Tax Reform for Economic Growth and Increased Welfare

Today, the Government has presented a white paper on tax reform aiming at reducing the tax on labour, decreasing the net wealth tax, abolishing the taxation of imputed rent from housing and decreasing the rate differential between labour and capital taxation. The reform aims at tax reductions of NOK 12 billion. The reform will strengthen the business sector and stimulate labour supply.

The proposal 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.

Bridging the gap between taxation of individuals and companies

The Government proposes to maintain the 28 per cent tax rate on corporate income. The tax rate on corporate income should not be increased, due to the tendency in many countries of decreasing the corporate tax rate. Norway continues to have a relatively low formal tax rate on corporate income, but a relative broad tax base implies that the effective tax rate on company profits is in the middle range internationally. All in all, the company taxation seems to be well adapted to the current international situation, but developments need to be monitored.

The highest marginal tax rate on labour income has increased during the last decade and is now relatively high (64.7 per cent, including employers’ social security contributions). Due to Norway’s dual income system, with a flat 28 percent tax rate on capital income and a progressive taxation of labour income, there is 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 returns to owners’ capital investment exceeding the risk-free return. The aim is to make the taxpayer broadly indifferent (on the margin) as to whether income from work is received in the form of wages or ownership income.

For personal shareholders, dividends or realised capital gains from shares, exceeding the risk-free return, 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 to capital corresponding to a risk-free rate of interest are exempt from tax. Thus, the model is attractive from the perspective of investment and financing neutrality.

The self-employed will be taxed upon accrual, subject to an exemption for capital returns based on the risk-free rate of interest (the source based model), adopting principles similar to those of the shareholder model. The non-exempt part of the income is treated as personal income (and thus liable to social security contribution and surtax).

The tax on high (non-exempt) returns to owners’ capital must be seen in the light of the proposed reduction in the net wealth tax. In all, the Government’s proposals imply an overall reduction in the taxation of capital.

Reduced taxation of labour

The abolishment of the split model requires the highest rates of marginal tax on labour to be revised downwards to broadly compare with the overall tax rate on income from shares. The company tax and the shareholder tax together imply a total tax rate of 48.16 percent (0.28 + (1- 0.28)*0.28).

Marginal tax rates on lower labour incomes will be reduced as well. Lower tax on labour income will provide incentives for working more and postponing retirement, thereby strengthening the Norwegian economy over time.

Tax exemption of dividends and gains on shares derived by companies

The current cost price adjustments of shares applied for computing share gains (the so-called RISK-adjustments) and the imputation method for avoiding economic double taxation of dividends, treat Norwegian and cross-border flows of share income differently. This may give rise to uncertainties with regard to the EEA Agreement. The Government proposes that, as a general rule, dividends and gains on shares derived by companies shall be exempt from tax. The exemption method shall apply to dividends deriving from and including the 2004 income year, and to share gains derived and losses incurred as of the date of submission of the presented white paper (26 March 2004). Combined with the shareholder model, dividends and gains on shares will be taxed on extraction from the company sector, and only to the extent 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. The exemption model for companies, combined with the shareholder model for individual shareholders, make it possible to abolish the RISK- and imputation systems.

Taxation of imputed rent from housing and the net wealth tax

The taxation of the imputed rent from owner occupied housing will be abolished. However the unlimited deduction of interest on debt will be maintained.

The Government will halve the net wealth tax in connection with the reform, and thereafter continue to scale it back with a view to abolishment. This will improve the conditions for private ownership, innovation and investment in Norway, reduce the risk of tax-induced emigration and stimulate savings.

Proceeds and implementation

The Government aims for the reform to yield overall income and wealth tax reductions in the region of NOK 12 billion. The Government plans to phase in the reform across the fiscal years 2005, 2006 and 2007.

The reform should be regarded as a whole, as individual proposals depend on each other. Due to administrative considerations, the shareholder model is proposed to be introduced from 2006. A significant reduction of the marginal tax rate on the highest wage incomes is a prerequisite for the introduction of the shareholder model. The Government intends to reduce the marginal tax rates during the course of 2005 and 2006, preparing the ground for the shareholder and the source based models.

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 during 2006 and 2007.

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

An English translation of chapter 1 of the white paper is available here.