The Final Tax Reform? Effects of a Flat Rate Individual Income Tax
European Taxation, Vol. 41, No. 2, pp. 42-46, 2001
Posted: 18 Jul 2009
Date Written: 2001
Throughout the last couple of decades, the individual income tax systems of most industrialized countries have been (repeatedly) the subject of considerable reform efforts. Many OECD countries have implemented tax reforms characterized by base broadening, reduction of tax rates and flattening of the rate structure. Recently, the focus has also been on lower tax-to-GDP ratios. For example, the German government carried out a major tax reform in 2000; the package implies a tax reduction amounting to EUR 25 billion annually in 2005. The Netherlands has just implemented a major reform.The new Income Tax Act 2001 creates a system with a broader base and lower rates, introduces tax credits and makes a fundamental change in capital taxation. Remarkably enough, when the plans for this reform were discussed (and enacted) in the parliament, members of parliament were already expressing interest in a new tax reform. Specifically, they asked the government to investigate the possibilities (or impossibilities) of a flat rate individual income tax. Various proposals for a flat tax have been made in other countries, especially in the United States. The meaning of a 'flat tax' is somewhat ambiguous in political debates and in the economic literature, but generally, a flat rate tax system has two key features: a very broad tax base and one fixed rate. Implementing a flat rate individual income tax in the Netherlands seems to be in line with earlier reforms, and could be seen as a major - final? - tax reform. In this article, we show some of the main effects of such a system. We simulate a very simple flat rate individual income tax system for the Netherlands and compare the distribution of the current individual income tax (including social contributions) to thedistribution of the simulated flat rate tax.3 Essentially, the effects are simulated of eliminating deductions in exchange for a reduction in tax rates sufficient to keep individual income tax revenue constant. Under 'our' flat tax, a uniform proportional rate is levied on a very broad individual income base, while only fixed personal exemptions are deductible from pre-tax incomes (i.e. a tax credit). For our analysis we use an extensive income survey of Statistics Netherlands, which covers 217,000 income recipients. Sample data have been combined with data from the tax administration. As a result, the survey contains the personal distribution of incomes (pre-tax, taxable and after-tax), the distribution of tax liabilities and almost all deductions. The article is organized as follows. Section II. evaluates the pros and cons of implementing a flat rate individual income tax. In section III. the individual income tax reform in the Netherlands is described briefly. Section IV. presents the characteristics of the simulated flat tax, while the income effects of such a tax are illustrated in section V.
Keywords: flat tax, income tax reform
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