Abstract
This paper discusses the introduction of a flat rate income tax in the Netherlands; however, several of the points it makes may be relevant to other EU Member States. Especially, by combining it with other social security contributions the distributional effects become small.
The paper first presents an overview of the 2001 tax reform proposal and then continues with the recent and more detailed proposal of a flat rate income tax. Such a system can boost efficiency, employment and growth through simplification and the provision of better incentives. This system would therefore lead to a better-functioning labour market and fewer administrative costs for employers. There would also be fewer distortions for investments in housing and firms.
By itself, a flat rate tax usually has adverse distributional effects. However, if we allowed the income-dependent health care contribution to be given a flat rate as well, the distributional effects would be substantially reduced. The paper further discusses the implementation of the flat rate in other European countries, especially in Eastern Europe, where the basic allowance was increased to offset some of the adverse distributional effects. Nevertheless, such increases can have a negative effect on the functioning of the labour market. The literature seems to indicate that flat rate reforms are unlikely to spill over into Western Europe because there is little room for tax cuts in the coming years. Therefore, it is suggested to change the regressive Dutch health care contribution so that it applies to all wages.
In conclusion, there seems to be opportunity for a well-designed and administratively effective tax reform that combines flat rates and other social security contributions. The paper suggests lowering income taxes to a flat rate of 33.25%, which could be made possible by shifting the emphasis away from income taxes and towards value added taxes (VAT). Empirical analysis shows that consumption taxes, or VAT, are less harmful to growth and employment than are personal income taxes. In addition, a single-rate VAT has significant administrative advantages over the current multi-rate system. It should be noted that the author has limited the analysis to revenue-neutral policies. If cuts in government spending were allowed, the efficiency gains would be greater. A common approximation in economics is that the economic distortion (or excess burden) from an income tax is proportional to the square of the tax rate. A high marginal income tax rate raises the incentive for both legal avoidance and illegal evasion. Thus, there should be room for a further cut in income taxes through cuts in government spending, but this is something for future research. The implementation of a flat tax rate would improve taxpayer compliance and reduce red tape for companies and their employees.
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