A new dataset to measure the effective taxation of capital and labor globally since the 1960s
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A common view is that globalization erodes the taxes effectively paid by capital owners, shifting tax burdens towards workers. This is supported by the global fall of statutory tax rates on corporate income and evidence that in, OECD countries, globalization reduces personal income tax rates on mobile high-income earners at the expense of median-income workers (Egger, Nigai & Strecker 2019).
But assessing the extent to which globalization has affected the relative taxation of capital and labor requires a global and long-run dataset on effective tax rates (ETR) on labor and capital. In our new working paper, , available here.
ETRs capture all taxes paid: on corporate income, individual income, payroll, property, and consumption. They then assign each type of taxes to capital, labor or a mix of the two and divide these by respectively capital and labor flows in national accounts (Mendoza, Razin & Tesar 1994). ETRs make it possible to estimate total tax wedges—for instance the gap between what it costs to employ a worker and what the worker receives—and how these wedges vary internationally and over time. Since capital income is more concentrated than labor income, the relative taxation of the two factors of production is closely linked to the progressivity of the tax system.
Globally, capital taxation has fallen and labor taxation risen, leading to their convergence; but in developing countries, taxes on capital taxes are rising, and faster than those on labor.
Figure 2 shows the global evolution of factor income taxation: over the past 50 years the average effective labor and capital tax rates have converged, due to 10 points increase in labor taxation and 5 points decline in capital taxation.1 The global rise in labor taxation is driven by the expansion of payroll and social security taxes in the 1970s and 1980s. Yet the most striking pattern is the marked decline of capital taxation: in high-income countries, effective capital tax rates were close to 40% in high-income countries in 1965 and fell to about 32% in 2018, driven by the collapse in corporate profits taxation.
Figure 1: The Effective Taxation of Capital and Labor
Note: this figure plots the time series of average effective tax rates on labor (blue) and capital (red), as well as the effective tax rate on corporate profits (red dashed line). The top-left panel corresponds to the global average, weighting country-year observations by their share in that year’s total NDP, in constant 2019 USD (N=156). The bottom-left panel shows the results for high-income OECD countries (N=37), and the bottom-right panel for low- and middle-income countries (N=119).
In contrast to high-income countries, effective capital tax rates in developing countries have been on a rising trend since the 1990s, albeit starting from a much lower level. The effective capital tax rate increased from 10% to 20% since the 1990s, primarily in large economies such as China, Brazil, India, and Mexico.
How has globalization affected the relative taxation of capital and labor?
A major evolution is the globalization of exchanges: trade in goods and services has grown rapidly in high and low income countries alike. Firms’ ability to shift production processes across borders might limits governments’ capacity to tax capital, a hypothesis consistent with the long-run decline in capital taxation observed in rich countries, but not with developing countries experience: since the 1990s—the onset of the hyper-globalization period—they saw a rise, not a fall, in effective capital taxation.
Figure 3 shows that changes in trade (export and imports % of GDP) correlate negatively with changes in the taxation of capital in rich countries, but positively in developing ones. On the contrary, the correlation of trade and labor taxation is positive and similar across countries.
Figure 3: Changes in Effective Taxation of Capital and Labor vs Changes in Trade
Note: Association between changes in trade and changes in effective tax rates of capital (panels a and b) and labor (panels c and d), respectively for high income OECD countries and for low and middle income countries. Trade is measured as the sum of import and exports as a share of Net Domestic Product. Binned scatter plots of the outcome against trade, after residualizing all variables against year fixed effects.
, adapted from Egger et al. The results consistently show that .
Trade integration exerts a positive effect on tax capacity of developing countries
Which mechanisms might explain these results? As previously discussed, globalization exacerbates tax competition and creates new opportunities for tax avoidance, putting downward pressure on capital tax rates—a race-to-the-bottom effect. Indeed, trade liberalization is associated with a decline in statutory corporate tax rates across all countries, but more so in high-income countries.
However,: this facilitates the imposition of taxes, particularly of corporate taxes—a pro-tax-capacity effect. Concretely, we observe a rise in production from the corporate sector and an increase in salaried employment. Further, the positive impact of trade on capital taxation is stronger in populous countries and in countries with restrictions on capital flows, consistent with the notion that large countries and countries managing their capital accounts are less exposed to the race-to-the-bottom effect. On net, the trade-induced increase in tax capacity dominates the statutory tax rate reduction in developing countries, and vice-versa in rich countries.
The results paint a nuanced picture of how trade integration has impacted the taxation of capital and labor: in developing countries, trade induced a rise in the taxation of both labor and capital, albeit starting from much lower levels than in rich countries. In future research, the database could be used to study the effects of globalization on tax inequality between groups of individuals, by combining macroeconomic tax rates on labor and capital with estimates of the progressivity of labor and capital taxes. Moreover, changes in tax progressivity could be compared to the effects of globalization on the distribution of pre-tax income. This would make it possible to quantify the extent to which changes in taxation caused by globalization have curbed or exacerbated its inequality effects.
Egger, Peter H., Sergey Nigai, and Nora M. Strecker (2019). “The Taxing Deed of Globaliza- tion.” In: American Economic Review 109(2), pp. 353–90. doi: 10.1257/aer.20160600.
Mendoza, Enrique G., Assaf Razin, and Linda L. Tesar (1994). “Effective tax rates in macroe- conomics: Cross-country estimates of tax rates on factor incomes and consumption.” In: Journal of Monetary Economics 34(3), pp. 297–323. doi: 10.1016/0304-3932(94)90021-3.
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