The global mobility of capital, goods and services has risen dramatically over the past years. Nowadays, the added-value chain of companies is spread round the globe. They optimize the varying labour cost, investment, taxation and other conditions. Division of labour and specialization are on the rise. Clusters are being formed. Similar company functions are grouped around the same location, and labour-intensive parts of the production process are transferred via foreign suppliers or direct investments.
The increasing mobility of capital and labour (or knowledge) intensifies the competition between national economies. In view of this, the role of politics influencing the structural conditions of a location is growing in importance.
The goal is to optimize the structural conditions for a location to be able to assert itself. However, the appropriate strategy varies depending on a country’s comparative advantage. If the objective is either to prevent that industry and service branches leave or to obtain that new businesses settle, it is important to possess relative location advantages.
Switzerland: traditionally an attractive business location
Business location decisions depend on a variety of factors. Switzerland lacks raw materials and has a small domestic market as well as difficult geographic topographic and conditions. Under such circumstances, a favourable tax environment is of the utmost importance. However, many other factors influence the decision when it comes to the quality of a location, such as the availability of skilled labour, legal security with clearly defined ownership and liability rights, social cohesion, an efficient transportation system, a performing educational system, effective government, a liberal foreign trade policy, the low cost of capital, few trade hurdles, favourable exchange rate relations, internationally interlinked companies, and a balanced mix of economic sectors.
Looking at how tax policy has developed over the past years, Switzerland has reached an overall favourable position. On a federal level, the first business tax reform of 1998 strengthened it as a holding company location, in particular. Ten years later, the second business tax reform was drafted. It was directed at small and medium-sized enterprises. Worthy of particular mention is that the double taxation of dividend income has been alleviated for qualified shareholders. Accompanied by numerous cantonal reforms in the areas of profit and capital gains taxes as well as wealth and income taxes, Switzerland has thus strengthened its position as an attractive location for businesses. With a total profit tax burden of currently less than 15 per cent, the most attractive of the Swiss locations frequently rank at the top in worldwide comparisons.
However, location advantages are exposed to erosion. National tax systems are affected by intensifying international capital flows and the globalization of the financial markets. In particular, the development of corporate tax rates is impressive. While, for example, the average corporate tax rate in the 1980s was near 49 per cent in the OECD, it has now come down to about 28 per cent.
This is no different even when taking into account the various tax bases that tax rates use.
Multilateral initiatives – The answer to tax competition?
The dynamic development begs the question as to how to react to the challenges. At its summit in Freira (Portugal) in 1997, the EU took the initiative to identify harmful tax practices. Although the definition of harmful tax competition is still being debated, the EU decided to create a level playing field in the area of corporate taxation through a code of conduct. In order to achieve stability of the tax agreements inside the EU, non-EU countries such as Switzerland are also being urged to conform to the conduct guidelines.
A more or less marked distrust of the effects of tax competition is in the background. It is assumed that lowering tax rates is the expression of a ruinous race to lowering taxes. It is interesting, however, that tax revenues have risen sharply in Switzerland since 1970, despite falling corporate tax rates. While the GDP has risen by 2.9 per cent yearly on average, tax revenues have risen by an average 14.5 per cent and corporate tax revenues by 15.3 per cent on average. Even when considering just the last ten years, it is essentially the same picture:
The tax revenue in general and the corporate tax revenue in particular increased both in relation to the GDP as in relation to the total income.
Since the ruinous effects of tax competition have not been visible so far, Switzerland had better not consider negotiating its attractive cantonal tax regimes. After all, the cantonal tax regimes are comparable with the tax models of smaller national economies inside and outside of Europe, which apply reduced taxation to mobile capital gains in particular. In the end, the goal is to prevent double taxation.
Actively modelling tax competition through tax policy
If you stand for tax competition, you should also compare yourself with the competition. The trends in tax policy are clearly documented. The corporate tax rates are falling. Even personal income taxation has tended towards relief for some time now. The trend towards a growing gap between labour and capital income taxation is much stronger in small countries, which depend strongly on the developments in the international part of their economies, due to small domestic markets. Switzerland cannot escape this. With the taxation competence being decentralized, the different cantons have more or less strong needs for action.
Currently, the Swiss profit tax rates hover between 12.5 and 31.7 per cent.
Another trend is towards freeing the tax system of stamp duties. Particularly the stock issuance tax hinders the development of the capital markets and raises the cost of acquiring capital for companies. In addition, it is a very mobile tax base: Large firms have the ability to satisfy a part of their financing needs on international capital markets that do not impose such a tax. This is also the reason why competitive locations such as Belgium, the Netherlands and Ireland abolished the tax on domestic capital in 2006, and Luxemburg is reducing it to 0.5 per cent in 2008 and planning to abolish it in 2010. According to an EU directive draft, the few member states that still impose a stock issuance tax on domestic capital are to do away with it by 2010.
Furthermore, tax base calculations are becoming increasingly more technical. There is a tendency towards more generous solutions when it comes to loss deductions, namely by granting unlimited time periods and taking into account losses from foreign company locations. The current Swiss regulation limiting loss deductions to a period of seven years is too tight. In numerous other countries, loss deductions are not limited in time.
For groups organized into economic units, the recognition as a group is further gaining in importance. Most OECD countries offer that possibility for domestic groups, and there are even a few that extend it to foreign groups. Denmark and France offer possibilities for taking into account losses from foreign group companies; Austria and Italy have created the possibility within the framework of their most recent corporate tax reforms.
Traditionally, Switzerland has been an attractive location for businesses. The most recent tax reforms on the federal and particularly the cantonal level led to a strengthening of this favourable position. Further relief wi ll be necessary in order to improve Switzerland’s long-term location attractiveness. Switzerland is a small and open economy with high capital and labour force mobility. Tax attractiveness of the business location is, thus, critical for the prosperity, job availability and, last but not least, the preservation of our social institutions. However, location advantages are prone to erosion, as the competition keeps learning, too. Particularly the location attractiveness of the new EU member states should continue to increase with growing integration into the EU and rising legal security.
The author was born in 1948 and is the president of economiesuisse, an organization representing Swiss businesses. He studied economics at the university of Zurich and was first active at the Union Bank of Switzerland. From 1990 to 2000, Bührer worked for the group Georg Fischer AG, last as a manager. Since 2000, he has been an economic advisor and member of several boards of directors.