Distributional effects of a flat tax: An empirical analysis for the Netherlands

In this paper, we construct a flat rate/broad base personal income tax system and we compare the distribution of the current personal income tax (including social contributions) in the Netherlands to the distribution of the simulated flat rate tax. Using extended data (personal income panel survey), the effects are simulated of eliminating deductions in exchange for a reduction in tax rates, sufficient to keep personal income tax revenue constant at the initial level and distribution of pre-tax incomes. Our simulations indicate that: - The redistributive effect of the current rate structure of the Dutch tax system - with marginal rates of 37.5%, 50% and 60% - is substantially diminished by tax deductions. Deductions appear to be very income-elastic. - After the simulated base broadening, a proportional rate of 33.2% balances the budget (ex ante). Such a flat rate causes only relatively small changes in average tax ratios. For a clear majority of the taxpayers, effects on after-tax income lie within a range of minus/plus 5%. - Tax progressivity is mainly caused by the fixed personal exemption, which was maintained in the simulated flat rate tax. We calculated only a 7 percent lower income elasticity in a flat rate system. We conclude that the income effects of the introduction of a broad base/flat personal income tax would be relatively small and cannot be considered as prohibitive.