Lessons from Estonia
Julia Milis // 22 October 2020
Like other issues, taxes are one of those policy areas where the differences between EU member states are greater than the commonalities. The International Tax Competitiveness Index (ITCI) from the Tax Foundation is a measure of the competitiveness of OECD countries’ tax systems. Thus, it tries to assess how supportive domestic institutions and policies are for the productivity of a country. The 2020 version of this index indicates that Estonia has the most competitive tax code in the OECD for the seventh year in a row. In contrast, Italy has the least competitive tax system. Given that the Covid-19 pandemic and the associated economic downturn are at the forefront of economists’ contemplations, the following aims to deduce two lessons Italy can learn from Estonia to boost growth, investment and improve economic performance overall.
Whilst the EU is thinking of increasing corporate taxes on certain industries (such as digital services) to repay Covid-19 related debt, research from the OECD shows that rising corporate taxes are hampering economic growth. At a time when aiding the economic recovery is at the center of most policymakers’ ambitions, the EU’s plans, at first, appear contradictory and counterproductive. Figure 1 shows that a very competitive tax system like Estonia’s has a high score (of 99.84) in the “Corporate Taxes” category.
This high mark reflects the fact that the country only taxes distributed earnings which allows companies to reinvest profits without paying taxes. Furthermore, the country has a marginal corporate income tax rate (the rate at which each additional dollar of taxable profits is taxed) of under 20%. As the OECD average is 23.3 percent, this is comparatively low. Other things equal, countries with high marginal corporate tax rates such as Italy (see figure 2) tend to have less investment, and hence, less capital formation, and less growth. Certain EU officials suggest that the loss of investment is compensated by rising revenue available through the tax. However, the ITCI report indicates that corporate income taxes only raise limited amounts of revenue compared to other types of taxes. Considering this conclusion, the EU’s push for increased corporate taxes appears not to be entirely justified by the claim that it will bolster the heavily indebted post-Covid-19 EU budget. It seems as if this may do more harm to the competitiveness of European tax systems and corporate investment than it will do good to EU resources. Hence, not just Italy, but also EU leaders, should envisage what a corporate tax system like Estonia’s can do for an economy.
Another important message reflected by the ITCI findings is that Italy’s tax system, compared with Estonia’s, demonstrates a clear lack of efficiency and administrative capacity. In Italy, businesses require on average 169 hours to comply with personal income taxes (i.e. taxes levied on individuals’ income). This is more than double the OECD average of 66 hours and, thus, the highest compliance burden from the ITCI ranking. Unfortunately, Italy is not doing much better in terms of compliance with corporate income taxes. This is shown by their ranking at the bottom of both the individual and the corporate tax rankings in Figure 3.
Figure 3: 2020 International Tax Competitiveness Index Ranking of Estonia and Italy
The report clarifies that the compliance burden is usually related to the complexity of tax codes. Thus, the time required to comply with the individual or corporate tax increases proportionately with the complexity of the system. This suggests that Italy could move towards Estonia’s low compliance burden (ranked first in individual taxes and second in corporate taxes – see figure 3) by easing the requirements of paying income taxes. Working on administrative productivity in the tax system is of paramount importance (amongst others) due to individual taxes being one of the main ways to increase government revenue. As government spending is currently rising, efficiency in this domain is crucial. Furthermore, time-consuming tax compliance necessitates resources of businesses that could be used more effectively. Considering these possible productivity gains, the Common Consolidated Corporate Tax Base (CCCTB) being discussed by the EU could help Italy’s tax system progress. This is because a single set of rules for corporate taxes would cut compliance costs for businesses operating across the single market but also reform deeply inefficient tax systems such as Italy’s.
To conclude, one can say that the ITCI report identified two main lessons that Italy should learn from Estonia’s competitive tax system. On the one hand, competitiveness is advanced by reducing marginal corporate taxes and reforming what is taxed within corporate income. On the other hand, Italy needs to work on the effectiveness of its tax compliance for both individual and corporate income taxes by making it easier for businesses to comply with the Italian tax code. These two improvements will make the system more investment- and growth-friendly.
 This is a relative and not absolute ranking. Thus, Estonia’s score of 100 does not imply that the country has a perfect tax code but only that is the best compared to all other listed countries.
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