Estonia’s top score is driven by four positive features of its tax system, states the Tax Competitiveness Index 2021 report.
First, it has a 20 percent tax rate on corporate income (reduced to 14 per cent in case of regular dividends) that is only applied to distributed profits. This means that Estonia’s corporate income tax system allows companies to reinvest their profits tax-free.
Second, it has a flat 20 percent tax on individual income that does not apply to personal dividend income.
Third, its property tax applies only to the value of land, rather than to the value of real property or capital. It means that Estonia doesn’t have taxes on the transfer of real property (real estate, land improvements, machinery) from one person or firm to another.
Finally, it has a territorial tax system that exempts 100 percent of foreign profits earned by domestic corporations from domestic taxation, with few restrictions.
The world’s simplEST tax system
In addition to the above, tax compliance takes the least amount of time in Estonia. For example, in an average OECD country, 44 hours per year are used by companies to comply with just corporate income taxes. In Estonia, the figure is five hours. The report also stresses that other taxes, such as the value added tax (VAT) also have a low compliance burden.
Low marginal tax rates create a competitive tax code
According to Tax Foundation, the structure of a country’s tax code is an important determinant of its economic performance. A well-structured tax code is easy for taxpayers to comply with and can promote economic development while raising sufficient revenue for a government’s priorities. A competitive tax code is one that keeps marginal tax rates low.
In today’s globalized world, businesses can choose to invest in any number of countries throughout the world to find the highest rate of return. This means that businesses will look for countries with lower tax rates on investment to maximize their after-tax rate of return.
If a country’s tax rate is too high, it will drive investment elsewhere, leading to slower economic growth. In addition, high marginal tax rates can lead to tax avoidance. According to research from the OECD, corporate taxes are most harmful for economic growth.
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