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ISBN Number: 9264025782
Publication Date:
31 May 2006
Pages: 140
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OECD Tax Policy Studies N° 13: Fundamental Reform of Personal Income Tax
Centre for Tax Policy and Administration:
In a drive to encourage risk-taking, entrepreneurship and competitive fiscal advantage, many OECD countries have reformed their personal income tax system fundamentally over the last two decades. At the same time, governments are aware that they must maintain taxpayer’s faith in the integrity of their tax systems to fund public spending. Fairness and simplicity have become the byword of reformers, but the double challenge has meant that no clear consensus has emerged on an ideal personal income tax.
Although there are large differences in tax policies between OECD countries, almost all the reforms of personal income tax in the last two decades can be characterised as rate reducing and base broadening. This study examines the general trends in the taxation of capital income and of wage income, and the most significant changes that have taken place. It looks closely at the main drivers of reform, the trade-offs between policy objectives, the guidelines, objectives and design features of tax reforms and why fundamental reform of personal income tax systems has been so high on the agenda.
The principal systems of taxes on personal capital income and wage income - comprehensive, dual and flat – are thoroughly examined and evaluated in the OECD countries that have adopted these different systems or a mix thereof. They are each assessed in terms of the fundamental principles of sound tax policy: simplification, efficiency, equity, tax compliance and tax revenue, and their main advantages and disadvantages are discussed. The general way ahead will be set by the degree of success of the multiple experiences and policy mixes described in this analytical and comprehensive study.
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More information:
Many OECD countries have reformed their personal income tax system over the last two decades. Yet no clear consensus has emerged on what is the ideal personal income tax.These reforms have tried to create a competitive fiscal environment, which encourages investment, risk taking and entrepreneurship and provides increased work incentives. At the same time, fairness and simplicity have become the byword of reformers. Fairness requires that taxpayers in similar circumstances pay similar amounts of tax and that the tax burden is appropriately shared. Simplicity requires that paying your taxes becomes as painless as possible and that the costs of collecting taxes are kept at a minimum.Almost all of these tax reforms reduced the tax rates and broadened the tax base. Many countries have moved away from comprehensive personal income tax systems, which tax all or most wage and capital income according to the same progressive rate schedule. A number of alternative tax systems have been introduced.The dual income tax system established in the early 1990s in the Scandinavian countries taxes personal capital income at low and proportional rates while labour income continues to be taxed at high and progressive rates.More recently, flat tax proposals have been put high on the political agenda. Flat tax reforms mainly consist of two elements: reducing the tax rate schedule to a single rate and eliminating special tax reliefs, with the possible exception of a basic allowance.This Policy Brief looks at the recent trends in the taxation of personal income in OECD countries and evaluates the different types of personal income tax reforms.
What are the main tax reform trends?
There are large differences between OECD countries in the share of personal income tax as a percentage of both total tax revenue and GDP (see Figure 1). In 2003, personal income tax as a percentage of total tax revenue varied from almost 11% in the Slovak Republic to 53% in Denmark. As a percentage of GDP, it varied from 3.2% in Korea to over 25% in Denmark.There are substantial differences between OECD countries in the level of personal income taxes and in the reliance on social security contributions (see Figure 2). The tax wedges measure the difference between labour costs to the employer and the net take-home pay of the employee. Figure 2 also shows the parts of the wedges that are due to personal income taxes plus employee social security contributions and that are due to personal income taxes alone. Between 2000 and 2005, personal income taxes on labour have, on average, been reduced (see Table 1). For a single person earning 67% of full-time average production worker (APW) earnings, the rate has been reduced by 0.8 percentage points. They have been reduced by 0.6 and 0.7 percentage points at 100% and 167% of APW earnings respectively. The total tax wedge on labour is significantly higher when social security contributions are included.The unweighted OECD average of the top marginal income tax rates on labour income (see Figure 3) has decreased from 47% in 2000 to 43.3% in 2005. A reduction is also observed with respect to the top marginal tax rates on dividend income. This is part of a general trend of reducing tax rates at all income levels. It also suggests a reduction in the use of high marginal rates for top-income earners as a vehicle for income redistribution.As part of a trend towards “flatter taxes”, many countries have reduced the number of tax brackets. This trend – also caused by the reduction in the top marginal income tax rates – has continued after 2000. The number of brackets in the personal income tax system in 2005 varies from just one rate in the Slovak Republic to 16 in Luxembourg.
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Figure 1:
PERSONAL INCOME TAXE IN OECD COUNTRIES AS A SHARE OF
TOTAL REVENUE AND OF GDP
(2003)
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Figure 2:
INCOME TAX AND SOCIAL SECURITY CONTRIBUTIONS IN OECD COUNTRIES (2005)
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Table 1:
INCOME TAXES AND SOCIAL SECURITY CONTRIBUTIONS ON AVERAGE IN OECD (2000 VS 2005)
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Figure 3:
TOP STATUTORY TAX RATES ON WAGE INCOME (2000 AND 2005)
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Table of Contents
Executive Summary
Introduction
Chapter 1. Trends in the Taxation of Personal Income
- Personal Income Tax Revenue
- Trends in the Taxation of Labour Income
- Trends in the Taxation of Capital Income
- Trends in the Effect of Taxation on Income Distribution
Chapter 2. The Main Drivers of Personal Income Tax Reform
- Raising Revenue in an Internationally Competitive Environment
- Restoring Efficiency
- Maintaining Fairness
- Improving Compliance by Reducing Complexity
- Policy Choices Regarding Revenue Requirements, Equity-Efficiency Balance, Complexity of the Tax System, and External Pressures
Chapter 3. Personal Income Tax Design Questions
- Basic Concepts
- Tax Unit
- Rate Schedule
- Use of Tax Expenditures
- Impact of Inflation
- Effects of Personal Income Tax Reform on the Overall Tax-Benefit System
- Tax Compliance and Tax Administration
- Tax Reform Process
Chapter 4. Types of Personal Income Tax Systems
- Comprehensive Income Tax
- Dual Income Tax
- Semi-Dual Income Tax
- Flat Tax
- Expenditure Taxation
Chapter 5. Recent Proposals of Personal Income Tax Reform
- Flat Tax Issues in Russia, Slovak Republic, Switzerland, Poland, and Norway
- The Debate on the Dual Income Tax in Germany
- The choice of the Tax Unit: Stakes and Consequences
Chapter 6. Conclusion
- Simplification
- Efficiency
- Equity
- Tax Compliance
- Raising Revenue
- Fundamental Personal Income Tax Reform: The Road Ahead
References
How to obtain this publication
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