5. Tax Policy Challenges from Globalization and Aging: Issues and Options

Alessandro Zanello, and Daniel Citrin
Published Date:
November 2008
  • ShareShare
Show Summary Details


The tax system in Japan, as in other countries, faces increasing pressures from aging and globalization. This chapter draws on recent international experiences and trends to identify and review some of the key issues likely to arise, and options for addressing them.

Aging and the need to increase revenue

Fiscal pressures from an aging population arrive sooner in Japan than elsewhere—and are considerable. By 2025, annual social security benefits are estimated to rise to about ¥50 trillion (Ministry of Health, Labor, and Welfare, 2006), equivalent at annual real growth of 3 percent, to around 5.5 percent of 2025 GDP. It is unlikely to be possible to finance this additional expenditure without tax increases given the cuts in other spending that would be required. This fiscal challenge is amplified by a net public debt ratio that, at around 90 percent of GDP, remains uncomfortably high. Spending adjustment has a role to play, but prudence requires planning for an increase in revenue of some percentage points of GDP. And the sooner action is taken, the less the increased need will ultimately be.

Challenges of globalization

Tax systems worldwide are in a state of flux, as countries seek to adapt to the changing circumstances implied by globalization.1 The increased mobility of capital, in particular, poses a variety of difficulties. First, the location of real investments becomes more tax-sensitive, as the increased mobility of goods and services, consequent on trade liberalization and technological change, makes it easier to disassociate places of production and sale. Second, the more aggressive use of transfer pricing and similar avoidance techniques makes paper profits more ready to flow from high- to low-tax jurisdictions. And third, individuals find it easier to locate their savings abroad, with tax authorities often ill-placed to discover and tax the income so derived. In relation to commodity taxes, cross-border shopping and smuggling have in many countries also come to be significant constraints in tax setting. High income individuals may also relocate in response to tax differentials. All these factors are likely to lead to downward pressures on tax rates and hence revenue. The strength of these various forces will naturally vary across countries. Experience elsewhere, however, has shown the forces of globalization to have a powerful impact in shaping evolving tax systems, and Japan is unlikely to be an exception.2

Key features of the present tax system

The tax ratio in Japan is relatively low by the standards of high-income countries. Revenue (including from social security) is around 26 percent of GDP, lower than in all Organization for Economic Cooperation and Development (OECD) countries except Korea, Mexico, and the United States. An increase in revenues thus seems feasible. The question is how to achieve this in a way that minimizes adverse effects on growth, efficiency, and fairness, and overcomes political resistance to substantial tax increases.

Figure 5.1, which compares the level and composition of tax revenues in Japan with those of other G7 countries, provides some clues. Beyond the low overall level, three features of current tax arrangements in Japan stand out. First is the relatively small amount raised by taxes on goods and services: only the United States—the only OECD country without a VAT—raises a smaller amount of GDP this way. Second, though less marked, is that the personal income tax and social contribution also have a relatively low combined yield. Third, and in contrast, revenue from corporate taxation is relatively high. While there is no presumption that other countries’ choices would be appropriate for Japan, these features do provide an indication of the most distinctive aspects of the Japanese tax system, which reform efforts should examine especially closely.

Figure 5.1Tax Structures in the G7, 2004

(in % of GDP)

Source: OECD (2006), Revenue Statistics, 1965-2005.

Tax policy options

There are many elements of any tax system—both policy and administration—to which one should look for improvement and, perhaps, additional revenue. The discussion here is not intended to be exhaustive.3 It leaves aside the possible scope for strengthening tax administration—including through the adoption of a common taxpayer identification number—to focus on design questions related to three pillars likely to be central to the development of the tax system in Japan:4 the corporate income tax (CIT), the consumption tax (a form of VAT), and the personal income tax (PIT).

Corporate taxation5

The corporate income tax is a more important source of revenue in Japan than elsewhere. Reflecting both its relatively high yield and the low overall tax ratio, the CIT has accounted for around 14 percent of all tax revenue, compared to an OECD average of about 10 percent.6 This is also an area evidently affected by wider international tax developments, in terms of both statutory rate reductions—the OECD average falling from 41 percent in 1986 to 27 percent in 2007—and innovation in the fundamental structure of the tax. While revenue from the CIT is currently robust, the future of the CIT must thus be a central issue in considering the shape of the Japanese tax system in the coming years.

The impact of any CIT—on incentives to invest, methods of financing, and avoidance activities—is usefully analyzed in terms of three tax rate concepts. How the CIT affects these decisions depends not only on the headline rate of tax but also on its base, most notably the deductions provided for investment and financial expenses. Recognizing this complexity, there are three central summary statistics describing any CIT:

  • the headline statutory rate: it is this (relative to statutory rates in other countries) that shapes the incentive to shift paper profits in or out of Japan by transfer pricing or financial arrangements;

  • the average effective rate (AER), defined as the proportion of the lifetime pre-tax profit of some investment that is taken in tax (which may vary across different assets, and by methods of finance). All else equal, investors will locate any given project in the country that offers it the lowest AER; and

  • the marginal effective rate (MER), defined as the difference between the before- and after-tax returns on a project that the investor finds just worthwhile (which may also vary across assets and finance): this will affect how much an investor will choose to invest once they have decided in which country to locate the investment.

These three different measures of the tax rate,7 although related,8 provide distinct perspectives on the CIT. Table 5.1 reports each for a range of OECD countries.

Table 5.1Rates of Corporation Tax
Statutory RateAERaEquity FinanceDebt Finance
United Kingdom302420-28
United States392924-46

Equity financed, investment in plant and machinery, rent at 10%.

Investment in plant and machinery

Source: Institute for Fiscal Studies,

Equity financed, investment in plant and machinery, rent at 10%.

Investment in plant and machinery

Source: Institute for Fiscal Studies,

The most striking feature from international comparison of these rate measures is the high statutory rate in Japan. At around 40 percent,9 it became the highest in the OECD after that in Germany fell to around 30 percent at the start of 2008. Reflecting this, Japan, along with Germany, also stands out as having the highest AER (an effect that would be even more marked for a project earning a higher rate of return than assumed in the table). The MER on equity-finance investments is also the second highest in the OECD, though the gap is in this case less marked as a consequence of the operation of the various deductions. The MER on debt finance, in contrast, is strongly negative: these investments enjoy a substantial tax subsidy at the margin, since the combined effect of depreciation allowances and nominal interest deductibility is that the cost of an investment is in effect deducted against tax twice, while the return is taxed only once. The high statutory rate makes the bias towards debt finance, present in all countries shown, especially strong in Japan.

Looking forward, there will be pressure to reduce the statutory rate of CIT. Tax planning—shifting profits to lower tax jurisdictions—is reportedly becoming more aggressive, and corporate inversion (the relocation of company headquarters abroad) is a significant concern. While there is good reason to suppose that the appropriate CIT rate is higher in Japan than in countries less important in world capital markets (not the least being the likelihood that such a reduction will trigger further cuts elsewhere), 10 it would clearly be wise to plan to deal with the likely pressure on the CIT. Two, related, questions arise.

One key question is whether revenue from the CIT can be preserved at roughly its current level. The experience in other OECD countries is that, broadly, revenue has indeed been maintained despite large reductions in the statutory rate of CIT (Devereux and others, 2002). This reflects (at least in part) the tendency to accompany these rate cuts by measures to broaden the base of the tax, most commonly a reduction in the generosity of depreciation allowances (though it is not clear that these have been enough to account for the buoyancy of revenues).11 In Japan, the scope for base broadening appears limited: as a rough indication of this, the productivity of the CIT—revenue relative to GDP, divided by the main rate of the tax (a measure of the implicit CIT base)—was in 2005 around the OECD average for other than resource-rich countries.12 Depreciation allowances for plant and machinery seem to have been broadly in line with international norms until April 2007, when they were increased to more than double declining balance (allowable write-off also being increased from 95 percent to the more normal 100 percent); those for buildings, on the other hand, appear generous even before this.13 The credits provided for R&D expenditure may also merit re-examination: there is much evidence that such tax incentives do increase measured R&D (though they are of little benefit to new and perhaps more innovative companies, which may have insufficient taxable profit to benefit fully from such measures). But it is less clear that this brings the social (rather than private) benefits that warrant public support. Other countries, such as Germany, prefer to rely on targeted spending measures (through the support of research centers or programs, for example) to encourage R&D likely to generate substantial spillover benefits.

A second question is whether more fundamental restructuring of the CIT would be appropriate. The last few years have seen significant experimentation in this area, in two quite different directions. One set of reforms has been marked by tighter restrictions on interest deductibility, beyond standard thin capitalization rules (which deny deductions when debt-equity ratios exceed some level, commonly in the order of 3:1). The rate reduction in Germany, for instance, was accompanied by a restriction of interest deduction to no more than 30 percent of earnings before interest and taxes.14 These reforms, which represent a quite different kind of base broadening than has been typical, take the system closer to a comprehensive business income tax (CBIT) in which interest deductibility is eliminated. Another set of reforms has moved toward the opposite extreme, extending deductibility, in various ways, to equity finance, and so taking the CIT closer to a tax on supernormal profit. Belgium, for instance, has adopted an allowance for corporate equity (ACE) system that allows a deduction for an imputed cost of equity finance,15 while Estonia taxes only distributed profit. Each approach has its merits and weaknesses. The ACE, for example, achieves an MER at corporate level of zero, whereas the CBIT does not. To maintain revenue, however, an ACE would require a higher statutory rate and, consequently, also a higher AER.

Structural issues also arise in relation to international aspects of the CIT. As in the United States, there has been some discussion in Japan of moving from the present worldwide system (with profits earned outside Japan subject to tax on repatriation, credit being given for taxes paid abroad) to an exemption system (in which they would be free of tax). This might improve the competitiveness of Japanese subsidiaries abroad, but at the same time is likely to worsen problems of transfer pricing and other forms of profit shifting.

The challenge will be to maintain revenue from the CIT, with little prospect of a significant lasting increase. While the structural issues just raised16 will need to be faced in any fundamental review of the CIT, for more revenue, it seems, Japan will need to look elsewhere.

Consumption tax (VAT)

Japan derives a smaller share of its tax revenue from this source than any other OECD country that has a VAT: only 9.5 percent, compared to an average in the OECD (excluding the United States) of 19.3 percent. At 5 percent, moreover, the rate of VAT is far below the OECD average standard rate of nearly 18 percent (Figure 5.2), and indeed is the lowest in the world (shared only with Panama, Singapore, Taiwan Province of China, and the Kingdom of the Netherlands—Netherland Antilles). All this makes the VAT a candidate for meeting additional revenue needs. Assessing the case for this requires consideration of a range of issues of efficiency, fairness, and practicality.

Figure 5.2Standard Rates of VAT, 2006

Source: OECD Tax Database.

On efficiency grounds, a strong case can be made for the VAT as a marginal source of revenue in Japan. Part of the reason follows from the equivalence, in present value, between a consumption tax applied uniformly to all commodities and a uniform tax on wages, profits, transfer receipts, and existing savings: the former taxes an individual’s use of funds, the latter taxes their sources.17 A consumption tax thus provides a useful adjunct to withholding in taxing labor income, notably in relation to small and informal enterprises. And so far as it bears on past savings, which reflect decisions already taken by the taxpayer, it has no distorting effect. There is also some evidence that countries which rely more heavily on consumption taxes (which, unlike capital income taxes, do not distort savings decisions) tend to grow faster in the long run (Kneller and others, 1999), and that many OECD countries have experienced efficiency gains from the VAT (which they have taken in part in the form of reduced reliance on more distorting taxes: see Keen and Lockwood, 2006).

The design of the VAT in Japan, moreover, has several strengths. It compares favorably with most other OECD VATs, being levied on a relatively broad base and at a single rate. This is evident, for example, in a C-efficiency ratio—VAT revenue divided by the product of consumption and the standard rate (which would be 100 percent for a textbook VAT levied at a uniform rate on all consumption)18—of 65 percent. This is significantly exceeded in the OECD only by the much admired system in New Zealand. The implication of the broad base is that raising the VAT rate to—purely for illustration—8 percent would increase revenue by nearly 1.5 percent of GDP.19

The widespread perception that the VAT is inherently regressive is much overstated. It is true that VAT payments as a share of current income fall as the level of income increases (though only modestly so in Japan: see Dalsgaard and Kawagoe, 2000). But an individual’s income in any one year is a poor indicator of their well-being, as it varies systematically over the life-cycle (potentially being lower for university graduates with good earnings prospects, for example, than for manual workers in prime age). People’s consumption, reflecting their own assessment of the spending they can sustain, may be a better measure of their true ability to pay tax than their current income. The equivalence noted above, moreover, stresses that the impact of any increase in the VAT rate will fall largely on those with accumulated savings at the time of the increase (more so, in particular, than would increased wage taxation). This will mostly mean the relatively old, which may have some appeal in terms of intergen-erational burden sharing. More fundamentally still, the distributional impact of any tax in isolation is—or should be—of little interest: what matters is the combined impact of all taxes and spending. To the extent that raising additional revenue by the VAT enables increased spending that benefits the poor, including through the provision of state pensions, the net impact may well be progressive.

This misperception may be difficult to overcome, however, so that any increase in the VAT rate could lead to calls for accompanying measures of redistribution. With many workers outside the PIT, as noted below, there is little scope for offsetting adjustment of the income tax rate schedule (short of introducing an earned income tax credit, a very substantial undertaking). Targeted spending measures are likely to be more effective. In particular, with the VAT falling in part on transfer income there may be pressure to adjust these payments for the increase in consumer prices (a point stressed by Hatta and Oguchi, 1992), and indeed social security payments are indexed to the CPI. To the extent that pension payments are for this reason increased, the additional revenue needed to deal with aging is of course further increased.

There may also be calls to protect the poor against a general VAT increase by applying a reduced rate to some basic items. While multiple VAT rates are indeed quite common in the OECD, the weakness of the case for their use has come to be widely recognized (so that most new VATs, such as that in Australia, are single rate). The key point here is that while the poor may spend a lower proportion of their income on some basic item, the rich may well spend a large absolute amount, and so derive more benefit from a reduced rate; in high-income countries, with a rich set of policy instruments available to them, there are likely to be better ways of pursing equity aims.

The general case for a single rate of VAT is reinforced in Japan by a particular practical consideration. Uniquely, Japan implements its national VAT not by the usual invoice-credit method (with the right to credit for VAT paid on inputs resting on invoices provided by the supplier) but by subtraction (charging tax on the difference between purchases and sales as shown in accounts).20 Though unusual, this appears to work reasonably well. A substantial increase in the standard rate, by making concealment of sales more attractive, could put the subtraction method under more pressure. Rate differentiation, however, would pose somewhat deeper challenges for the workability of the subtraction method, since (in order to give the proper implicit credit) it would become necessary for both sellers and buyers to identify the goods involved in any transaction. In this way, substantial elements of de facto invoice-credit taxation would become unavoidable, the question then arising of whether wholesale movement to such a system would be appropriate. This would be a major reform, requiring a wider assessment of the relative merits of the two approaches.

Other technical issues that would arise in increasing the VAT rate appear manageable. The main risk under the subtraction method is of giving excess implicit credit after the increase for commodities bought prior to the increase. Likely to be more of a concern is advance purchasing, especially of consumer durables, in anticipation of the increase. Recent experience in Germany shows that these effects can be significant, but not excessively disruptive. One estimate is that anticipation of the 3-point increase at the start of 2007 resulted in advance purchases of around 0.2 percent of GDP, with some marked sectoral effects (in automobiles, for example). More generally, the relative ease of the increase in Germany no doubt reflects the strong cyclical position at the time.

Personal income tax

Two sets of issues arise regarding the PIT: the potential broadening of its base, especially on employment income, and the broad architecture of the tax. These issues are separable, the main design issues relating to the treatment of income from capital rather than employment.

Base broadening

The revenue yield of the PIT in Japan is amongst the lowest in the OECD, about 5 percent of GDP in 2005, compared to an OECD average of 9.2 percent. This is not because marginal rates are low, at least on higher incomes: at about 50 percent, 21 the top marginal rate is now high by international standards. Rather, it appears largely to reflect base erosion by such features as: a relatively high basic exempt amount and dependent allowances (removing about 20 percent of all employees, including part time, from the PIT); an abatement for employment income (excluding from tax some fraction of such income, this fraction falling as income rises); and a variety of deductions (for life insurance premiums, for example, and certain work expenses). Ishi (2001) estimates that (in 2000) the revenue cost of the various reliefs available under the PIT was around 5 percent of GDP. This is something of an upper bound, since some of the “erosions” commonly included in such calculations—such as the relatively low rates applied to capital income—are, as will be seen, arguably appropriate. Nevertheless, there is evident scope for base-broadening measures that would increase revenue without increasing statutory rates of PIT.

Some aspects of base broadening may have relatively little, and even potentially beneficial, effects on income distribution and incentives. Reducing the basic exemption, for instance, would increase the amount of tax payable most for those taxpayers facing the highest marginal tax rate. For them, a reduction in exemption acts as a lump sum reduction in after-tax income that tends (through an income effect) to increase work effort. The precise incentive and distributional impact would of course vary across the potential measures. One general consideration, however, is that base broadening in itself would inevitably raise effective marginal tax rates, and so tend to worsen the labor market distortions created by taxing labor income. This could be mitigated by reducing statutory tax rates, though at some revenue cost. Given the fairly low effective marginal rates at present, especially at lower incomes (here also taking account of the relatively low rate of VAT, which, as seen, acts in large part as a tax on labor income), the adverse incentive effects of base broadening seem likely to be moderate.

Eliminating the abatement for wage income is likely to require accompanying action to strengthen enforcement on the self-employed. As in other countries, the rationale for this provision—a source of complexity that serves only to apply a different schedule to employment income than to other income—is to provide rough parity between the employed and the self-employed given the greater ability of the latter to avoid or evade tax. This raises wider issues concerning the treatment of the self-employed, touched on later.

Grand designs for the income tax

More fundamental issues also arise concerning the basic structure for the PIT. This has been an area of considerable experimentation and innovation in recent years, reflecting in large part various challenges posed by globalization. The lessons from these experiences merit close attention, since without a clear view of the system it is intended to create, piecemeal measures that complicate and undermine its coherence and stability can hardly be avoided.

For many years, the standard model for the income tax was the comprehensive income tax, as set out in the Shoup report and still formally the guiding principle in Japan. This applies a progressive schedule to the sum of income from all sources. Technical problems in doing this—notably those from the difficulty of taxing capital gains as they arise rather than, as is in many cases more practical, when they are realized—have long been recognized. But increased capital mobility has brought to the fore a more intrinsic limitation: it becomes hard to enforce taxes on capital income at rates as high as those that many countries wish to apply to (less mobile) labor.

There are three main alternative grand designs for the income tax. One is an expenditure tax, which would simply exempt capital income (if it is not desired to tax supernormal returns) or provide a deduction for all savings but tax both return and principal when spent (if it is). The second is a flat tax, which—as adopted in many countries of central and eastern Europe—applies a single rate to all labor income (above some tax-free amount).22 The third is a dual income tax (DIT), pioneered in the Nordic countries, which applies a flat rate to all forms of capital income and a progressive schedule to labor income.23

Which option is best suited to Japan? Many countries provide expenditure tax treatment for some forms of long-term saving (and Japan already provides such treatment for pensions24), but no country does this for all savings. (The general shift toward indirect taxation noted above, however, is to some degree a shift toward expenditure taxation.) Adoption of a flat tax has in some cases been part of a wider package including a reduction in exemptions and exclusions. But it is not clear why flatness itself—rather than judicious rate cuts—is needed for this. Moreover, it seems that the appeal of the flat tax has in many cases been as a way of signaling a fundamental regime change, marked by a greater commitment to market-oriented policies. This is clearly a far less vital concern in Japan. And while flat taxes can retain considerable progressivity, through the operation of a tax-free amount, current concerns at rising inequality in Japan mean that political support for applying a single marginal rate would be limited.25

The DIT seems in many respects well suited for Japan, as a flexible compromise between the difficulty, on the one hand, of taxing capital income without creating undue distortions and avoidance, and, on the other, an apparent social consensus on the desirability of marked progressivity. And indeed the present system is already in many respects close to a DIT: interest is taxed at a flat 15 percent, as are dividends (but with an option for inclusion in aggregate income) and taxable capital gains on most securities (with 50 percent exclusion of long-term gains). These features no doubt reflect a pragmatic recognition of the same forces that have led to explicit adoption of the DIT elsewhere.

Moving to a full DIT would mean pursuing uniform flat taxation of capital income not as an exception but as an objective. Such a direction for reform—which was advocated by Hatta (1992) for Japan even before its adoption by the Nordic countries, and is favored by Dalsgaard and Kawagoe (2000)—would require a systematic review and equalization of the effective tax rates applied to different forms of capital income (including dividends, interest, capital gains, and income from real estate). Given the considerable degree of uniformity at present, the most substantial issues would be in the treatment of the self-employed and close companies. The difficulty is that these have substantial ability to exploit any difference between the effective rates on labor and capital income by in effect relabeling income: paying salary to a spouse, for instance, rather than taking a profit. The Nordic countries have developed a range of ways to deal with these, differing in detail but in essence imputing some part of income to capital and taxing the rest as labor.26 These schemes are cumbersome, but needed given that the gap between the two tax rates in these countries can be in the order of 20-30 percentage points. Where the gap is smaller, as would likely be the case in Japan, they are less necessary.


The challenges for tax policy design in Japan over the coming years—many of which are also faced by other countries—are substantial. Increasing revenue when many external pressures act to reduce it will not be easy. What this overview suggests, however, is that Japan is in many respects relatively well-placed to deal with these challenges. It has a relatively low initial tax ratio, a well-designed VAT, and a variety of country-specific factors that may make tax bases less mobile than elsewhere.27


I am grateful to Kiyoshi Nakayama, Motohiro Sato and members of the IMF’s Japan team for many helpful comments and suggestions.


Some aspects of globalization, it should be noted, point towards higher taxation. Since many countries find taxing foreigners attractive, for example, increased holding of equity in domestic firms by nonresidents may tend towards heavier corporate taxation.

The increased international mobility of tax bases increases the risk that tax setting by each country pursuing its own interest will lead to collectively undesirable outcomes and hence implies a potential case for international coordination. These issues are not considered here.

A full review of the Japanese tax system would need to address a far wider set of issues than touched on here, including: property and land taxation; the level and role of the excises; tax and wider fiscal policy towards energy use and climate change; the tax treatment of small and medium-size enterprises (SMEs); the proper scope of earmarking; complexities arising from the differing bases of, and interaction between, national and local corporate and personal income taxes; and the financing of local government more generally.

Macroeconomic aspects of alternative fiscal consolidation strategies are explored in Botman and others (2007, Chapter 4 of this volume).

Dalsgaard (2008) provides a more complete discussion of CIT issues in Japan, including in relation to SMEs.

Revenue figures are from OECD (2007), and for 2005, except where indicated.

To see the difference, consider a CIT that taxed only supernormal profit at, say, 30 percent. In this case, the MER would be zero, since profits in excess of the minimum required by the investor can be taxed at any rate and still leave the project worthwhile for the investor: if (and only if) a project would have been profitable in the absence of tax, it is also in this case profitable in its presence. The AER, however, would be 30 percent, this being the proportion of pre-tax profit taken in tax. Such a tax would be non-distorting for investments that could only be located in Japan (because of the zero MER), but—to the extent that the AER is higher or lower than 30 percent elsewhere—could clearly have an impact on those that could be located elsewhere.

The AER is a weighted average of the statutory rate and the MER, the weight on the former being the ratio of the post- to the pre-tax cost of capital (Devereux and Griffith, 2003).

This comprises the national CIT rate of 30 percent and, giving rise to variation across localities—enterprise and inhabitants tax at prefectural level, and municipal inhabitant’s tax.

Smaller countries are expected to set lower tax rates than large because in considering a rate reduction they have relatively little revenue to lose from their narrow domestic tax base, compared to the large base abroad that they can hope to attract. There are also, perhaps, external benefits to the rest of the world from the maintenance of a relatively high tax rate in Japan, to the extent that a lower rate there would lead others to lower their rates too, aggravating the potential collective inefficiency from tax competition.

Other possible explanations include a secular increase in the share of profits, notably of the financial sector (Devereux and Klemm, 2005), increased volatility of profits (which, with tax payable on positive profits but not rebated on losses, tends to increase expected tax payments; Auerbach, 2006), and/or a greater tax attractiveness of incorporation consequent on lower CIT rates (de Mooij and Nicodème, 2008).

Japan’s CIT productivity of 0.1 was around the median for the countries in Table 5.1, and substantially exceeded only by Australia, Canada, Norway and—an exceptional case, with by far the lowest statutory rate—Ireland.

Internationally comparable figures on depreciation allowances are available at

In similar spirit, Denmark restricts interest deductions to the lesser of 55 percent of earnings before interest and taxes, and an amount calculated by applying notional interest to approved assets; and Canada proposes to restrict interest deductions related to income earned abroad.

Forms of ACE have also been used in Brazil, Croatia, and Italy. Klemm (2007) reviews these experiences.

On the comparison between CBIT and ACE, see Devereux and Sørensen (2005); on the comparison between worldwide taxation and exemption, see Mullins (2006).

This equivalence is developed, for instance, in Ebrill and others (2001).

Ebrill and others (2001) discuss the uses and limitations of C-efficiency measures.

VAT revenue in 2005 was about 2.6 percent of GDP, or around 0.5 percent for each point of the VAT rate.

There are a number of subnational VATs levied by subtraction, most notably the Italian IRAP, but these are levied at relatively low rates (a central rate of 4.5 percent in Italy). The IRAP does allow some modest rate variation across sectors.

Inclusive of the typical prefectural and municipal inhabitant’s tax.

This should be distinguished from the Hall-Rabushka flat tax, which is a form of expenditure tax. Experience with flat taxes as recently adopted is reviewed in Keen and others (2008).

Experience with the DIT is reviewed by Sørensen (1998) and Cnossen (2000).

Indeed the treatment of pensions is rather more generous than this, since contributions are deductible and funds exempt while cumulating, but pensions in payment are less than fully taxable.

The present system has substantial elements of flatness for many taxpayers, around 80 percent of whom pay at a marginal rate of 10 percent. They account, however, for only around 35 percent of PIT revenue.

These schemes are described in Sørensen (2005).

As an island, it may also be less vulnerable than are countries with long, open land borders to the risk that high excise taxes will be undermined by illicit trade.

    Other Resources Citing This Publication