Historical archive

Chapter 1 The Government’s Tax Reform Proposal – Challenges, Objectives and Main Features

Historical archive

Published under: Bondevik's 2nd Government

Publisher Ministry of Finance

Report No 29 (2003-2004) to the Parliament

1.1 Tax Reform for Economic Growth and Welfare

Improvements to the system of direct and indirect taxation form a key part of the Government’s economic policy. Guidelines for this effort are laid down by the Sem Declaration. The general objectives are an improved system and a reduction in the level of direct and indirect taxes, contributing to economic growth and the attainment of distributional goals. Thus far, overall reductions in direct and indirect taxes under the present Government amount to NOK 19.4 billion. A good tax system will strengthen the business sector and economic performance. It will provide incentives for increased effort, and offer each individual more freedom of choice. This will establish a solid foundation for economic growth and increased welfare.

It is the view of the Government that it is necessary to combine improvements to the tax system with tax reductions. In line with the Sem Declaration, one is aiming for the reform to yield overall income and wealth tax reductions in the region of NOK 12 billion. Tax reductions over and above the Sem Declaration commitments will depend, amongst other things, on how the tax bases develop, hereunder the effects of the tax reform on economic growth, how the Petroleum Fund develops, and any possible shifts within direct and indirect taxation. In the Government’s view, the reform should be phased in over three fiscal years.

The Government will retain the 28 percent tax rate on company profits and other capital income, and a progressive taxation of labour income. Consequently, there will still be a need for bridging the gap between the taxation of individuals and companies. The Government proposes that the current split model be replaced by a tax on high returns on capital on the part of owners. For personal shareholders, high returns on capital that are distributed as dividends or realised as capital gains from shares, will be taxed as ordinary income (the shareholder model). The shareholder model is materially different from the classical system of unmitigated double taxation of dividends, inasmuch as returns on capital corresponding to a risk-free rate of interest are exempt from the tax. For the self-employed one proposes a tax upon accrual, subject to an exemption (the source-based model) in line with principles similar to those of the shareholder model. The non-exempt part of the income is treated as personal income (on which social security contributions and surtax are levied). The surcharge on high (non-exempt) returns on capital on the part of owners must be evaluated in the context of the gradual reduction of the wealth tax. The Government’s proposal implies an overall reduction in the taxation of capital.

Moreover, the taxation of the imputed rent from housing will be abolished.

The shareholder model and the opportunity cost model will offer more accurate taxation of real labour income than does the current split model. This is necessary to ensure a fairer tax system with greater legitimacy. The model is based on the premise that a taxpayer will on the margin end up with much the same outcome irrespective of whether income from work is received in the form of wages or ownership income. The Government proposes that, as a general rule, dividends and capital gains on shares accruing to companies shall be exempt from tax. When combined with the abolition of the split model, this enables the abolition of both the RISK and the imputation systems. With the adoption of these changes, the taxation of shareholders will be compatible with Norway’s obligations under the EEA Agreement.

Phasing out the split model requires the highest rates of marginal tax to be reduced to about the overall tax rate on high income from shares. (The sum of company tax and shareholder tax comes to 48.2 percent.) In other words, the highest marginal tax rate on labour income should at least be reduced to the 1992 level. A balanced reform requires that the tax on lower income be reduced as well. Lower tax on labour income will provide incentives for working more and postponing retirement. That is an important contribution towards strengthening the Norwegian economy over time.

The Government believes that it is important to simplify and streamline the tax system. It is often high-income groups that benefit the most from allowances and special provisions within the tax system. Consequently, less reliance on such provisions is a good thing from a wealth distribution policy perspective. Allowances and special provisions that are not well founded should be reduced and phased out. The same applies to provisions that are highly complex, and which may lend themselves to abuse and enforcement problems. Certain social objectives that are at present being attended to via the tax system could be served better through schemes on the expenditure side of the budget. The Government will revert with specific proposals in the budgets.

The Report is based on the work carried out by the Skauge Committee, cf. the Green Paper NOU 2003: 9, “Skatteutvalget – Forslag til endringer i skattesystemet” (“The Tax Committee – Proposed Changes to the Tax System”). The Committee, under the chairmanship of Arne Skauge, submitted its recommendations on 6 February 2003. The Skauge Committee document was circulated to interested parties for their comments in May 2003. The present Report presents some of the views expressed through these comments. The comments themselves accompany the Report as an unprinted attachment. That is also the case with a report from First Securities ASA, assessing the shareholder model proposed by the Skauge Committee.

1.2 Challenges, Objectives and Principles

To meet the challenges facing the Norwegian economy

Developments in the Norwegian economy are favourable. The upturn in the business cycle appears to have become entrenched. Low interest rates contribute to stimulating domestic demand. Together with stronger growth internationally, weaker Norwegian krone exchange rates imply improved prospects for the industries exposed to international competition. Unemployment has levelled off, and an increase in employment and a reduction in unemployment are expected for both this year and the next.

Nevertheless, Norway is facing important economic policy challenges as the result of mounting future pension expenditure and other age-related health and care expenditure. The financing of pensions and health and care appropriations for the elderly will consume a steadily increasing share of the country’s total income in coming years. Consequently, there is a need for a long-term, comprehensive economic policy that reinforces the scope for growth in the economy. The main priorities include utilisation of manpower resources and strengthening of weak groups’ involvement with economic life. Tax reform, pensions reform, as well as the scale and scope of public sector resource utilisation, must be coordinated with each other. This will make it easier to face the challenges relating to the financing of welfare schemes.

Adherence to the guidelines for the use of petroleum revenues will ensure significant public sector savings in coming years. This is an important contribution to creating the fundamental confidence in the Norwegian economy that is necessary for Norway to be an attractive country in which to invest. However, public sector saving through the Petroleum Fund will only be able to finance part of the expected expenditure growth, cf. the calculations presented in the 2004 National Budget. Consequently, implementation of a success pensions reform is of decisive importance. The Government will follow up on the proposals of the Pension Commission (cf. the NOU 2004: 1 Green Paper, “Modernisert folketrygd - Bærekraftig pensjon for framtida” (“Modernising the National Insurance Scheme – Sustainable Pensions for the Future”) in a separate Report to the Storting.

A key challenge for tax reform and pensions reform is to stimulate increased and prolonged participation in economic life. This is necessary to uphold and develop the Norwegian welfare state. It must become more remunerative to work for both retirees and other groups. Reduced marginal tax rates on labour income are necessary to stimulate increased and prolonged participation in economic life. This is a core objective of the tax reform.

More equal treatment and reinforced legitimacy

The shareholder model, the source-based model and reduced marginal tax rates on labour income will ensure more equal tax treatment of real labour income than at present. Equal tax treatment combined with an expanded tax base will contribute to a simpler and fairer tax system, and thereby to improved confidence in the tax system. Typically, high-income groups have more opportunities and greater incentives for utilising allowance schemes and special provisions of the tax system. Furthermore, equal tax treatment and an expanded tax - base will also improve resource allocation, partly because tax planning becomes less profitable.

Since the 1992 tax reform, the tax system has been based on a two-tier structure, with all capital income taxed at a flat rate of 28 percent, whilst labour and pensions income (personal income) and wealth are taxed progressively. The split model, which was introduced in 1992, aimed at ensuring that returns on labour earned by active shareholders and the self-employed were taxed as personal income.

The split model no longer works as intended. Since 1992, the rate differential between labour and capital has increased from 28.1 to 36.7 percentage points, inclusive of employer’s National Insurance contributions. Increased marginal tax rates on labour income, combined with a dilution of the split model, have made it both more profitable and easier to structure income in a manner that results in actual returns on labour being taxed as capital income. This is reflected in the fact that the share of limited companies subject to split-income taxation has decreased from 46 percent in 1994 to 32 percent in 2000, and that more than 70 percent of limited companies subject to split-income taxation have negative estimated personal income. The consequences are that redistribution through the tax system is impaired, that the principle of equal taxation of equal income is violated, and that the legitimacy of the tax system is undermined. The Government is of the view that it is necessary to make changes to the tax system that permit an abolition of the split model.

Make the tax system robust in the face of increased internationalisation

In an integrated international economy, particular attention must be paid to ensuring that the tax system makes it attractive to work, invest and operate business in and from Norway. Increased mobility of goods and productive resources implies that differences between countries may become more important. Consequently, the tax systems of other countries are important factors in deciding how the Norwegian tax system should be designed. In addition to tax rules, important considerations in the localisation of businesses are proximity to markets, infrastructure, access to natural resources and qualified manpower, relative labour costs, predictability, etc. The Norwegian tax system should be simple, predictable, and provide a good general framework that reinforces economic growth.

The tax system must be adapted to the requirements laid down by the EEA Agreement, hereunder freedom of establishment and the free flow of capital. Tax rules shall not, as a general rule, discriminate against foreign owners or foreign shares. Dividends and capital gains from foreign shares are at present taxed more heavily than dividends and capital gains from the shares of Norwegian companies. One of the reasons for this is that the imputation system (which ensures that dividends are subject to the same level of taxation as other income) only applies to Norwegian shares and Norwegian taxpayers. Moreover, the RISK regulations (introduced to prevent income taxed on the part of the company from also being taxed as a capital gain on the part of the shareholder upon realisation) do not apply to foreign shares.

Several other countries within the EEA have – or have had – various types of imputation system featuring limitations as to their scope of application corresponding to those of the Norwegian one. The lawfulness of such rules has not been tested before the EU Court or the EFTA Court, but the EU Court is scheduled to hear a case concerning the Finnish imputation rules. The EU Commission has stated in a communication1 that a Member State cannot operate a system whereby domestic dividends are subject to more lenient effective taxation than are cross-border dividends, under reference to the provisions on the free flow of capital. It is hereunder pointed out that an imputation system will be unlawful if it only applies to domestic dividends, with the consequence that incoming dividends are subject to a higher effective taxation.

There are also ongoing proceedings before the courts concerning withholding taxation of dividends from Norwegian companies to shareholders in a different EEA country.

Developments within EU law imply growing uncertainty as to whether the present Norwegian system of dividend taxation may be considered to violate the EEA Agreement. A corresponding uncertainty may also apply to the taxation of gains from shares. The Government has therefore found it important for amendments to the rules on the taxation of income from shares to comply with the requirements laid down by the EEA regulations.

Improve conditions for businesses and private Norwegian ownership

To ensure favourable conditions for operating a business in Norway, overall taxation of capital must not be too high compared to that of other countries. Taxation of companies and owners, and of capital income and capital assets, must be seen as a whole. Norway has a relatively low formal tax rate on company profits, and the RISK regulations and the imputation system imply that the owner is only taxed once on company profits. However, Norway has, unlike most other countries, a wealth tax that adds considerably to the overall taxation of capital.

The wealth tax suffers from several serious weaknesses. It impairs incentives to save. The skewed and in part arbitrary valuation of various wealth components contributes to distorting the composition of investments away from business. This reduces the overall return on savings. Moreover, the wealth tax makes it more difficult to keep businesses under Norwegian ownership because it only affects Norwegian owners. In addition, it may cause tax-induced relocation from Norway. This applies in particular to owners of businesses that become listed on a stock exchange with a high valuation because of expected high future income, whilst suffering weak earnings during an expansion phase. The Government will therefore scale back the wealth tax with a view to its abolition.

Streamline and simplify

The main objective of the tax system is to finance public sector expenditure in a manner that contributes, to the maximum extent possible, to efficient resource allocation. The tax system should at the same time play a key role in terms of wealth distribution policy, first and foremost through a progressive taxation of personal income.

The taxation of individuals, in particular, is characterised by allowance schemes and special provisions designed to attend to various causes. This narrows the tax base, makes it more difficult to keep tax rates low, and increases the complexity of the tax system. Besides, a broad tax base is important to ensure that the progressive rate structure has the intended distribution effect. Only individuals with taxable income can benefit from the allowance schemes of the tax system, and the tendency is for high-income groups to have the largest allowances. On this background, there is a need for simplifying and streamlining the tax system.

Simplification of the tax system should partly be accomplished through abolishing or restricting schemes that are no longer sufficiently well founded, and partly by relocating schemes that should remain prioritised to the expenditure side of the budget. Grants can more easily be targeted at specific recipients, if desirable, and therefore tend to be better targeted than tax allowances. It may also contribute to reducing the overall administrative costs relating to such schemes. The tax administration currently dedicates considerable resources on processing individual cases within areas that fall outside their core area of competency. Simpler rules and fewer exemptions will contribute to more equal treatment, both formally and in practise, and will make it easier for ordinary taxpayers to understand and abide by the tax rules.

Upholding the principles underpinning the 1992 tax reform

As was the case with reforms in many other countries, the 1992 tax reform attached considerable weight to designing the tax system in accordance with the principles of equal treatment, broad tax bases, low rates, neutrality and symmetry. The objective was improved resource allocation, more just allocation of the tax burden, and simplification. The reform was intended to result in more equal treatment of different taxpayers, industries, types of income, and types of organisation, and to reduce the scope for tax-induced adaptations.

The Skauge Committee emphasises that it is of considerable importance for the ability of the economy to generate growth that the need for efficient resource allocation is attended to in the design of the rules on direct and indirect taxes. The Committee is of the view that the said reform played an important role in the positive developments the Norwegian economy underwent during the 1990s, although it is difficult to separate the contribution of the tax reform from other factors. The tax reform contributed to a better correlation between pre- and post-tax profits. This has resulted in more efficient resource allocation and increased returns on capital. Furthermore, the Committee shows that the reform has probably contributed to increased savings, both on the part of households and on the part of business. The reform contributed to making capital more mobile, both between businesses, and between households and businesses. This was reflected in increasing dividend payments during the 1990s, although the upturn in the business cycle after 1992 also played a role. Improved profitability and expanded tax bases contributed to increased tax income from businesses despite the tax rate being reduced under the reform.

The Government emphasises that the main principles of equal treatment, broad tax bases and low tax rates made the 1992 reform highly successful, and will continue to rely on said principles when moving forward.

1.3 The Government’s Proposal

The taxation of businesses and capital

The Government proposes that the 28 percent tax rate on ordinary income, which is also the tax rate on corporate income, be upheld. The Government is of the view that the tax rate on corporate income should not be increased, given that the tendency in many countries is for this to be scaled back. Norway continues to have a relatively low formal tax rate on corporate income, but the broad tax base implies that the effective tax rate on company profits is in the international middle range. All in all, company taxation would appear to remain well adapted to the international situation, but developments need to be monitored.

For a tax system to gain widespread acceptance, labour income must be taxed equally, irrespective of whether it is earned by an employee, an active owner through his or her own limited company, or a self-employed person. At present, the split model does not work as intended. It is highly profitable to accrue true labour income through a proprietary business, taxed as dividends at 28 percent. The dilution of the split model through the 1990s was partly a consequence of the standard templates inherent in the split model. Standard templates may seem unreasonable in individual cases, and this gives rise to a pressure for modifications that make the model less effective. The Government shares the scepticism of the Committee as to whether it is possible to achieve a better and tighter split model that would remain stable over time.

The Government is of the opinion that a better solution would be to introduce a tax on high dividends and capital gains, implying that, on the margin, it does not matter much from a tax perspective whether the shareholder extracts returns on labour in the form of wages or in the form of income from shares. This will make it possible to abolish the split model for active owners, provided that the marginal tax rate on high labour income is reduced.

At the same time, the Government wishes to preserve the principle from the 1992 tax reform that the tax system should not distort company investments or financial structures. A tax on dividends should not make it more profitable to deposit money in the bank than to invest them in business ventures. The Government will therefore not recommend a classical tax on dividends, with all company profits being taxed fully on the part of both the company and the owner. That would make it significantly more expensive to finance investments by new share capital from Norwegian investors than by borrowing, retained profits or share capital from foreign investors. A classical tax on dividends might be particularly detrimental to small start-ups that, to a larger extent than well-established businesses, depend on infusions of new share capital. Neither will the Government recommend dividend taxation at a reduced rate or with a reduction in the amount posted as taxable income, corresponding to the interim tax on dividends abolished by the Government in connection with the 2002 budget. Such dividend taxation models would not permit the abolition of the split model for limited companies, because wages and dividends would continue to be taxed differently on the margin.

The Government is of the opinion that the shareholder model proposed by the Skauge Committee is best suited to furthering the objectives and considerations underpinning the reform. The shareholder model implies that only high dividends and capital gains are taxed as ordinary income on the part of personal recipients. The model is attractive from the perspective of investment and financing neutrality, since returns on capital corresponding to the risk-free rate of interest are exempt from increased tax. There are no tax benefits from retaining profits in the company rather than distributing them to the owner in person. Consequently, dividend taxation will not result in company capital being locked in. Since the shareholder model applies to both dividends and capital gains, the RISK regulations applicable to capital gains tax can be abolished. Since capital gains and dividends from Norwegian and foreign shares are treated equally, the shareholder model complies with the requirements of the EEA Agreement respecting the free flow of capital.

The shareholder model may provide taxpayers with an incentive to extend loans to the company instead of contributing equity, with a view to extracting company profits in the form of interest instead of dividends. It is therefore proposed, in line with the recommendation of the Committee, that particularly high interest income on loans from personal taxpayers to limited companies be subject to a tax corresponding to that on high dividends.

It will be challenging on the part of both the taxpayer and the tax authorities to implement and follow up the shareholder model, but this will be facilitated by a shareholder register. Besides, the new administrative tasks relating to the shareholder model must be considered in the context of a simultaneous abolition of the imputation system and the burdensome RISK regulations pertaining to capital gains taxation, together with the removal of the split model.

Fully equal treatment across organisational forms would require corresponding extraction taxation of the self-employed (partners of partnerships and sole proprietorships) as of limited companies. However, the shareholder model is not directly applicable to the self-employed because it is impossible to identify extraction from the business. The Skauge Committee was of the opinion that extraction taxation of the self-employed should be considered in more detail as part of the follow-up effort.

Given the close integration between the finances of the business and those of its owners, it would in the Government’s view not be appropriate to levy extraction tax on the self-employed. Instead, the Government proposes a surcharge on the self-employed upon accrual, with a cost exemption based on principles similar to those of the shareholder model. The non-exempt part of the income is treated as personal income (on which social security contributions and surtax are levied). As is the case under the shareholder model, the source-based model will not distinguish between active and passive partners, implying that a computed personal income will be attributed to all personal partners of partnerships. Similar rules apply to sole-proprietorships. The source-based model may, when taken in isolation, appear more restrictive than the present split model, because, amongst other things, the maximum limits on computed personal income are abolished and the income base for computing personal income is expanded. However, this must be considered in the context of reductions to the surtax and the wealth tax, as well as the objective of more equal treatment of true labour income.

Neither will the Government recommend that the shareholder model be applied to tax dividends and capital gains on shares between companies, as this would result in higher income from shares being taxed repeatedly in chains of multiple Norwegian companies (chain taxation). This would create incentives to reorganise in order to avoid such chain taxation, and would moreover impair the mobility of capital within the corporate sector.

The Skauge Committee proposed the continuation of the RISK and imputation systems within the corporate sector until other solutions could be assessed. The RISK and imputation systems will normally prevent chain taxation. The current RISK and imputation methods, however, entail differences in the treatment of Norwegian and cross-border flows of income from shares. This may give rise to uncertainties with regard to compliance with the EEA Agreement. The Government will not recommend that this issue be resolved by expanding the scope of the RISK regulations to encompass the shares of non-resident companies. This would create a number of administrative difficulties, and it is basically not advisable to simultaneously apply both the complex RISK regulations and the shareholder model.

As was pointed out by the Skauge Committee, one solution could be to exempt dividends and capital gains on shares between companies from taxation. Other income derived by companies will be taxed on an accrual basis as today. Dividends and capital gains on shares will be taxed on extraction from the corporate sector, and only to the extent that such income exceeds the risk-free return. The exemption will, as a main rule, apply equally to domestic and cross-border share income, and thereby ensure that Norway’s obligations under the EEA Agreement are met. At the same time an exemption method for companies, when combined with the shareholder method for individual shareholders, enables the complete abolition of the RISK and imputation systems. The Government proposes, on this background, the introduction of an exemption method for companies. The exemption method shall apply to dividends accruing as from the 2004 fiscal year onwards, and to capital gains and losses on shares that are earned or incurred as from the date of submission of the present Report to the Storting.

The Government takes the view that the tax base for business taxation must continue to be based on the principles underpinning the 1992 tax reform, which attached considerable weight to the importance of efficient resource allocation. This implies, amongst other things, that the tax base should, to the maximum extent possible, correspond to the actual profits or losses of the business, and that income and expenses should be treated symmetrically. The Government agrees with the Committee that the current rules for determining the base for business taxation are, generally speaking, in line with these main principles. Nevertheless, there may be a need for certain amendments to make the tax system simpler and more neutral.

Taxation of wealth and real property

The current wealth tax results in a highly unequal tax burden, depending on what assets the wealth comprises. This affects savings decisions, and has unreasonable implications in individual cases. Moreover, it is very difficult to develop sufficiently precise valuation rules for purposes of the wealth tax. The Government points to the opinion of the Skauge Committee that the wealth tax should be abolished. This may improve the general framework for private ownership, innovation and investment in Norway, reduce the risk of tax-induced emigration and stimulate increased savings. The Government will therefore halve the wealth tax in connection with the reform, and thereafter continue to scale it back with a view to its abolition.

The gradual reduction of the wealth tax must be considered in the context of the Government’s proposal for increased tax on high dividends and capital gains. A change of emphasis in the taxation of capital, from wealth to income, will bring us more in line with the taxation practises of other countries. The wealth tax has become a less important source of proceeds for many countries over the last few decades, and several countries have abolished the wealth tax. Besides, it is the Government’s view that it is better, in terms of both industrial and distribution policy, to tax capital income upon its extraction from the corporate sector, rather than to tax wealth.

The Government proposes that the gradual reduction of the wealth tax be implemented by reducing the rates and increasing the basic allowances. One may also consider a joint valuation discount applied to the valuation of all shares. A general valuation rule for shares would ensure that Norwegian and foreign shares are treated equally, and would thereby be in line with the principle of the free cross-border flow of capital, etc.

The Government will not back the Committee’s proposal for the introduction of a rule prescribing valuation at 30 percent of market value for all assets, as well as debts. A reduced valuation of debt would result in increased wealth tax for many taxpayers, which the Government finds unreasonable during a phase-out period. Apart from that, the Government agrees with the Committee that it would not be desirable to exempt productive capital from wealth tax, as suggested in some of the submitted comments. Such a solution raises complex demarcation issues. It is the view of the Government that it would be unfortunate to introduce such an administratively challenging distinction under the wealth tax during a phase-out period. Besides, the Government’s proposal for a gradual reduction in the wealth tax will considerably improve the tax framework for business.

The Government considers the imputed rent from housing an inappropriate tax base. The Government does not want any tax on living in one’s own home. The current rules have arbitrary implications, and it would be most difficult to define a valuation system that would not have unreasonable implications. The Government is therefore committed to abolishing the taxation of the imputed rent from housing, and has followed up on this by scaling back housing taxation every fiscal year. The Government intends to abolish the remainder of the tax on imputed rent in connection with the tax reform.

The Government believes that taxation of real property should continue to be voluntary on the part of local government, as is currently the case. The Government will not back the Committee’s proposal for the taxation of the imputed rent from housing to be replaced by a mandatory tax on real property. The Government intends to make certain changes to the taxation of real property in order to offer municipalities more scope for tailor-making the real property tax.

Taxation of wages and pensions

The Government agrees with the Committee’s view that tax rates on high personal income must be reduced to ensure equal taxation, on the margin, of wages and capital income. The current marginal tax rate of up to 64.7 percent, inclusive of employer’s social security contributions, is, in the view of the Government, much too high. As pointed out by the Committee, it is doubtful that very progressive taxation of labour income results in the intended redistribution of post-tax income, because, amongst other things, increased taxes on high wages may be offset by increased pre-tax wages. The Government also believes that it is important to prevent the progressiveness of the tax system from weakening the scope for retaining and attracting highly qualified manpower. Besides, it is imperative to reduce the highest tax rates on wages if one is to abolish the split model upon the introduction of the shareholder model. The shareholder model will see dividends being taxed at about 48 percent on the margin, if the company and the owner are taken together. Consequently, the marginal tax rate on high personal income must be reduced down to about this level.

The Government intends to reduce the rates of surtax and abolish the extra employer’s social security contribution on wage income above 16 times the base amount of the National Insurance system, as recommended by the Skauge Committee. More moderate progressiveness, combined with the introduction of the shareholder model, may give rise to more effective redistribution, because, amongst other things, equal income will to a larger extent be treated equally by the tax system.

The current allowance structure for wage income is complex, and may reduce incentives to work. This applies in particular to the salary allowance, which was introduced in connection with the 2000 budget settlement. The motivation behind the salary allowance was to make it more profitable to work than to receive social security benefits, but the allowance has not had the intended effect. The salary allowance probably led to an increase in marginal tax rates for low-income groups, thus entailing reduced labour supply. Another unintended effect is that it is in fact other groups than those earning a low salary that have benefited from the allowance, since full-time employees receive too high a salary for the salary allowance to have any effect. It is primarily pupils, students and self-employed persons with a limited salary who benefit from such allowance.

The Government therefore proposes the abolition of the salary allowance, with it being replaced by an expanded minimum allowance applicable to wage income only. It is proposed that the minimum allowance applicable to pensions income be maintained as per current rules.

The current unequal treatment of wages and pensions can contribute to reducing the real retirement age. A tax system with a better design may make it profitable to continue working for longer. An increased minimum allowance for wage income will contribute to narrowing the gap between the taxation of pensions and wages, without any increase in the taxation of pensions. The issue of real retirement age is at the core of the report of the Pension Commission (NOU 2004: 1). The Pension Commission concludes that one of the main challenges in ensuring a sustainable pension system is to induce employees to continue working for longer than before. The tax system and the social security system should be aligned in this effort. Changes to the taxation of pensioners must partly be considered in the context of follow-up work relating to the Pension Commission recommendations, and partly in the context of other changes to the tax system.

The Government agrees with the Skauge Committee that the capped contribution rate applicable to National Insurance contributions on income from self-employment in excess of 12 times the base rate of the National Insurance system should be abolished. This implies that income from self-employment as a main rule is subject to National Insurance contributions at a rate of 10.7 percent. The reason for abolishing the cap at 12 times the base rate of the National Insurance system is partly that there is no corresponding cap on employee’s or employer’s National Insurance contributions on wages, and partly that there is no direct correlation between National Insurance contributions made and pensions received at this income level. The Government agrees with the Committee that such unequal treatment of income from self-employment and wage income is not desirable. The proposal must be considered in the context of the surtax reductions and the effort to promote a simpler tax system.

Scaling back and simplification of certain allowance schemes

In principle, the taxable income of individuals should reflect their actual economic circumstances. This implies that all income, hereunder benefits in kind, should form part of the tax base, with expenses that were required to earn such income being deductible. Broad tax bases make it possible to maintain relatively low tax rates, which will reduce taxation costs. Besides, tax bases that reflect actual economic circumstances are important to ensure that individuals with equal income are subject to equal tax treatment, and that tax rate progressiveness results in the intended redistribution of income.

At the same time, the tax system should be simple to understand and comply with for taxpayers, and simple to administer for tax administrations. Consequently, practical considerations would suggest that one does not prioritise taxation of the imputed rent from owning consumer goods, that one employs standardised solutions to the taxation of certain benefits in kind, and that certain expenses that are normally required to earn income are considered reflected in the minimum allowance.

The Government agrees with the Skauge Committee that there is a need for reviewing the various income allowances with a view to simplification. An expansion of the minimum allowance should be combined with the abolition or scaling back of certain income allowances. In principle, the Government also agrees with the Committee that it may be appropriate to move certain allowance schemes and special schemes within the tax system to the expenditure side of the budget, and will consider this in more detail.

Indirect taxation

In Norway, indirect taxes represent a relatively high share of public sector revenue. The Committee believes it to be prudent for indirect taxes to account for a relatively high share, and proposes a certain increase in the level of indirect tax for purposes of financing cuts in the taxation of income. The Committee did not prioritise a detailed examination of such issues, but it did outline certain main perspectives. The Committee hereunder emphasised that distribution policy and industrial policy objectives should, to the extent possible, be attended to outside the indirect taxation system, and that value added tax should apply to a broad base with goods and services being taxed at the same rate. The Government has not prioritised a broad discussion of indirect taxes in the present Report.

1.4 Distribution Effects

The Government believes that the tax system has an important role to play in the redistribution of income. Maintaining a progressive system for the taxation of wage income ensures redistribution between low and high income (vertical distribution). Introduction of the shareholder model ensures more equal taxation of equal income earned in different ways (horizontal distribution).

At the same time, the role of the tax system in furthering wealth distribution policy objectives cannot be assessed in isolation. Public services and transfer schemes, the education system and labour market policy etc., will in many cases be far more important, and the main consideration is the overall distribution effect from all policy areas. One should avoid focusing solely on statistical calculations of how tax changes affect various population groups. One might then easily overlook economic relationships and potential adaptations that are important in terms of distribution, and which result in individual persons being treated unequally. It is the view of the Government that a tax system that offers disincentives to work, and which makes it profitable and possible to reclassify labour income as dividends, suffers from serious defects in terms of distribution policy as well.

The Government’s outlined reforms have several favourable distribution effects. The tax on dividends from shares will result in certain high labour income, which is at present taxed as capital income at 28 percent, being subject to the same taxation as other wage income. This entails the abolition of one source of unfair and unequal treatment of individuals with equal income. The Government is at the same time proposing a reduction in the marginal tax rate at lower wage levels. This may increase labour supply, and thereby the income of part-time workers and others with low income. A weak affiliation with the labour market is one of the main characteristics of those who have a persistently low income. The reduction in the highest rates of marginal tax on wages will benefit those who are at present paying a lot of surtax. However, this is a necessary restructuring to ensure more equal taxation of equal income, which is a fundamental characteristic of a tax system with favourable distribution effects.

The gradual reduction in the wealth tax will entail tax reductions on the part of those who at present hold taxable wealth. However, this must be considered in the context of the introduction of a tax on dividends. Those who earn high returns from investments in shares, and who typically belong to high-income groups, will from this perspective face heavier taxation as a result of the tax on dividends. In the view of the Government, it is preferable in terms of both industrial policy and distribution policy to tax capital income upon it being extracted by the owners, rather than to tax net wealth. Moreover, the gradual reduction of the wealth tax will also reduce unequal treatment attributable to different valuation rules.

1.5 Proceeds and Implementation

Tax proposals that contribute to more effective resource use will, over time, contribute to economic growth, and thereby to increased tax proceeds. However, it is the view of the Government that one should not rely on such effects during the phase-in years, because, among other things, it may take some time before efficiency gains are reflected in increased tax income. The significant uncertainty involved in trying to quantify such effects would suggest the same. At the same time, the Government wishes to emphasise that one must consider the potential gains in the form of increased returns on overall resources when assessing the scale and scope of the reform.

In line with the Sem Declaration, the Government aims for tax reductions in the region of NOK 12 billion within income and wealth taxation as a result of the reform. Tax reductions in excess of the Sem Declaration commitments will depend, amongst other things, on how tax bases develop, hereunder the effects of the tax reform on economic growth, how the Petroleum Fund develops, and any possible shifts within direct and indirect taxation.

Important elements of the Government’s outlined reforms will entail, as of themselves, large tax reductions within the taxation of wages, wealth and homes. Part of the reform will be funded through other tax changes, hereunder the tax on high dividends and capital gains, which are estimated to generate proceeds of about NOK 3 billion. In addition, the Government will review various allowance schemes, etc., to assess the scope for simplification and funding.

The Government plans to phase in the reform across fiscal years 2005, 2006 and 2007. Requirements as to responsible budget policy imply that a balanced reform, which is intended to benefit large groups, must be introduced over a period of time.

Somewhat more time will also be needed before certain changes can be introduced from a purely technical perspective; administrative considerations suggest, for example, that the shareholder model should not be introduced until 2006. In addition, one needs to take into consideration that several of the changes are logically interconnected. A significant reduction of the marginal tax rate on the highest wage incomes is a prerequisite for abolition of the split model upon the introduction of the shareholder model. The Government therefore intends to reduce the marginal tax rate on the highest incomes during the course of 2005 and 2006, thus preparing the ground for the abolition of the split model in 2006. At the same time, one plans to reduce the tax on work at lower income levels. This will stimulate an increase in labour supply, and ensure that also individuals at lower and median income levels partake of the tax reductions. To curtail any scope for tax avoidance, it is proposed that the tax exemption shall apply to dividends accruing as from 1 January 2004, whilst the tax exemption shall apply to capital gains accrued and losses incurred on shares as from 26 March 2004.

The gradual reduction of the wealth tax must be considered in the context of the increased tax on dividends. Consequently, it would be appropriate to initiate such gradual reduction in 2006, upon the implementation of the shareholder model. The Government proposes that the wealth tax be halved in 2006 and 2007, and that it thereafter be reduced further with a view to its abolition.

The Government will in its annual budgets revert with specific amendment proposals in line with the guidelines presented in the present Report.