A Working Paper written by Andrés Fuentes and published by the OECD looks at features of the Swiss tax system and examines the extent to which certain aspects of the system may have a distorting effect on the Swiss economy. Generally Switzerland keeps tax rates down by imposing high compulsory payments on employers in respect of health and social security. These contributions flow to private non-profit organizations rather than to the government. The individual tax rates are however relatively high while the consumption tax remains low. Another feature of the Swiss tax system is that regional and local governments play a larger role in government finances than is normally the case elsewhere. As these sub-national entities have wide ranging taxation powers there is tax competition between them. Another feature of the Swiss system is that taxation rates are often determined by popular vote at the level of the cantons and municipalities.
The working paper suggests that shifting the tax burden towards consumption tax and real estate taxes would reduce the distortion in the system and may therefore encourage economic activity. High personal income tax is seen empirically to discourage entrepreneurial activity and investment, so lowering the taxes on individuals would have the effect of encouraging such activity.
There is scope to increase the amount of consumption tax collected and to use this to reduce personal tax rates. The value added tax rate could be increased, and some exemptions and zero rates could be abolished. Simplifying the VAT system by abolishing distortive exemptions and zero rates would also lower the administrative costs for business.
The Federal individual income tax rates are progressive in nature, with low or no tax on small incomes. This progressive effect is however not so evident in personal tax imposed by the cantons. The tax competition between cantons has led to tax incentives for high income earners in some places. This reduces the progressive effect of the Federal tax rates because high income earners often choose to live in low tax cantons. If the tax system were reformed by raising more consumption tax while lowering personal tax rates this might have the effect of increasing the tax burden on low income households, who would be paying more consumption tax through higher rates and fewer exemptions. This effect might be countered by raising government transfers to low income households in respect of compulsory health insurance.
Despite the introduction of tax incentives for two-earner households, the tax wedge on second earners in a household is still higher than that on the first earner. This is a consequence of the joint taxation of personal income provided for in the Federal income tax system. The introduction of separate taxation would therefore bring benefits in terms of incentives for second earners. This could be combined with the harmonization of the taxation of households across all levels of government.
The working paper suggests possible measure to create a level playing field for the financial services sector, including the abolition of certain taxes on financial transactions. Another possibility put forward for consideration is the application of VAT to all financial services, including banking services that are currently exempt. This is theoretically possible though generally not applied by any countries in practice. One disadvantage would be the additional administrative burden involved. Another possibility for leveling the playing field would be an additional tax on the profits and salaries of financial intermediaries that would offset the exemption from VAT on banking services, or the imposition of a higher tax rate on profits in excess of a notional return on equity. Such additional tax might however create further economic distortions.
The Swiss tax system contains incentives for households to become more indebted. This is another distorting effect of the system that could be modified because household indebtedness is already relatively high. This could give rise to dangers from the familiar combination of an increase in interest rates, a fall in house prices and a stock market fall or credit crunch. Swiss households may be particularly liable to problems of indebtedness owing to the high number of financial intermediaries in the country. Interest payments are tax deductible up to a certain ceiling and capital gains on household equity stock holdings are generally not taxed. Capital gains on residential housing are subject to restrictions and exemptions. The elimination of the tax deduction for interest payments by individuals could help to broaden the tax base. The lost revenue could be partly offset by also abolishing the taxation of imputed rental income.
There is some corporate tax rate competition between cantons and although the amount of corporate tax collected in Switzerland is broadly in line with other similar economies, there is some room for elimination of distorting effects. For example, some cantons levy progressive corporate tax rates which could be seen as a disincentive for companies to grow. This is particularly distorting because small, growing companies are important drivers of economic growth and employment. Such progressive tax rates may also encourage the splitting of businesses purely for tax reasons with further distorting effects. Taxes relating to issuance of equity may also distort economic activity.
