Without empirical proof, I’ve often surmised that the higher a country’s effective tax rates (i.e., income-tax rates plus social-security contributions), the lower the country’s stock market appreciation. So I decided to check in on the hypothesis with a variety of country ETFs.
Italy, Sweden, France and Germany are among the most taxed. One emerging market makes that list as well… India. On the flip side, Spain, Japan, Switzerland and the U.S. are among the least taxed. The biggest emerger makes the least-taxed list as well… China.
Here’s how these country’s U.S.-exchange based investments performed over 10 years:
|10-Year Returns For High Taxed Nations Versus Low Taxed Nations|
|Effective Tax Rate||10-Yr %|
|The India Fund (IFN)||43%||318%|
|iShares MSCI Italy (EWI)||42%||31%|
|iShares MSCI Sweden (EWD)||41%||44%|
|iShares MSCI France (EWQ)||36%||32%|
|iShares MSCI Germany (EWG)||35%||16%|
|iShares MSCI Spain (EWP)||30%||122%|
|The China Fund (CHN)||27%||433%|
|iShares MSCI Japan (EWJ)||25%||-17%|
|iShares U.S Russell 3000 (IWV)||25%||-12%|
|iShares MSCI Switzerland (EWL)||17%||39%|
The first thing that jumps out at me is that developed nations that are taxed less haven’t seen their stock markets benefit more than other developed nations with greater tax burdens. Some could even attempt to argue that the U.S. and Japan had the worst 10-year run in spite of the lower effective tax rates.
Of course, that would ignore the fact that the U.S. and Japan aren’t just lower taxed entities… they’re the largest economies in the world. And in the artificial time period of 9/4/1999 – 9/3/2009, the largest economies grew slower than the world at large. Moreover, their respective currency devaluation accounts for a large percentage of discrepancies in developed market 10-year returns.
Nevertheless, there’s simply no evidence that effective tax rates over a long-term horizon have had an appreciable impact on stock asset prices in the developed world. As for the emerging world, however, China has run circles around its chief growth rival, India. And China has done so without the benefit of significant currency appreciation against the U.S. dollar.
Yet even here, I would be quick to suggest that cultural differences and political changes (e.g., big shifts for China towards quasi-capitalism) are at play. China’s stock growth superiority has less to do with a more favorable tax scenario than its middle class growth, exports and sheer political will.
In actuality, world markets respond to hundreds of factors, and tax rates alone won’t guide an investor on the best markets to invest in. Moreover, the effective tax rates on individuals say nothing about the tax rates on businesses. Indeed, it may be that the higher the tax burden for corporations, the lower the country returns.
Consider this: Japan has the highest national corporate income tax rate in the world… and the stock returns may partially reflect it.
How about the U.S.? The Tax Foundation reported that 25 U.S. states have a higher combined corporate tax rate than Japan and that all 50 states have higher marginal rates than France. (It makes you rethink whether effective income tax rates for citizens are ever an issue or whether corporate income tax burdens are partially responsible for the adverse effect on shareholder returns.)
Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.