of investment -- in the United States. See Appendix B for an estimate of the U.S. effective corporate tax rate that includes the effects of bonus depreciation.

¹⁰ Another factor that increases the value of the interest deduction is the inflation rate. In many countries, including the United States, companies deduct the current-dollar value of interest payments. Thus, the amount of the deduction increases as inflation rises, causing both taxable income and the effective corporate tax rate to fall. For this analysis, CBO generally used an inflation rate of 2.5 percent for all G20 countries. To examine the effects of inflation on effective corporate tax rates, CBO also estimated those rates under scenarios that used a higher rate of inflation for all countries or rates that differed from one country to the next (see Appendix B).

¹¹ Other countries have adopted similar measures, among them Turkey in 2015. Since 1995, Brazil has allowed corporations to deduct payments of interest on net equity to shareholders but not to deduct the return on retained earnings or the payment of normal dividends. Countries outside of the G20, including Belgium and Croatia, also provide for the deduction of some portion of returns on equity.

 

Exhibit 1.

 

Statutory Rates for U.S. Federal Corporate Income Taxes,

 

2012

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 11.]

 

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 2.

 

Top Statutory Corporate Income Tax Rates in Selected Countries,

 

Arrayed by GDP, 2012

 

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 3.

 

Top Statutory Corporate Income Tax Rates in G20 Countries,

 

2003 and 2012

 

 

 

 

______________________________________________________________________

 

When companies are deciding whether to operate in a particular country, they consider, among other factors, the total amount of corporate income taxes they would pay to that country relative to the income earned there. That ratio -- the country's average corporate tax rate -- encompasses all of the provisions of the country's corporate income tax code. The advantage of using the average corporate tax rate to evaluate investment incentives is that it can capture features of the tax code that are missed both by the top statutory corporate tax rate and by the effective marginal corporate tax rate. Because the average corporate tax rate is sensitive to economic conditions, however, a disadvantage of its use is the possibly significant variation in estimates -- depending on the year and the sample of companies used to calculate the ratio.

Other factors affect average tax rates. To the extent that a tax system provides opportunities for companies to minimize their taxes or avoid compliance with tax laws altogether, for example, average tax rates will be lower than they otherwise would be. Those opportunities for tax avoidance or evasion may contribute to a country's appeal both as an investment location and as a place to shift profits from higher-tax countries.

If a U.S. multinational corporation was deciding whether to invest in the United States or in some other country, it probably would compare the average tax rate faced by its domestic affiliates with those faced by its foreign affiliates. Although this section contains estimates of the average tax rates faced by companies operating abroad, those rates deviate in two important ways from the rates companies consider when they make decisions about their investments.

First, the estimates of U.S. rates in this report use the ratio of U.S. taxes paid to U.S. income for foreign-owned companies incorporated in the United States. Data that specifically identify tax payments of the U.S. affiliates of U.S. multinational corporations are not available. Second, for countries other than the United States, the estimates of average tax rates were calculated as the ratio of worldwide tax payments to worldwide income for U.S.-owned businesses incorporated in that country. Thus, the estimates of foreign tax rates and the estimate of the U.S. rate are not precisely comparable but can be considered proxies for the information used by companies to make investment decisions. Data that would allow for the same concepts of income and tax for U.S.-owned companies and for foreign-owned companies are not available. For further discussion of the methods that CBO used to derive estimates of average corporate tax rates, see Appendix A.

 

Exhibit 4.

 

Number of U.S.-Owned Foreign Corporations in Other G20 Countries,

 

2004 and 2012

 

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 5.

 

Average and Top Statutory Corporate Income Tax Rates

 

in G20 Countries, 2012

 

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 6.

 

Average Corporate Tax Rates in G20 Countries, 2004 and 2012

 

 

 

 

______________________________________________________________________

 

Because CBO's estimates of effective corporate tax rates are derived from simulations based on hypothetical cases, they are less sensitive to economic conditions than are estimates of average tax rates. However, there is a limit to the specific aspects of the tax code and economic environment that can be incorporated into simulations, so the effective corporate tax rate misses some differences between countries that are captured by the average corporate tax rate.

For this analysis, CBO estimated effective corporate tax rates that would be faced by hypothetical companies operating in G20 countries. The study focused mainly on two kinds of tax provisions in each country: statutory corporate rates and cost recovery allowances (the deductions from taxable income for the loss in value that is attributable to an asset's depreciation). The estimates in this report do not account for other differences between countries in the tax treatment of corporate income. In particular, CBO did not consider some features of tax systems that affect cross-border investment -- such as treaties between countries that determine the tax treatment of income earned by companies in foreign countries.

Two factors largely determine whether the effective corporate tax rate is higher or lower than the statutory corporate tax rate: the value of cost recovery allowances relative to economic (actual) depreciation and the method that a company uses to finance its investment. Returns on equity-financed investments are taxed at the statutory rate when the present value of economic depreciation and the present value of cost recovery allowances are equal. (A present value is a single number that expresses a flow of current and future income, or payments, in terms of an equivalent lump sum received, or paid, at a specific time.) Cost recovery allowances that have a smaller present value raise the effective corporate tax rate above the statutory tax rate, and allowances that have a greater present value result in effective corporate tax rates that are below the statutory tax rate. Cost recovery allowances vary from country to country and by asset type. In most countries, such allowances are more advantageous for buildings than for equipment. However, under U.S. tax law, the reverse is true: In the United States, allowances are more advantageous for equipment than they are for buildings.

The method of financing that companies use for investment affects effective corporate tax rates because, in most countries, companies cannot deduct from taxable income the dividends they pay to shareholders or the capital gains they earn, but they can deduct interest paid to lenders. As a result of that deduction, effective corporate tax rates are lower for debt-financed investments than for equity-financed investments on the same depreciation schedule. The value of that deduction increases as statutory tax rates rise. Companies can deduct nominal (current dollar) interest payments. Inflation increases the size of those interest payments and causes effective corporate tax rates for debt-financed investments in all G20 countries to fall below zero. Those negative rates indicate that corporations received, on net, a government subsidy on marginal investments financed with debt.

Countries with statutory rates that are higher than others may still have lower effective corporate tax rates because of interest deductions and differences in cost recovery systems.

With some exceptions, CBO computed effective corporate tax rates holding four conditions the same for all countries:

First, the shares of total assets attributable to buildings, equipment, intangible assets (those that are not physical, such as patents or trademarks), and inventories were based on the allocation of those resources in the United States (48.1 percent for buildings, 22.9 percent for equipment, 18.6 percent for intangible assets, and 10.5 percent for inventories).

Second, in scenarios in which assets were financed both by debt and by equity, the mix was set to be the same in each country (35 percent and 65 percent, respectively, of total financing).

Third, expenditures on intangible assets were subtracted from taxable income immediately in the year of purchase, and no additional subsidies were provided for such investments.

Finally, inflation rates, interest rates, economic depreciation, and other economic conditions were held the same for all countries.

Since 2012, Italy's tax code has included an allowance intended to equalize its treatment of debt and equity.¹ For this report, CBO's estimates of Italy's 2012 effective tax rates are based on a scenario in which the return on equity-financed investment is treated as if it were a return on debt. Because of the deduction for the return on equity, Italy's 2012 estimated effective corporate tax was negative: Corporations received, on net, a government subsidy on marginal investments.² Unlike average corporate tax rates, effective corporate tax rates as estimated by CBO are limited to income earned by a company in that country and the amount of taxes a company owes to that country. Additionally, the estimates of effective corporate tax rates are not based on the experiences of a specific sample of corporations. Instead, the estimates measure the tax burden on a marginal investment for a hypothetical corporation with asset and financing mixes as specified above. The rate faced by a corporation in a given country depends on corporation- and country-specific variables that are not included in CBO's estimates. (See Appendix A for a description of CBO's method and Appendix B for information on the sensitivity of CBO's estimates to inflation and other analytical choices described above.)

 

Exhibit 7.

 

Effective Corporate Tax Rates and Top Statutory Corporate Income

 

Tax Rates in G20 Countries, Inclusive of All Types of Assets and

 

Financing Sources, 2012

 

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 8.

 

Effective Corporate Tax Rates in G20 Countries, Inclusive of All

 

Types of Assets and Financing Sources, 2003 and 2012

 

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 9.

 

Effective Corporate Tax Rates for Buildings and Equipment in G20

 

Countries, Inclusive of All Types of Financing Sources, 2012

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 10.

 

Effective Corporate Tax Rates for Equity-Financed

 

Buildings and Equipment in G20 Countries, 2012

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 11.

 

Ratio of the Present Value of Cost Recovery Allowances to

 

the Present Value of Economic Depreciation for Buildings in

 

G20 Countries, 2012

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 12.

 

Ratio of the Present Value of Cost Recovery Allowances to

 

the Present Value of Economic Depreciation for Equipment in

 

G20 Countries, 2012

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 13.

 

Effective Corporate Tax Rates for Debt or

 

Equity-Financed Buildings in G20 Countries, 2012

 

 

 

______________________________________________________________________

 

______________________________________________________________________

 

 

Exhibit 14.

 

Effective Corporate Tax Rates for Debt or

 

Equity-Financed Equipment in G20 Countries, 2012

 

 

 

______________________________________________________________________

 

² Between 1997 and 2003, Italy had a dual income tax that provided a reduced tax rate for the return on equity. The effective corporate tax rate is a forward-looking measure, and thus the dual income tax is not included in the estimate of the effective corporate tax rate for Italy in 2003 because the elimination of the dual income tax had already been announced.

Statutory Corporate Tax Rates

CBO's comparison of statutory corporate income tax rates for 2003 and 2012 was based on data from KPMG International and the OECD.³ When those two sources differed in their assessment of a country's top statutory corporate tax rate, CBO selected the rate that best captured subnational taxes and the tax laws that were in effect for the relevant tax year.

Average Corporate Tax Rates

The average corporate tax rate on investment in a given country is the total amount of corporate income taxes that a company would pay to that country relative to the income it earns there:

 

 

Average corporate tax rates are sensitive to fluctuations in economic conditions. The ability to carry forward (that is, to defer) deductions of losses to a future year, for example, can result in low average tax rates for several years after an economic downturn. The average corporate tax rate also can depend on a company's recent rates of new investment because tax depreciation allowances are usually realized ahead of output gains from that investment. Those factors can create significant variations in average tax rates from year to year.

No comprehensive data sources provide enough data to use for estimating the average corporate tax rate that would be faced by a multinational corporation in a particular country if that business moved some or all of its operations to that jurisdiction. CBO developed two proxies to estimate those rates. For G20 countries other than the United States, it used data on the worldwide tax payments and worldwide income of U.S.-owned foreign corporations incorporated in each country to estimate the average corporate tax rate a multinational corporation would face in that country. For the United States, CBO used data on the tax liabilities and income of foreign-owned U.S. corporations to estimate the average corporate tax rate a multinational corporation would face.

U.S.-Owned Foreign Corporations

CBO uses a specific type of business entity -- the U.S.-owned foreign company -- when it estimates average corporate tax rates for foreign countries. Because many U.S. companies channel their investments in foreign countries through such entities, the average corporate tax rates faced by those businesses are, in CBO's judgment, useful proxies for the incentives faced by companies that are deciding whether and where to undertake large or long-term investments.

This report defines U.S.-owned foreign companies as those that are incorporated in a country other than the United States but that have more than half of their stock owned by a single U.S. taxpayer; that group includes all foreign companies that are controlled by U.S. corporations.⁴ For those companies, CBO used earnings and profits as a measure of income. For each country, CBO calculated average corporate tax rates by dividing total taxes paid by all U.S.-owned companies incorporated in that country by their current earnings and profits before income taxes.

 

 

For the current work, CBO estimated average corporate tax rates faced by U.S.-owned foreign corporations in 2004 and 2012 (the most recent year for which complete data were available at the time of this analysis).⁵ Estimates were derived from data samples compiled by the Internal Revenue Service (IRS) from Form 5471, which U.S. taxpayers who are shareholders in such companies must attach to their income tax returns.⁶ Changes in the composition of that sample probably contributed to the differences in the estimated average tax rates from 2004 to 2012.

Although the estimates are categorized by the country of incorporation, the estimates of average tax rates -- based on the available data -- reflect total income earned in all the countries in which businesses operate and the sum of the income taxes, including U.S. taxes, paid to those countries. The larger the scope of a U.S.-owned foreign company's operations in its country of incorporation relative to its business dealings in other countries, the more closely the estimates of average tax rates approximate the conceptual measure. Because CBO used those worldwide measures in this report, foreign average tax rate estimates to some extent also capture the effects of profit shifting -- the movement of income from high-tax to lower-tax countries. If a corporation can reduce its corporate tax payments through profit shifting, that movement will result in a lower average corporate tax rate because the taxes paid will fall even though worldwide earnings and profits are relatively unaffected. The opportunities for tax avoidance may contribute to a country's appeal as an investment location.

Foreign-Owned U.S. Corporations

CBO's estimates of average tax rates in foreign countries were made on the basis of data about the foreign affiliates of U.S. multinational corporations. Had the necessary data been available to more fully evaluate companies' decisions about where to locate, CBO would have estimated the U.S. average tax rate for the U.S. affiliates of U.S. multinational corporations. However, such data were not available, so CBO instead measured the U.S. average tax rate on the basis of income and tax data for foreign-owned companies incorporated in the United States.

Tax returns filed by foreign-owned U.S. corporations contain information on taxable income and income taxes.⁷ Unlike the information available on U.S.-owned foreign corporations, however, U.S. tax returns identify income earned in the United States and taxes paid to the U.S. federal government. The estimate of the U.S. average tax rate is, therefore, less affected by profit shifting than are the estimates of the average tax rates faced by U.S-owned foreign companies. The U.S. average tax rate probably would be lower if it also had been estimated using worldwide income and taxes.

The ratio of U.S. federal tax payments to income that can be calculated directly from the IRS data would not be comparable to CBO's measure of the U.S. top statutory corporate tax rate because the top statutory corporate tax rate used in this report includes state taxes. In CBO's judgment, the inclusion of state taxes would increase the average corporate tax rate by the same percentage that those taxes increase the statutory corporate tax rate. CBO's estimates of the U.S. average corporate tax rate include such an adjustment for state tax payments.

Effective Marginal Corporate Tax Rates

An effective marginal corporate tax rate (in this report, an effective corporate tax rate) summarizes in a single number the features of the tax code that apply to the return generated from an investment in an asset over that asset's life span. An effective corporate tax rate measures the effect of taxes on the return from a marginal investment -- that is, a prospective investment that earns just enough to yield the after-tax market rate of return (roughly the equivalent of the return on an index fund of corporate bonds or equities, depending on the source of financing).

In this report, CBO estimates effective corporate tax rates for the G20 countries, focusing on the way two features of tax systems -- the statutory corporate tax rate and the treatment of depreciation -- affect those rates. The approach for this report thus differs from earlier work in 2014 in which CBO's estimates of the effective tax rates on capital income in the United States reflected both individual and corporate taxation.⁸ The 2014 report compared effective tax rates on capital income for different types of business entities, some of which -- sole proprietorships and partnerships, for example -- are not subject to corporate income tax, although their owners pay individual income taxes on their profits. The earlier report also gave estimates of effective tax rates for various assets and industries (as well as sources of financing, as in the current report). That study also examined some of the incentives for investing in a variety of assets and sectors in the United States.

This report examines a different question: What are the important tax considerations for corporations that are deciding on the best places to locate their foreign investments? CBO's answer is that the corporate tax rate for each country is the most relevant information to use in addressing that question. Individual tax rates in an investor's home country can affect the after-tax return on an investment because a corporation's income is taxed again at the individual level when that income is paid to investors as dividends and capital gains. However, individual-level taxes do not depend on an investment's location, and they are excluded from this study because they do not strongly influence corporations' decisionmaking about where to locate foreign investments.

The estimates of effective corporate tax rates do not account for all factors that influence companies' decisions about location. For example, CBO's computations did not account for the effects of tax treaties that might have consequences for decisionmaking about cross-border investment. Additionally, CBO's estimates focus on permanent provisions in the tax code and do not include temporary features, such as bonus depreciation in the United States.

Effective corporate tax rates are measured for a hypothetical company by calculating the difference between the return on the marginal investment before and after imposition of the corporate tax. That resulting difference is divided by the before-tax return to give the effective corporate rate of tax on a marginal investment:

 

 

The before-tax return for equity-financed investment is computed as follows:

 

 

In deciding whether to invest another dollar in a project, a company compares the present value of the after-tax return on that investment with the amount it would earn from lending those funds to another investor. In that respect, R represents both the discounting factor that the company used to make the decision and the resulting after-tax real return in the effective corporate tax rate formula. The company is indifferent between investing in the project and saving that amount if the after-tax returns from the two choices are equal.

The source of a company's financing affects estimates of effective corporate tax rates. The formula in Equation A4 is used to measure the effective corporate tax rate of a company that finances an investment with its own equity. If the company instead uses debt to finance the investment, in most G20 countries the nominal return (that is, without accounting for inflation) is deducted. Therefore, the company's discount rate must account for the deduction of nominal interest, and the before-tax return includes the inflation rate (i):

 

 

Over the past two decades, Italy has moved toward equalizing the treatment of debt and equity. Between 1997 and 2003, Italy applied a lower tax rate to the return on equity. CBO excluded that lower rate from its computations of Italy's 2003 effective corporate tax rate because that measure was forward looking and the deduction was already being phased out in 2003. In 2012, Italy adopted an allowance for corporate equity that was intended to equalize the treatment of debt and equity by allowing companies to deduct the "notional return" on new equity. The rate on such a return is based on the average returns on Italian treasury bonds and initially was set at 3 percent, then at 4 percent in 2014, and at 4.5 percent in 2015. The rate does not equal the nominal return of 7.5 percent that CBO used to estimate effective corporate tax rates. However, to capture the intended effect of the legislation, the estimate for Italy allows for the full deduction of the nominal return. CBO used the same formula to determine the before-tax return for investments financed by debt or by equity. The resulting effective corporate tax rates for debt-financed and equity-financed investments are thus the same -- a negative estimated rate (-23.5 percent) for Italy in 2012. That estimate would be less negative if the actual rate of return in Italy was greater than the notional rate of return.

Key Parameters for Calculating Effective Corporate Tax Rates

For this analysis, CBO estimated effective corporate tax rates in 2003 and 2012 for each of the G20 countries. Because of changes in some parameters, such as the after-tax real return and the rate of inflation, the estimates for 2003 differ somewhat from those reported by CBO in 2005.¹²

To estimate effective corporate tax rates, CBO varied just two features of the tax systems from country to country: the top statutory tax rate under a country's tax system and its cost recovery allowances.¹³ Interest rates, inflation, and economic depreciation were set to be the same for all countries, and changing the value of each of those parameters -- either by making that value the same for all countries or by incorporating the economic conditions in each country -- affected both the level of each country's effective corporate tax rate and the ranking of the countries examined. (For more information, see Appendix B.)

After-Tax Real Return (R). The after-tax real-return was set at 5 percent and held constant for all countries. The after-tax real return on a company's marginal investment is equal to the amount that the company would earn from lending the funds to another investor. That rate probably would be similar to the real lending interest rate. Among the G20 countries for which it was available, that interest rate had a median of 3.2 percent in 2012 -- ranging from -3.4 percent in Argentina to 30 percent in Brazil.¹⁴ The same after-tax real return was used for both debt and equity.

Inflation Rate (i). CBO set the inflation rate at 2.5 percent and held it constant for all countries. Actual inflation rates in the G20 countries for 2012 ranged from -0.9 percent in Japan to 18.7 percent in Argentina.¹⁵ The median rate was 2.4 percent for all G20 countries that year.

 

Table A1.

 

Tax Treatment of Depreciation for Selected Types of Assets

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 34.]

 

 

 

Corporate Tax Rate (). For this analysis, CBO-followed the practice it outlined in 2005 of using each country's top combined (national and local) corporate tax rate.¹⁷ The top national rate was the statutory rate on income in the highest tax bracket. In 2012, most G20 countries had a flat tax rate that applied to all taxable corporate income. The local rate was the average of the highest rates set by subnational governments in a given country. Only in Canada, Germany, Japan, South Korea, and the United States among the G20 countries were corporations taxed at the subnational level.

Present Value of Cost Recovery Allowances (z). In all G20 countries, companies generally can claim cost recovery allowances to cover the loss in value of buildings and equipment over time (see Table A1). Each country's tax code sets a fixed time span over which those allowances can be claimed, and the periods may differ by investment type. Thus, the present value of any future tax deductions for recovering the cost of the asset is included in determining the return a company must earn on its investment to cover taxes. Information on cost recovery allowances, by type of investment, in each G20 country for 2003 and 2012 was available from a data set compiled by CBT.¹⁸ The researchers attempted to identify each country's tax treatment of buildings (deemed to have a useful life of 25 years) and equipment (deemed to have a useful life of 7 years).

Some countries use other methods to address the depreciation of assets. In some cases, taxpayers can expense the full cost of an asset by means of a deduction in the year of purchase. For a marginal investment, expensing eliminates any tax liability because all of the expected returns on that investment are offset by that one-time deduction. To simplify the calculations underlying the analysis presented in the exhibits in this report, all intangible assets are treated as though they are subject to expensing. Because inventories are viewed as unfinished goods until they are sold, tax codes do not offer any adjustment for wear and tear on those assets.

Method of Financing. In the current work, CBO-follows CBT's assessment that 35 percent of an investment in buildings, equipment, and intangible assets was financed by debt and that the rest was financed by equity. Inventories were financed entirely by equity.

Total Effective Corporate Tax Rate

To compute the overall effective corporate tax rate, CBO first calculated the rates for four categories: buildings, equipment, intangible assets, and inventories. Except as otherwise noted, the estimates of effective corporate tax rates in this report were based on the allocation of assets in the United States and weighted as follows to represent the share of total capital: 48.1 percent for buildings, 22.9 percent for equipment, 18.6 percent for intangible assets, and 10.5 percent for inventories. The value of tangible assets was based on an average of data gathered from the Federal Reserve's Financial Accounts of the United States (a comprehensive set of accounts that includes detail on the assets and liabilities of households, businesses, and governments) for 2000 through 2012.¹⁹ CBO obtained the value of intangible assets in 2003 from an earlier Federal Reserve study.²⁰ The value of intangible assets was added to the value of nonfinancial assets of corporate businesses to determine total allocable assets.

The share of intangible assets is based on data that are older than those used to determine the value of tangible assets, and, because companies are spending more money now on intangible assets than they did in 2003, more recent data would probably indicate a larger share of capital investments in intangible assets today. Because investments in intangible assets were considered to be expensed for this analysis, an increase in the share of such assets would have resulted in lower effective corporate tax rates than those shown in this report.

CBO gave greater weight than did CBT to the share of capital associated with intangible assets and less to the share attributed to inventories. Those researchers used shares of 8.7 percent for intangible assets and 41.7 percent for inventories.²¹ That higher share allocated to inventories is inconsistent with OECD data on assets and inventories, which showed inventories' accounting for between 5 percent and 15 percent of the nonfinancial assets of corporate businesses in 2012.²² (Appendix B gives estimates of effective corporate tax rates using CBT's allocation.)

Measuring Effective Corporate Tax Rates for Intangible Assets and Inventories

The tax treatment for intangible assets and inventories differs from that for buildings and equipment. The methodology for estimating effective corporate tax rates therefore was modified to account for the special provisions that apply to those two asset types.

Intangible Assets. Intangible assets include copyrights, patents, and goodwill (the value of a company's brand name, customer base, and its relationships with its employees). Because intangible assets are not physical, their value is more difficult to determine than is the value of any other type of asset.

In the United States, the tax system treats various types of investments in intangible assets differently. Some costs -- such as those for advertising to create or maintain a brand -- are expensed immediately. Other tax preferences, including the research and experimentation credit in the United States, can be used to offset the costs of some investments.

For this report, CBO applied the same treatment of intangible assets for all G20 countries: All such investments were expensed, and no additional subsidies were provided. (Appendix B gives estimates of effective corporate tax rates that more fully reflect the tax treatment of expenditures on research and experimentation in the G20 countries.)

Inventories. Inventories are inputs -- steel purchased by an automaker to manufacture cars or stock held by retailers, for example -- that are purchased and stored for later use. In all G20 countries, inventories are considered unfinished goods that are not taxed until sold. When inventories or the products made from them are sold, the costs of the inputs used in their production are deductible against the income from the sale. As a result, the before-tax return on inventories is calculated differently from that on other assets because their holders are not permitted to take cost recovery allowances for any loss in value for the purpose of determining taxable income.

The marginal investment in inventories by a profit-maximizing company was anticipated to cover the amount that a company must pay to the lenders who financed the original purchase and the taxes it must pay on the value of sales attributable to the inventories. More specifically, a corporation's marginal investment of $1 held for some fixed number of years must appreciate by enough to earn the amount needed to pay taxes on the increase in value and still leave enough to cover the company's cost of funds (r).

CBO judged the typical holding period for inventories to be about 20 weeks on the basis of the observed ratio of 39 percent for the total end-of-year inventories to final sales per year in the United States from 2000 through 2012.²³ A briefer holding period would cause CBO's estimates of effective corporate tax rates on inventories to decline.

Because Italy's allowance for corporate equity applied to new equity alone, CBO's estimate of Italy's effective corporate tax rate on inventories does not incorporate a deduction for the return on equity; doing so would result in an overall effective corporate tax rate that was even more negative.

² The G20 consists of Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States, and the European Union (a group of 28 countries, including France, Germany, Italy, and the United Kingdom).

³ KPMG International, "Corporate Tax Rates Table" (accessed March 2, 2017), http://tinyurl.com/qbf9wmu; and Organisation for Economic Cooperation and Development, "OECD Tax Database: C. Corporate and Capital Income Taxes" (accessed March 2, 2017), Table II.1 (Corporate Income Tax Rates), http://tinyurl.com/pwnz24p.

⁴ The Internal Revenue Service's Statistics of Income Division compiles data on U.S.-owned foreign companies. The information published is available only for controlled foreign corporations that have more than half of their stock owned by a single U.S. taxpayer. For income tax purposes, however, the definition of a controlled foreign corporation is broader. U.S. taxpayers include citizens, residents (who are permitted to live and work permanently in the United States or who meet other residency requirements), domestic partnerships, corporations, trusts, and estates.

⁵ Although this report includes comparisons of the statutory rates and effective corporate tax rates in 2012 with those in 2003 (a year included in the 2005 CBO report), the data needed to compute average tax rates were not available for 2003. Also, for two countries, Indonesia and South Africa, the Internal Revenue Service's disclosure rules prevented the release of information for 2012, so 2010 values are reported for that year instead.

⁶ Information from the sample of Forms 5471 is publicly available for 2004, 2010, and 2012 at Internal Revenue Service, "SOI Tax Stats -- Controlled Foreign Corporations" (2004 and 2010 data accessed May 23, 2014; 2012 data accessed March 10, 2016), http://go.usa.gov/x897D. The data used include national and subnational tax payments.

⁷ Taxable income consists of income from any source that is not specifically excluded by the tax code and is net of the costs of doing business, depreciation, and interest payments. Dividend payments, however, are not subtracted from total income before taxable income is calculated.

⁸ See Congressional Budget Office, Taxing Capital Income: Effective Marginal Tax Rates Under 2014 Law and Selected Policy Options (December 2014), www.cbo.gov/publication/49817.

⁹ See Robert E. Hall and Dale W. Jorgenson, "Tax Policy and Investment Behavior," American Economic Review, vol. 57, no. 3 (June 1967), pp. 39-414, www.jstor.org/stable/1812110. A present value is a single number that expresses a flow of current and future income or payments in terms of an equivalent lump sum received or paid at a specific time. The present value depends on the rate of interest -- the discount rate -- that is used to translate future cash flows into current dollars. For example, if $1,000 is invested on January 1 at an annual interest rate of 5 percent, it will increase to $1,050 by January 1 of the following year. At an annual 5 percent discount rate, the present value of $1,050 payable a year from today is $1,000.

¹⁰ Another way to equalize the treatment of debt and equity is to disallow the deduction for interest payments, an approach usually referred to as a comprehensive business income tax. See Department of the Treasury, Report of the Department of the Treasury on Integration of the Individual and Corporate Tax Systems: Taxing Business Income Once (1992), http://go.usa.gov/x8yJ9 (PDF, 2.6 MB).

¹¹ See Alexander Klemm, Allowances for Corporate Equity in Practice, Working Paper 06/259 (International Monetary Fund, 2006), http://tinyurl.com/jgkgxzu (PDF, 455 KB).

¹² Congressional Budget Office, Corporate Income Tax Rates: International Comparisons (November 2005), www.cbo.gov/publication/17501.

¹³ CBO derived most of the information on cost recovery allowances from work by other researchers. See Katarzyna Bilicka and Michael Devereux, CBT Corporate Tax Ranking 2012 (Oxford University Centre for Business Taxation, June 2012), http://tinyurl.com/j9dlyjl (PDF, 529 KB); and Katarzyna Bilicka, Michael Devereux, and Clemens Fuest, G20 Corporate Tax Ranking 2011 (Oxford University Centre for Business Taxation, July 2011), http://eureka.sbs.ox.ac.uk/3512. Details on the cost recovery allowances are found in the appendixes to those reports. The particulars of the tax treatment of depreciating assets in each of the G20 countries are described in a database maintained by the Oxford University Centre for Business Taxation, "CBT Tax Database" (accessed March 2, 2017), http://tinyurl.com/h9xassb; and in a separate Appendix C for Bilicka, Devereux, and Fuest, see Oxford University Centre for Business Taxation, "Reports, G20 Corporate Tax Ranking 2011" (accessed March 2, 2017), http://tinyurl.com/zwqja3r.

¹⁴ The interest rate is the real lending interest rate, which is not available for all G20 countries. See World Bank Economic Indicators, "Real Interest Rate (%)" (accessed September 17, 2014), http://data.worldbank.org/indicator/FR.INR.RINR

¹⁵ See World Bank Economic Indicators, "Inflation, GDP Deflator (Annual %)," (accessed August 14, 2015), http://tinyurl.com/2dym8p9.

¹⁶ See Katarzyna Bilicka and Michael Devereux, CBT Corporate Tax Ranking 2012 (Oxford University Centrefor Business Taxation, June 2012), http://tinyurl.com/j9dlyjl (PDF, 529 KB); and Katarzyna Bilicka, Michael Devereux, and Clemens Fuest, G20 Corporate Tax Ranking 2011 (Oxford University Centre for Business Taxation,July 2011), http://eureka.sbs.ox.ac.uk/3512. Those depreciation rates for buildings and equipment are slightly higher than the rates CBO used to estimate effective tax rates on capital income in the United States. See Congressional Budget Office, Taxing Capital Income: Effective Marginal Tax Rates Under 2014 Law and Selected Policy Options (December 2014), www.cbo.gov/publication/49817. In a 2006 study, the Bureau of Economic Analysis used a 15 percent rate for economic depreciation for intangible assets. That agency has recently undertaken research to refine its estimates of the depreciation of intangible property. Although its initial findings display a wider range of rates for various categories of intangible assets, the research continues and includes categories with depreciation rates within 5 percentage points of CBO's rate. See Wendy C.Y. Li, Depreciation of Business R&D Capital (Bureau of Economic Analysis, October 2012), http://tinyurl.com/jkmbr22 (PDF, 550 KB).

¹⁷ See Congressional Budget Office, Corporate Income Tax Rates: International Comparisons (November 2005),Chapter 2, www.cbo.gov/publication/17501. For the data used in the present analysis, see KPMG International, "Corporate Tax Rates Table" (accessed March 2, 2017), http://tinyurl.com/qbf9wmu; and Organisation for Economic Cooperation and Development, "OECD Tax Database: C. Corporate and Capital Income Taxes" (accessed March 2, 2017), Table II.1 (Corporate Income Tax Rates), http://tinyurl.com/pwnz24p.

¹⁸ See Katarzyna Bilicka and Michael Devereux, CBT Corporate Tax Ranking 2012 (Oxford University Centre for Business Taxation, June 2012), http://tinyurl.com/j9dlyjl (PDF, 529 KB).

¹⁹ See Federal Reserve Board, Financial Accounts of the United States Z.1, Data Download Program, Table B.103 (A) Balance Sheet of Nonfinancial Corporate Business, http://go.usa.gov/x9grh.

²⁰ Carol Corrado, Charles Hulten, and Daniel Sichel, Intangible Capital and Economic Growth, Finance and Economics Discussion Series 200624 (Federal Reserve Board, April 2006), Table 3, http://go.usa.gov/x9gYq.

²¹ See Katarzyna Bilicka and Michael Devereux, CBT Corporate Tax Ranking 2012 (Oxford University Centrefor Business Taxation, June 2012), http://tinyurl.com/j9dlyjl (PDF, 529 KB).

²² See Organisation for International Cooperation and Development, "Detailed National Accounts: Balance Sheets for Non-Financial Assets" (accessed September 17, 2014), http://dx.doi.org/10.1787/data-00368-en.

²³ Council of Economic Advisers, Economic Report of the President, Tables B8, B22 (March 2013), http://tinyurl.com/hlnz3do.

• Nearly half of all assets consisted of buildings, with smaller shares attributable to equipment, intangible assets, and inventories;

• The rate of inflation was 2.5 percent for all countries;

• The split for financing of investments was 35 percent for debt and 65 percent for equity; and

• No investment subsidies other than cost recovery allowances were provided under any country's tax system.

Asset Allocation

The actual allocation of investments in capital assets varies from one country to another for several reasons. Specific factors -- for example, the educational attainment of the population or the abundance or scarcity of natural resources -- influence businesses' decisionmaking about investing in particular types of assets. A country's tax code also influences such choices. Many tax systems give preferential treatment to investments in intangible assets, such as patents or trademarks, typically in one of two ways: Either they allow full expensing by, for example, allowing businesses to subtract the cost of advertising from their taxable income for the same year in which the expenses are incurred, or they offer large subsidies in the form of research and experimentation tax credits, for example. Tax preferences for intangible assets can result in a very low, or even negative, effective corporate tax rate on the return from an investment in intangible assets. The return on an investment in inventories, by contrast, is generally taxed at or close to the statutory corporate tax rate.

Drawing on data from the Federal Reserve for U.S. companies (see Appendix A), CBO determined the shares of total assets for this analysis as follows: 48.1 percent for buildings, 22.9 percent for equipment, 18.6 percent for intangible assets, and 10.5 percent for inventories.¹ Other researchers have used an alternative allocation, with a much smaller percentage for buildings and a much larger percentage for inventories: 24.0 percent for buildings, 25.6 percent for equipment, 8.7 percent for intangible assets, and 41.7 percent for inventories.² Those weights are based on data from European companies' financial reports. However, the larger share allocated to inventories is inconsistent with data from the Organisation for Economic Co-operation and Development on assets and inventories, which showed that inventories accounted for between 5 percent and 15 percent of the nonfinancial assets of corporate businesses in 2012. The divergence between the two allocations results in calculated effective corporate tax rates that differ by as much as 29 percentage points (see Figure B1). Effective corporate tax rates for all countries in the Group of 20 (G20) are higher under the alternative allocation, which gives greater weight to inventories, which typically are subject to effective corporate tax rates that are close to the statutory rates.³ The increase differs from one country to another because of differences in statutory tax rates and cost recovery allowances.

 

Figure B1.

 

Effective Corporate Tax Rates With Alternative

 

Allocations of Asset Shares in G20 Countries, 2012

 

 

 

CBO's estimates of effective corporate tax rates are sensitive to the choice of an inflation rate because of the divergent effects of inflation on the value of interest deductions and cost recovery allowances. Depending on which provision dominates, a higher rate of inflation causes effective corporate tax rates either to fall or to rise.

First, inflation boosts interest rates and thereby increases the nominal value of interest payments. When companies can subtract interest payments from taxable income, their tax liabilities and effective corporate tax rates fall when there is a general increase in prices. Because the value of deductions rises with the statutory rate, effective corporate tax rates for debt-financed investments drop more steeply in high-tax countries than in countries with lower statutory rates when inflation is higher.

 

Figure B-2.

 

Effective Corporate Tax Rates With Alternative Rates

 

of Inflation in G20 Countries, 2012

 

 

 

The estimates provided in this report were based on a fixed inflation rate of 2.5 percent in all G20 countries. That rate is the approximate median for those countries in 2012. Actual rates for the year, however, ranged from -0.9 percent in Japan to 18.7 percent in Argentina. Excluding those two outliers, the range was 1.0 percent to 7.6 percent.

To examine the influence of inflation, CBO also estimated effective corporate tax rates in the G20 countries, using a rate of inflation of 6 percent (see Figure B-2). The higher rate resulted in lower effective corporate tax rates in most countries, suggesting that the increase in nominal interest deductions in those countries at least offset the loss in the value of cost recovery allowances. The changes in effective corporate tax rates generally were small, but the higher inflation rate had some effect on the overall ranking of countries. For example, at an inflation rate of 2.5 percent, the United States had the fourth-highest effective corporate tax rate. With an assumed inflation rate of 6 percent, that ranking dropped to fifth because the high U.S. statutory rate made the increased nominal interest deductions relatively more valuable. CBO based its estimates of effective corporate tax rates on a scenario in which economic and other nontax factors were the same for all G20 countries. Companies' investment decisions, however, typically account for a variety of characteristics that are specific to the country. Actual inflation rates vary from country to country, and each country's decisions about tax policy reflect specific expectations, including those concerning domestic inflation. Therefore, accounting for differences in inflation that would be expected for various countries could be a better way to capture policymakers' targets for their country's effective corporate tax rates. International variations in inflation, however, have effects that cannot be captured by the simplified model that CBO and some other researchers have used.⁴ At higher rates of inflation, the demand for loans in lieu of equity increases because of the deductibility of interest payments. A more comprehensive model would allow adjustments to the mix of debt and equity used to finance investments and would include the effect on real (inflation-adjusted) interest rates of that increased demand for debt.

That relationship between inflation and the demand for loans suggests that if country-specific inflation rates were included in estimates of effective corporate tax rates, the scenarios should reflect the debt-and-equity mix in each country. For most G20 countries, however, information on the financing mix is not available. Moreover, investments in countries with high inflation rates may carry higher risk that cannot be captured in a simplified model that does not include some measure for risk. If investors require a higher real rate of return in exchange for risk, then including variation in inflation rates among countries in the model also would require reevaluating whether the real rate of return is the same for all countries.

To examine the effects of variation in expected inflation rates from one country to another, CBO used its simplified model to estimate effective corporate tax rates using each country's actual inflation rate in 2012 as a proxy for expected inflation (see Figure B3).⁵ For most countries, including the United States, that change had little effect on the effective corporate tax rate. Using each country's actual inflation rate did, however, cause some changes in the relative rankings of the countries because of the effect of inflation on after-tax nominal returns on investments in each country. Argentina's extremely high inflation rate of 18.7 percent in 2012, for example, led to a dramatic reduction in the estimate of that country's effective corporate tax rate. With inflation set at 2.5 percent, Argentina had the highest effective corporate tax rate, but it fell to ninth among the G20 countries using the actual inflation rate for 2012. Although Japan rose to first among the G20 countries when the rate of inflation was changed from the G20's median rate of 2.5 percent to its actual rate for 2012 of -0.9 percent (the lowest among all G20 countries in that year), Japan's effective corporate tax rate actually dropped by 1.2 percentage points, from 21.7 percent to 20.5 percent.

Financing

Companies' financing choices are influenced by the tax treatment of debt and equity because the interest payments they make to lenders generally are deductible, whereas dividends paid to stockholders are not. However, a country's capital markets and its social attitudes toward leveraging also influence decisions about how to finance investment. Largely because of those factors, companies in different countries vary notably in their reliance on debt. Among the European Union countries, debt-to-asset ratios (that is, the share of assets financed by debt) in 2007 ranged from 40 percent for Luxembourg to 68 percent for Italy.⁶ (Data on those ratios were not readily available for more recent years or for countries outside the European Union.) For the countries in both the European Union and the G20 -- Italy, Germany, France, and the United Kingdom -- debt-to-asset ratios were higher (68 percent, 63 percent, 58 percent, and 66 percent, respectively) than the 35 percent used in CBO's main analysis.⁷

 

Figure B3.

 

Effective Corporate Tax Rates With Uniform and

 

Country-Specific Rates of Inflation in G20 Countries, 2012

 

 

 

 

Figure B-4.

 

Effective Corporate Tax Rates in G20 Countries With

 

Alternative Financing Mixes, 2012

 

 

 

For this analysis, CBO considered that investments in all intangible assets, such as research and experimentation, were expensed immediately -- that is, the entire cost of the investment was deducted in the year of purchase. However, the tax treatment of intangible assets varies from one country to another and by the type of asset, the method of production, and the manner of acquisition. Consequently, as an alternative, CBO also estimated effective corporate tax rates to more accurately reflect the actual treatment of research and experimentation in G20 countries on the basis of information concerning expensing, tax credits, and related subsidies in 15 countries, as reported by Canada's Department of Finance.⁸

Of the 15 G20 countries reviewed for that report, only South Korea and Russia did not allow full expensing of current investments in research and experimentation. Four countries also permitted full expensing of equipment related to research and experimentation. Five provided cost recovery allowances beyond expensing (and of those, two extended that subsidized cost recovery to equipment for research and experimentation). Five countries provided tax credits in addition to expensing of current expenses; South Korea disallowed full expensing and provided only a credit. The treatment of research and experimentation was less generous than full expensing in Germany and Mexico, which allowed expensing of current expenses but did not extend it to equipment and provided no credit. Russia neither allowed expensing nor provided a credit.

 

Figure B-5.

 

Effective Corporate Tax Rates in Certain G20 Countries With

 

Alternative Tax Treatments for Investments in

 

Intangible Assets, 2012

 

 

 

 

 

CBO converted those subsidy rates into a combination of cost recovery allowances (which could be more generous than expensing) and credits. The formula for computing the before-tax rate of return for equity-financed investment in Equation A4 (see Appendix A) was then adjusted to reflect investment tax credits and subsidized cost recovery allowances:

 

 

In this alternative analysis, the estimates of the effective corporate tax rates more accurately reflect the tax treatment of research and experimentation in the 15 G20 countries for which data were available (see Figure B5 on page 39). Half of the amount invested in intangible assets was assumed to be related to research and experimentation. For countries that provided a credit for that investment, v was set equal to 1 (except for South Korea, for which v was less than 1), and the value of the investment credit, k, was included in the calculation of the before-tax return on investment in research and experimentation. Nine countries had no investment credits for research and experimentation. For those countries, v was calculated using the subsidy rate, with k set equal to zero. The resulting value for v was greater than 1 in all countries except Germany, Mexico, and Russia. The other half of the amount invested in intangible assets was assumed to be subject to full expensing in each country (regardless of the country's tax code) and did not benefit from any other subsidies.

The alternative tax treatment of research and experimentation yielded lower tax rates for 12 of the 15 countries for which data were available. The effective corporate tax rate in the United States was 13.3 percent -- more than 5 percentage points lower than it would be had the credit not existed. In contrast, the smallest subsidy for research and experimentation was that in Russia, which did not allow expensing for such expenditures. After taking into consideration the actual treatment of investments in research and experimentation, CBO estimated that Russia's effective corporate tax rate was 5.3 percent in 2012 -- nearly 1 percentage point higher than under the scenario in which the costs of research and experimentation were expensed.

Canada, France, and Turkey were among the countries with the largest subsidies for research and experimentation. Their subsidies were generous to the extent that -- when combined with the tax benefits from debt financing and cost recovery allowances -- the overall effective corporate tax rates became negative, according to CBO's estimates.

Other Provisions of Tax Codes That Favor Investment

The tax codes of the G20 countries in some cases include special provisions that favor investments other than those in research and experimentation. The availability and generosity of such provisions vary from country to country, and they therefore affect both the absolute and the relative effective corporate tax rates.

The United States, for example, allows businesses to deduct from their taxable income a percentage of what they earn from certain domestic production activities. Adjusting the statutory tax rate for that provision reduced the U.S. effective corporate tax rate in 2012 from 18.6 percent to 17.1 percent, according to CBO's analysis. In 2012, eligible companies also were permitted to use "bonus depreciation," a feature of the tax code that allowed the immediate deduction of expenses from some types of investment. If half of the equipment purchased had been eligible for expensing, the U.S. effective corporate tax rate would have fallen from 18.6 percent to 16.1 percent for that year.

² See Katarzyna Bilicka and Michael Devereux, CBT Corporate Tax Ranking 2012 (Oxford University Centrefor Business Taxation, June 2012), http://tinyurl.com/j9dlyjl (PDF, 529 KB).

³ The G20's members include Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, and the United States. The European Union -- which consists of 28 countries, including France, Germany, Italy, and the United Kingdom -- is a member of the G20 as well.

⁴ CBO follows an approach that uses cost-of-capital equations to determine effective tax rates on investments. See Mervyn A. King and Don Fullerton, "The Theoretical Framework," in King and Fullerton, eds., The Taxation of Income From Capital: A Comparative Study of the United States, the United Kingdom, Sweden, and West Germany (University of Chicago Press, 1984), pp. 7-30, http://tinyurl.com/gum5hn6. Although those researchers allowed inflation rates to vary in one set of estimates, their model did not account for the effects on capital markets. Other work has allowed inflation rates to vary but has not accounted for the effects on capital markets. See, for example, Duanjie Chen and Jack Mintz, 2013 Annual Global Tax Competitiveness Ranking: Corporate Tax Policy at a Crossroads, SPP Research Papers 635 (University of Calgary, November 2013), http://tinyurl.com/hnlb36m; and Michael P. Devereux and others, "Corporate Income Tax Reforms and International Tax Competition" Economic Policy, vol. 17, no. 35 (October 2002), pp. 449-495, http://www.jstor.org/stable/1344772.

⁵ Each country's actual inflation rate is set to be equal to the 2012 value as shown in World Bank, "Inflation, GDP Deflator (Annual %)" (accessed August 14, 2015), http://tinyurl.com/2dym8p9.

⁶ See Ruud A. de Mooij and Michael P. Devereux, Alternative Systems of Business Tax in Europe: An Applied Analysis of ACE and CBIT Reforms, Taxation Paper 17 (European Commission, 2009), Figure 3.2, http://tinyurl.com/h79rkk3.

⁷ See Katarzyna Bilicka and Michael Devereux, CBT Corporate Tax Ranking 2012 (Oxford University Centrefor Business Taxation, June 2012), http://tinyurl.com/j9dlyjl (PDF, 529 KB).

⁸ Department of Finance Canada, "An International Comparison of Tax Assistance for Investment in Research and Development," in Tax Expenditures and Evaluations (December 2009), pp. 33-58, http://tinyurl.com/zj3wywu.

Molly Saunders Scott and Jennifer Gravelle (formerly of CBO) wrote the report with guidance from Janet Holtzblatt and from Frank Sammartino and David Weiner (both formerly of CBO). Mark Lasky of CBO, Rosanne Altshuler of Rutgers University, Alan Auerbach of the University of California-Berkeley, Don Fullerton of the University of Illinois, Jack Mintz of the University of Calgary, and William Randolph (formerly of CBO) provided comments. (The assistance of external reviewers implies no responsibility for the final product, which rests solely with CBO.)

Jeffrey Kling, John Skeen, and Robert Sunshine reviewed the report; Kate Kelly edited it; and Jorge Salazar and Gabe Waggoner, along with Jeanine Rees and Maureen Costantino (both formerly of CBO), prepared it for publication. Maureen Costantino produced the cover. The report is available on CBO's website (www.cbo.gov/publication/52419).

Keith Hall