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Does A Flat Rate individual Income Tax Reduce Tax Progressivity? A Simulation For The Netherlands

Author: KOEN CAMINADA AND KEES GOUDSWAARD
Published in PFM, Vol. 1 No. 4

Throughout the last couple of decades the individual income tax
systems of most industrialized countries have been (repeatedly) the
subject of considerable reform efforts. Although the reform packages
vary to a wide extent across countries, the direction of change is
roughly similar. Most tax reforms are characterized by base broadening,
reduction of tax rates, flattening of the rate structure, and lower
tax to GDP-ratios. Implementing a flat rate individual income tax
seems to be in line with these reforms, although several steps further
along.
In this paper, we construct a flat rate/broad base individual
income tax system and we compare the distribution of the current
personal income tax in the Netherlands to the distribution of the
simulated flat rate tax. Using extended data, the effects are simulated
of eliminating deductions in exchange for a reduction in tax rates,
sufficient to keep personal income tax revenue constant. Our
simulations indicate that:
After drastic base broadening, a proportional rate of 27.7%
balances the budget (ex ante). Such a flat rate causes only
relatively small changes in average tax ratios.
Overall tax progressivity is mainly caused by the fixed personal
exemption, which we maintained in the simulated flat rate tax. We
calculated only a 6 percent lower income elasticity in the flat rate
system; the concentration (Gini) index of taxes indicates a modest 4
percent decline in progressivity.
JEL-classification H22, H24
Keywords flat tax, deductions, progressivity, distribution of the tax
burden

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