How the ‘fun box’ shows that the system is broken and how to fix it

Since its implementation in 2001, we are dealing with a tax system which seems to be oddly imbalanced. It contains quite a few loopholes within its complex system, filling thousands of pages with legislation, its rules and exceptions. The majority of fiscal legislation regards a box-system: box 1 contains income from work and housing, box 2 contains substantial interest and box 3 contains income stemming from capital. All these boxes have different tariffs and contain different types of income. The names of these boxes can be misleading, since not all income from capital is taxed in box three. This poses a problem, since this enables tax experts to minimalize tax expenses of the wealthy by means of arbitrage. The same system can thereby be used to treat people differently without justification.

Fun box

The total amount of equity owned by the Dutch population is 2,900 billion euros. Around 1,300 billion euros is invested in future pensions, another 1,300 billion in housing and the another 400 billion euros in companies. Even though those 400 billion euros are deemed a small and dull fraction of total wealth, it is a very important part. It is taxed in box 2 and around 400,000 people are taxed in box 2. Fiscal experts have given box 2 the nickname ‘fun box’, referring to fiscally beneficial set-ups. For instance, it is possible to borrow money from your own company and retain a beneficial tax rate. Another example is a way to inherit capital at much lower rates via regulation regarding business succession. According to the CPB Netherlands Bureau for Economic Policy Analysis, the average tax paid via the business succession scheme is as low as 1.1%.

Disruption of the economy

In a report on the Dutch tax system, Jacobs and Cnossen explain why tax on equity is inconsistent and illogical. According to Jacobs, the Dutch government disrupts the optimal distribution of capital and risk in the economy: ‘the government provokes tax arbitrage with the plurality of tariffs, enabling the achievement of the lowest possible tax burden’. Computations of Jacobs show that tariff rates in all tax brackets could be reduced by as much as 8 or 9 percentage points if all subsidies regarding pensions and housing would be removed from the system. All these differing fiscal regimes cause a welfare loss and makes the Dutch economy more prone to cyclical changes.

In order to combat these welfare losses and the increasing inequality partly due to the tax system, Jacobs suggests to implement the same system on all fronts. This means that all equity should be taxed at the same rate; in this way, tricking the system will become much harder. However, Jacobs warns against a very strong lobby of wealthy people and tax experts. Since they have a significant interest in the continuation of the current system, they will bring forward every argument against changing the system. The golden solution seems to be gradualism: slowly transform the system to a uniform set of regulations.