CPB about the self-employed tax deduction: Leads to lower entrepreneurial growth but can be good for outsiders.

CPB about the self-employed tax deduction: Leads to lower entrepreneurial growth but can be good for outsiders.

The Centraal Planbureau (CPB) has criticised the he self-employed tax deduction in its current form. In the CPB policy letter 2012/02 the CPB investigated both the self-employed tax deduction as the SME-profit exemption on economic justification.

According to the CPB the self-employed are more flexible and therefore react stronger to tax incentives. From that point of view the preferential tax treatment of the self-employed is justifiable and an argument can be made for a lower tax for the self-employed. In this case, a distinction should be made  between the average tax rate and the marginal tax rate. The marginal tax rate is the rate that you pay over an extra earned euro.

Fiscal measures and the effects on the marginal rate

Research has shown that the income of the self-employed is more sensitive for the marginal rate than the average rate. The self-employed tax deduction, that narrows the base income, has a smaller effect on the marginal tax rate then the SME-profit exemption. The SME-profit exemption can be seen as a discount on the tax rate and therefore has a direct influence on the marginal rate. The self-employed tax deduction works digressively. In other words: The more profit the self-employed professional makes, the lower the self-employed tax deductions will be. This discourages further growth, This is, among other things, because entrepreneurs are more sensitive for the marginal tax rate (Source: SER. 2010).

Outsiders on the labour market

The CPB also states that fiscal measures are not suitable to stimulate innovation and work employment. However, for the group of outsiders on the labour market, who become entrepreneurs lower taxed can be justified . Outsiders on the labour market are, among others, people who are low in productivity, older job seekers, and occupationally disabled people. The CPB is of the opinion that reshaping the self-employed tax deduction into a deduction that is focussed on vulnerable groups on the labour market decreases the disruption of the choice of entrepreneurs or employee. This is because the difference in the average tax pressure between entrepreneurs and employees decreases.

Development of the self-employed tax deduction

The self-employed tax deduction has been introduced in 1971 as a temporary investment deduction for small entrepreneurs. Several years later this deduction was converted into a tax free withdrawal. In 1983 the hour standard and the age standard were added. The most important reasons that are given, throughout the years, for the introduction/continuation and expansion of the self-employed tax deduction are:

Income support for small entrepreneurs (this is equal to the oldest motive). The self-employed tax deduction takes into account several functions of the profit income, namely: consumption, investment and reservation. Source: Contributions to similar fiscal treatment of the entrepreneur in the income tax and the executive-majority shareholder (Weekblad Fiscaal Recht, 22.01.’04)

It could be argued that reason 3 is entirely absorbed by the MSE- profit exemption, that has also been especially created to neutralize the differences between rates of entrepreneurs in the income tax and corporation income tax as much as possible. Besides that, the small-scale investment tax deduction (Kleinschaligheidsinvesteringsaftrek, KIA) offers fiscal benefits to investments and all political parties for the house of representatives (Tweede Kamer) of the 12th of September take into account the introduction of social services for entrepreneurs in their program. Because of this, consumption is the primary function of profit income. The reasoning that the self-employed tax deduction continues to exist for small entrepreneurs, in this way, is in line with the proposal of the CPB to reshape the self-employed tax deduction and to only apply it to people who are low in productivity.

Reshaping the self-employed tax deduction

Although FNV Zelfstandigen reacted with criticism to the CPB Rapport, they are not opposed to reshaping the self-employed tax deduction. Furthermore, they want the generating of profit to play a more prominent role and not the worked number of hours. This way the entrepreneurship can be stimulated better.

In politics, plans exist to alter the hourly standard of the self-employed deduction to a revenue standard. Where the whole deduction is accredited to entrepreneurs with a revenue above EUR 10.000  and half of the self-employed tax reduction to entrepreneurs with a revenue below EUR 10.000. Artlupa is not positive about this alteration to a revenue standard, because this transformation will be difficult to check in practice and is complex and prone to fraud. Furthermore, the problems, as stated by the CPB, will not be solved by this transformation.