Does A Flat Rate Individual Income Tax Reduce Tax Progressivity? A Simulation for the Netherlands

Abstract

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.