It is often said that death and taxes are the only certainties in life, but are you certain about how much income tax you actually pay? And how do your taxes compare with taxes paid by people from other countries?
Imagine for instance a US and a Swedish worker talking to each other about how much they earn while away on holiday. The American is surprised to hear that the Swede pays a top income tax rate of just 25% on his earnings, and complains that she pays 35% on hers. Could Swedish people really pay so much less income tax?
The answer is yes, but only because both people are referring to the higher central government tax rates on income. People tend to focus on these higher marginal rates when comparing taxes. But a truer comparison demands looking behind these headline rates at the likes of tax allowances and relief, state and local income taxes, social security contributions and other charges. Adding in such factors can make the answer quite different; indeed, because of them, the Swedish earner would discover he pays quite a lot more than the headline rate would suggest, though so would the US earner (see figure 1). This is an important point, particularly now as countries tackle fiscal reforms to boost the recovery and cut their deficits.
Click to enlarge
All central governments in the OECD area levy tax on personal income and according to a similar fundamental structure too. But there are key differences. First up are personal exemptions which appear in different forms in different countries.
The “personal” or “standard tax allowance” exempts a standard amount of personal income from tax as is the case for instance in Belgium, Japan, Korea, the Slovak Republic, Spain, the UK and the US. Other countries do not exempt the first slice of income but tax it at a zero rate instead; this was the case in 10 OECD countries in 2009: Australia, Austria, Finland, France, Germany, Greece, Luxembourg, Norway, Sweden and Switzerland. This zero band has the same effect as a standard tax allowance. An alternative system is to tax all income, and give all taxpayers a reduction in their tax bill in the form of a “basic tax credit”, as is done in Canada, the Czech Republic, Denmark, Ireland, Italy, the Netherlands, Poland and Portugal.
Then there is tax relief, which may come on top of the standard tax allowances and credits. Some countries provide specific relief to single taxpayers or married couples on low incomes, to lone parents or married couples with children, or to cover work-related expenses, for instance. Employee social security contributions are also deductible from personal income tax in most OECD countries, though not in Hungary or the UK. In the Czech Republic and Hungary, social security contributions paid by the employer are even added to the income that is taxed under the personal income tax.
Evaluating earnings by couples can also alter the picture. Belgium, for instance, implements an income splitting system, which allows a proportion of the income of the principal earner in a couple to be attributed to the low-earning spouse in a bid to reduce the amount of tax that each partner would face individually. Splitting systems also exist in France and Poland where they reduce the overall family tax burden.
In short, the interplay of tax allowances and credits, and other tax rules and exemptions affects the tax landscape considerably. Take an individual who is single and has no children. For this category of earner, most countries exempt between 10-50% of the average worker’s annual gross wage from tax, though Japan and France exempt hardly any, while at the other end of the scale, Greece exempts 57% and Mexico exempts 73% of the average worker’s annual gross wage (see figure 2).
Click to enlarge
Tax brackets are another key feature to consider when comparing income taxes. All OECD countries use tax brackets, though the Czech Republic, Iceland and the Slovak Republic have just one tax bracket for everyone. Even in these countries, a significant amount of tax progressivity can be obtained through the level of the basic allowance. In 2009, there were two tax brackets in Hungary, Poland and the United Kingdom, for instance, while Portugal, Mexico, Switzerland and Luxembourg have over half a dozen each.
As part of a trend towards “flatter taxes”, many countries have reduced the number of tax brackets. All taxable income within a bracket is taxed at the same rate, and taxed progressively from bracket to bracket–as total taxable income rises, a growing share of it goes to the taxman. For instance, a taxpayer might pay, say, 20% in taxation on income up to $25,000, and 40% on all income above that amount.
However, as earners move into higher tax brackets, their tax relief and allowances actually rise in value too, so well-paid earners can end up recouping more from the state. Because of this, many countries have moved away from tax allowances and have started implementing tax credits whose value is independent of the taxpayer’s income level, making them more equitable.
Preserving the progressivity of the tax system also depends on how wide the tax brackets are and when higher brackets kick in. After all, a worker earning $30,000 who pays 20% on the first $20,000 dollars of income and 30% on the next $10,000 is a thousand dollars better off than a worker paying 20% on the first $10,000 and 30% on the next 20,000. This is because the lower tax band for the first worker is wider than for the second, and less of their income is exposed to the higher rate.
In Iceland, the Czech Republic and the Slovak Republic–the OECD countries that levy only one rate–and in Hungary, Ireland and Luxembourg, taxpayers at the income level of an average worker are already exposed to the top marginal rate. In contrast, workers in Germany must earn six times, and in the US nearly ten times, the average wage before they start paying the top rate (see figure 3).
Click to enlarge
How much people actually pay in tax also depends on how comprehensive the income tax system is. In some systems, such as those of Australia and New Zealand, other types of personal income are taxed jointly with wage income, whereas in others a schedular tax system is implemented which separates capital income from labour income and taxes them at different rates. This is the practice in dual income tax countries, such as Norway, for instance.
Other factors can influence the amount of tax paid, such as whether deductions are allowed for mortgage payments, as in the Netherlands, investment in renewable energy, as in France, or pension savings and charitable donations, as in Belgium; these “non-standard tax reliefs”, which depend on the actual expenses made by the taxpayer, are not included in the top statutory and “all-in” rates in our graphs. In short, people in countries with lower statutory tax rates yet very comprehensive tax systems and fewer exemptions, could be paying more income tax than in countries with higher statutory rates on wage income.
Nor does our comparison end there. Take the Medicare Levy in Australia, or Germany’s solidarity tax. These surcharges levied by central governments can bump up the final tax paid. Also, income earners may have to pay local, regional, provincial or state income taxes on top of the central government income tax. These can be relatively hefty: in Sweden the typical top rate of provincial and local income taxes is 31.5%, which is more than the standard 25% income tax rate levied by the central government. In some countries, state, regional or local income taxes paid are deductible from central government income tax. Comparing all-in tax rates must take this deductibility into account.
Employee social security contributions are also widely seen as taxes because they come off wages. In some systems their revenue is earmarked to finance programmes that essentially cover the whole population and hence resemble the personal income tax, even though there is a ceiling or “cap”. Some countries run social insurance programmes which only protect workers. The tax base is wage income, usually up to a ceiling, which in turn is related to the maximum amount of wages insured against the risks of unemployment and disability.
Nevertheless, social security contributions are compulsory payments to government, and as the benefits they provide are unrequited in that they are not normally in proportion to the payments made, covering costly events such as losing a job or falling ill, the OECD classes them as tax.
However, some social insurance contributions, even if compulsory, as in Denmark, Hungary, Iceland, Mexico, the Netherlands, New Zealand, Poland and Sweden, are not classed as taxes because the payments are typically requited when the employee retires and are paid into privately-managed funds. These “non-tax compulsory payments” are therefore not included in the all-in rates; the special feature in the 2009 edition of Taxing Wages contains more information on these payments.
Also not included in the all-in rates are those social security contributions and non-tax compulsory payments directly paid by employers, even though these may eventually be borne by labour through tighter wage deals. On the other hand, when labour is much in demand, employees may be able to shift part of their income taxes and employee contributions back onto employers by successfully demanding additional wage increases.
Consumption taxes are not included in the “all-in” rates either, although their inclusion could provide a more comprehensive measure of the extent to which the income tax system reduces the quantity of goods and services that workers can purchase (see the special feature in the 2008 edition of Taxing Wages).
In sum, comparing “all-in” tax rates rather than just statutory tax rates shows that the differences in tax paid on the last dollar or euro of earnings between top income earners in various OECD countries are narrower than widely portrayed in the headlines. When all is included, our US earner pays some 43.2% on her marginal income rather than just 35%, but the Swede pays an all-in rate of over 56%, which is more than twice the statutory income tax rate, as our first graph shows. Similarly, the all-in marginal tax rate for 2009 stood at 62.8% in Denmark instead of 26.5% for the statutory rate, 62% in Hungary instead of 36%, and 59.4% in Belgium, up from 50%. The lowest all-in rates were 31.1% in the Czech Republic, 29.9% in the Slovak Republic and 29.6% in Mexico, all of which are higher than statutory rates. In fact, “all-in” rates were higher in every country than the corresponding top statutory tax rate, except in the Netherlands, where some non-tax compulsory payments qualify as personal income tax relief and so bring down the total.
Despite these high rates, there has been a notable fall over the past decade in the top “all-in” marginal tax rates for the OECD area, from an OECD average of 49.6% in 2000 to 45.9% in 2009. However, to pay the top rate in 2000 taxpayers had to earn almost three times the average wage, while in 2009 taxpayers had to earn slightly below 2.5 times the average wage. In other words, earners are hitting top marginal rates at lower income levels than they were a decade ago.
A key point is that workers still face very high top all-in rates in many OECD countries. Policymakers must bear this in mind as they reform their own tax systems in an attempt to restore public finances while creating or maintaining a fair and equitable, yet pro-growth, tax environment.
OECD (2010), Taxing Wages, Paris
OECD (2010), forthcoming, “Making pro-growth tax reform happen”, in OECD Tax Policy Studies, N° 20
OECD (2006), “Fundamental Reform of Personal Income Tax”, in OECD Tax Policy Studies, N° 13
OECD (2009), Revenue Statistics.
De Kam, Flip and Chiara Bronchi (1999), “The income taxes people really pay” in OECD Observer N° 216, March
©OECD Observer N° 280 July 2010