Policy Brief: Reforming Personal Income Tax

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.