Capitalism, Socialism and 10-Year Returns of Country ETFs

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.

Comments

[Tokyo Picker:]

The basic flaw is linking the level of tax/regulation to the change in stock market valuation. The reason why India and China have done so well is that their tax and reulatory environments have been improving, even if they still have a long way to go. The reason why the advanced countries have had relatively little increase in market value is because they have had little (if any) improvement. Change correlates to change.

Sep 07 08:25 AM

[Alphameister:]

Emerging markets inherently have much greater room for growth because they don't require extensive innovation to achieve such growth; they need only an increased respect for the virtues of capitalism. High corporate tax rates are paid by all of us and cannot be ignored when comparing tax burdens country by country. When you compare investment returns 5 to 10 years from now, my bet is that China will again surpass the U.S. and other developed economies by a very wide margin.

Sep 07 10:14 AM

[whidbey:]

This is not the first research on the topic. The NBER has several good papers on the subject.

Personally I am at a lose as to why one would think that tax rates affect equity prices over time. Equity prices are loosely correlated with earnings of corporations, but sales are not
a driver of earnings simply because margins are not well correlated with sales. The real effect of tax rates is their effect on the quantity of goods consumed per household. India is a case in point I think. A low income society consumes less. No question that corporate taxes are paid by consumers, but the distributional and wealth effects are seen at the household levels.

I like your question and you did well on a first cut showing what is going on in the aggregates. Thank you.

Sep 07 06:30 PM

[razorfangius:]

I don't understand your annualized column. It looks like your ten year column, divided by ten.

Sep 07 07:26 PM

[Hank Rearden:]

Good point razorfangius: "I don't understand your annualized column. It looks like your ten year column, divided by ten." I assume it is just an embarrassing stuff up on his part.

But equally silly is the idea that we can get statistical relevance from a sample of ten countries apparently picked at random.

Sep 08 12:55 AM

[Twakum:]

High tax rates in this case signal social models that WORK, not the nuttiness we have here with spitting right wing anti-everything that is SOCIALISM "OH MY GOD RUN AWAY!" Dont let that dark skinned person have my health care you commie!

Better working social models in the long run = better economies.

Sep 08 08:13 AM

[Analyste de...:]

Uber-capitalist wingnuts have long insisted that lower capital-gains taxation leads to greater growth. That's probably oversimplified bullcaca, but the author doesn't prove the thesis wrong either.

For a 10-Year snapshot, you'd have to rank socialist>capitalist, rank the rate of change of the tax rates, adjust for inflation, and compare apples-to-apples (large developed; small emerging; etc.) I'm not even sure that would present meaningful &obvious conclusions for the past 10 years!

This article (comparison) is fails to do that, so it's basically bunkum. But the underlying critique - that any economist's dictum should be questioned now - is spot on.

Economists' EPICALLY failed - as did almost all of those trained in their universities & b-schools - to foresee the Global Financial Crisis. Hold them accountable for their blatant failures & warped propaganda!

Sep 08 03:19 PM

[mna:]

you'll need to correct for survivorship bias. Especially since you're using russell 3000 instead of the larger cap funds, the survivorship bias effect is likely to be amplified. I'd be very interested in the final results though. Also, one more point that could skew the results significantly is the inclusion of various tax breaks/subsidies etc, which I suspect would alter the effective tax rate significantly. Either way, I appreciate the effort to bring some actual numbers to the table. Thanks!

Sep 08 03:46 PM

[lavalamp:]

A better label would be "average annual rate of return", "annualized" infers using compounding which is clearly not the case here.

Sep 08 06:15 PM

[kotika98:]

the tax rates you are using are all wrong!

The US rate is much more than 25%, and China's is much less than 27%. India wishes it collected 43% of income, but doesnt.

If you are going to do statistics, you better collect more accurate data, and on more qualtities. Otherwise, you should just make an in depth analysis just on a couple of similar otherwise countries but which have a significantly different level of taxation.

Sep 08 09:46 PM

[Thomas Smic...:]

When one examines all of the OTHER taxes that are paid over and above those analyed in this article, I would think the surmises would be different.

Sep 08 11:30 PM

[Stelly:]

This isn't even research on the topic....


On Sep 07 06:30 PM whidbey wrote:

> This is not the first research on the topic. The NBER has several
> good papers on the subject.
>
> Personally I am at a lose as to why one would think that tax rates
> affect equity prices over time. Equity prices are loosely correlated
> with earnings of corporations, but sales are not
> a driver of earnings simply because margins are not well correlated
> with sales. The real effect of tax rates is their effect on the
> quantity of goods consumed per household. India is a case in point
> I think. A low income society consumes less. No question that corporate
> taxes are paid by consumers, but the distributional and wealth effects
> are seen at the household levels.
>
> I like your question and you did well on a first cut showing what
> is going on in the aggregates. Thank you.

Sep 09 07:05 AM

[Windsun33:]

There are so many factors not taken into account here that any labels like "socialism" are washed out. As others noted, the tax rates in many cases are an illusion, and there are few (if any) statistics for the actual collected tax rate.

Sep 09 11:06 AM

[Thomas J. G...:]

To have the kind of test Gary is advocating you'd have to have 1/2 the countries start socialism and 1/2 the countries start capitalism and then measure the results from there. I'm not sure what the significance of measuring 10 countries, starting 10 years ago, when they've already had policies that effect their returns prior to the 10 years, is. It's an interesting idea though. His proxy for socialism is tax rate, which isn't terrible. I wrote a similiar article a while back.

Sep 09 04:44 PM

[xsellside:]

For the 39 years ended 12/31/2008, the top five country index returns are: Hong Kong +14.68%, Sweden +12.84%, Denmark +12.57%, Netherlands +12.16%, and Switzerland +11.47%. The bottom five are: Canada +9.43%, **USA +9.12%**, Austria +8.69%, Australia +8.45%, and Italy +5.99%. It is interesting that the top 5 are considered very “socialist” countries yet have had the highest returns. Source: DFA Funds

Sep 09 05:07 PM

[Moon Kil Woong:]

One should focus not on just individual tax rates but coroprate tax rates. Or going even further we should look at not just corporate tax rates but equalize the relative costs incurred by businesses for what socialized countries offer.

One of the biggest taxes of our industry is the amount businesses have to pay to give basic healtchare to their employees. With health insurance costs outpacing inflation and real growth in earnings by businesses it is no wonder America's businesses are in trouble.

If not universal health care we need some mechanism to hold these costs in check and get the insurers and lawyers out of the food chain. They are like maggots on meat. They spoil the whole dish no matter how good our doctors, medical practitionors, and treatments are.

Because of that, we now pay the highest price (the greatest percent of our GNP) to healthcare and are rated worse than the top 10 industrial; nations (partially because some people can't get treatment or you can't get proper care because they try pushing you out of the hospital or doctors office as fast as possible. It is a mess. Take medical expenses into account and corporate taxes rise astronomically because you pay them whether or not you're even profitable.

Sep 10 01:07 AM

[GotLife:]

Any list comparing China to Switzerland across one variable has no value. Switzerland has a population the size of Virginia while China is 173 times its size in population. And that is only the beginning of the dramatic differences between these two economies and cultures.

And why would equity price growth / tax rates even be a valued comparison? Wouldn't GDP / tax rates be better?

And as others have pointed out, growth from what base? As the GDP of a country expands, or the sales of a company increases, the percent of growth will necessarily slow. When Cuba or N Korea open their economies, they will become the fastest growing in the world. Just think of the autos that will be sold in Cuba to replace all those 1958 Oldsmobiles or in N Korea, the Cat graders to replace the shovels!

Sep 10 12:01 PM

[American in...:]

No, they have more capacity for growth because their costs are lower!


On Sep 07 10:14 AM Alphameister wrote:

> Emerging markets inherently have much greater room for growth because
> they don't require extensive innovation to achieve such growth; they
> need only an increased respect for the virtues of capitalism. High
> corporate tax rates are paid by all of us and cannot be ignored when
> comparing tax burdens country by country. When you compare investment
> returns 5 to 10 years from now, my bet is that China will again surpass
> the U.S. and other developed economies by a very wide margin.

Sep 10 12:06 PM