Today I’ve taken a look at the blog of prof. dr. Sylvester Eijffinger, which caught my attention since I mentioned him in my post of 5 September. I have some comments on his most recent post which discusses a proposal for a flat tax in the Netherlands. Because comments on his blog are disabled I’ll have to respond through my own weblog.
Tax brackets can discourage earning more income
One of the arguments Eijffinger gives in favor of the flat tax is that the current system of tax brackets in the Netherlands can discourage participation in the labor market. He notes that some people work part time, especially if they have a partner, to avoid higher tax brackets. If they work more they enter a higher tax bracket, which would require them to pay more taxes.
Eijffinger’s comment is rather short because it was a contribution to a discussion in the Dutch newspaper Metro, so I guess he couldn’t afford to give an example. Without an example it’s difficult to understand the problem, so let me give one. The first tax bracket in the Netherlands goes up to € 19.645 and has a tax rate of 37%. The second goes from € 19.646 to € 33.363 with a tax rate of 42%.
Let’s say I work part time to stay in the first tax bracket and make € 18.000. Then I get the option to work more so that I can earn € 22.000. In the first bracket I pay 18.000 * 0.37 = € 6.660. With the higher salary, I pay 19.645 * 0.37 = € 7.268,65 plus 2355 * 0.42 = € 989,10. Then the total tax I pay is € 8.257,75 over € 22.000, or 37,54%. Hardly a steep raise in the effective tax rate because I crossed the limit of the first tax bracket, right?
A solution without resorting to a flat tax
Let’s assume that my example doesn’t fit the point Eijffinger was trying to make. There is reason to believe that the effect can be stronger in other situations, the difference between the third and the fourth tax bracket for example is 10% instead of 5%. Let’s assume that mr. Eijffinger is correct.
In that case, couldn’t we simply use a formula to determine the tax rate for a progressive tax? It’s even simpler than tax brackets. For example, take the linear equation y=15+0.2*x which I’ve plotted here. In this formula “y” is the tax rate in percent and “x” is the income. This fixes the problem of suddenly having to pay much more taxes because the limit of a tax bracket is crossed.
I suggest this because I don’t believe that a flat tax can provide social justice for us. With a flat tax, a millionaire would pay the same percentage of taxes as a cleaner. Instead I think the strongest shoulders should bear the heaviest burden. Aren’t there plenty of other options to reduce inefficiency and bureaucracy in a progressive tax system?