Pay as you go income tax system and tax burden for 30 years

Abstract

This paper describes the income tax system of pay as you go from its introduction in 1988. An analysis of the system is given, and its main characteristics, which are then put into Nordic context. To clarify the analysis this paper gives formal definitions of tax burden and marginal taxes. Measures for the progressiveness of the tax system are formulated and applied to the latest tax changes. Generally, since 1988 the indexation of the tax credit to general price increases has been the overriding factor in the development of the system and the tax burden. The tax burden has increased more for lower income people than for those on higher income. This occurrence is defined as real fiscal drag and resulted in more people paying tax. These changes have not been without controversy politically and among academics. The evolution of the system is described here without making a judgment of the political decisions that preceded the changes in the system. The underlying current has been the evolution of the allowance and the tax credit. A system with such a current needs to be recalibrated at regular intervals if it is to achieve vertical equity. That calls for policy making on tax rates, (the level of rates and the number of steps) and how the allowance and other reference amounts in the system evolve over time. This paper gives an overview of the options that the government has been giving consideration to during the latest round of evaluation of the system. The policy changes that is now under consideration is evaluated in terms of the proposed changes in progressiveness of the system.