Dividend income after the 2005 tax reform and alternative tax models

Other Publications, Reports 15 Tuomas Matikka

Abstract

This report examines the corporate and dividend tax reform of 2005 and its impact on dividend income, and considers the problem areas in Finland’s current income taxation and the reform of the tax system.

The report investigates changes in dividend income and in the distribution of dividend income between 2004 and 2005. Dividend income is compared across all dividend recipients as well as within different socioeconomic groups. Dividend income is examined among entrepreneurs, shareholders in limited liability companies, and upper-level salaried employees, as well as among those who did not belong to any of the aforementioned groups. In addition, changes in dividend income are examined among the top one percent of earners. For high-income individuals, the impact of the tax reform on the composition of income is also investigated.

The second section of the report examines the problem areas in Finland’s current dividend and capital income tax system, and investigates various options for reforming income taxation. Reform of the current system is examined using the JUTTA microsimulation models. The JUTTA model is based on detailed modelling of tax and social security legislation, and can be used to examine the effects of tax changes on, among other things, average tax rates and the total amount of tax collected. The alternative tax models focus on reforms that narrow the currently large gap between the relatively low capital income tax rate and the highest earned income tax rate.

Dividend income did not, as was anticipated in many quarters, decline significantly across all socioeconomic groups following the entry into force of the tax reform. In particular, changes in the dividend income of entrepreneurs, senior salaried employees, and the top one percent of earners were small. On the other hand, dividend income of shareholders and the other group declined.

The current taxation of dividend and capital income contains many shortcomings, and there is a need to reform the tax system in the near future. By narrowing the gap between capital and earned income tax rates, the incentive for income conversion arising from the tax differential can be reduced. This report presents tax-revenue-neutral income tax models in which the highest earned income tax rate is lowered and the capital income tax rate is raised. In addition, the effects of a progressive capital income tax on the average tax rates across different income deciles are presented. (AI translation)

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