KPMG’s Individual Income Tax and Social Security Rate Survey 2012 shows that for the first time in several years there has been a rise in the average top personal income tax rate across all countries surveyed- up by 0.3 percent.
Not surprisingly, the increase has usually concentrated on targeting high income earners, and in countries with progressive taxation system, this has sometimes entailed the creation of new top rate income tax bands. Alternatively, some governments have introduced temporary taxes to address immediate budget deficit concerns. The most prominent examples of this can be seen in the recent French and Spanish reforms.
However, taxation can also be used as a strategy to attract investors, and hence increase budget revenue in a more indirect way, through generating economic growth. This has tended to be the policy of governments in Eastern European economies, which have retained low flat taxes varying from 10% to 19%. While the eastern part of Europe is trying to attract investors with this low rate which can also play a role in decreasing labor costs, Western Europe continues to lay claim to the highest personal tax rates of any sub-region globally (46.1 percent).
But income tax is not the only levy applied on individual income, and the personal income tax rate is only one indicator of what taxes individuals may pay in total. Social contribution rates can be just as influential, as these can sometimes be far higher than income tax. Let us take the example of Romania. With a flat tax rate of 16%, Romania could look appealing enough for investors and private capital, but this advantage is almost annihilated by high social security rates which are around 44% aggregate (employer’s plus employee’s share) even though there is a cap which eases the burden for high income earners.
KPMG’s survey for 2012 involved a careful analysis of combined rates of both income tax and social contributions across the world, and the resulting statistics give us a far better idea of the effective tax rate for employment income.
Looking at Europe, the graphics below show that Belgium has the highest rate, with a cumulated income tax and employee effective social security rate of 47%, followed closely by Greece with 46.5% and Croatia with 46%. While France is known as one of the countries with the highest social contribution costs, it seems that the burden is greatest for the employer, as for employees the income tax and social security rate is 42%, which places France in 7th place after the three countries mentioned above, followed by Italy (around 45%), Germany (43.8%) and Denmark with 42.1% (just income tax, no social contributions).
Romania, with a cumulated income tax and social security rate at employee level of 32.5% is not in the middle of the list as one could have suspected, but towards the lower end, because of the cap to which the pension contribution (10.5%) applies (currently around 2500 EUR per month), which allows a decrease of the effective tax rate for higher salary income (the higher the income, the lower the effective tax rate becomes).
While the government’s task is to implement a fair taxation policy and protect budget revenue, almost every company must today juggle with costs and staff motivation.
In the economic boom years, employers were forced to offer attractive remuneration packages to retain their best and most talented employees, because competition was fierce and the need for high skills was constantly growing. Once many economies plunged into recession, companies had to drastically review their remuneration policies due to lack of their own financing, or government incentives. This was not an easy task, as employers were obliged to maintain the impressive remuneration packages agreed in better times, especially if the employees were remunerated on a net basis.
Companies were forced to find solutions, and those which suffered most were firms with people as their main capital asset. The time for equity based compensation rewards had passed (stock markets around the globe showed weak signs of recovery, and were not nearly as attractive as several years ago), while governments were increasing taxation rates for high earners, so simply granting bonuses would not have the same net results as before.
So how can a balance between pressure on costs and the need to maintain staff motivation be achieved? Some companies have invested significantly in designing the right benefits packages, based on the principle that if the employee does not get what he or she really wants and needs, none of the employer’s efforts, time and money spent to increase employees’ motivation will pay off.
This was carried out partly through the so called “cafeteria” or “flexible benefits” concept. Cafeteria means that basically employees can choose between a range of benefits, picking those which are most appealing to them at a certain point in time. The right to choose or change the benefits package can be exercised annually or twice a year, depending upon the benefits policy adopted. Of course, different benefits could have different taxation regimes depending upon each country’s economic strategy in the medium and long term. For instance, Romania is interested in encouraging more saving among the young and middle aged (more tempted to spend than save) and encourages alternative pension plans by exempting from tax and social security participation by employees and employers in private pension plans up to a limit of 400 EUR per year each (800 EUR in total). Likewise, participation in stock option plans enjoys favorable tax treatment, but it seems that in practice the authorities tend to apply it only for Romanian companies (probably in an attempt to boost the Romanian capital market) and may not be willing to accept stock option plans implemented by non-Romanian companies and which also reward Romanian employees of a group company.
Coming back to Cafeteria and flexible benefits, the idea behind it is good although it is also very simple. Everybody prefers cash, this is a fact. However cash payments usually come with the highest tax and social security rates, so the net resulting value could be disappointing. The only way to counterbalance the preference for cash is to give each employee what he/she wants and needs at a certain point in time. It may be that when we are in our twenties we want gym subscriptions, but in our thirties we may need crèche tickets and when we approach our forties we could get more interested in pension plans. At the same time we are given the choice and if we still give priority to cash, we know that it comes at a price, so for instance the effective tax rate for an equal amount of money paid cash (net in hand) could be 20% higher than if we had invested the same amount (the gross value) in a pension plan.
Statistics show, however, that only a quarter of interviewed employers use or intend to use the flexible benefits/ cafeteria concept in the near future. Reasons for this low interest can vary from the implementation costs (which is often too high for small to medium companies) to the lack of predictability in some countries’ tax regimes (under which certain tax incentives can be attached to some types of benefits for a couple of years and suddenly withdrawn as the government’s economic strategy changes).
This is merely the top of the iceberg when it comes to this subject, as we only approached high level trends and financial rewarding instruments. HR specialists also know that there are many non-financial ways to encourage employee motivation, which are equally important, but this is a different topic.