CPB over Self-employed tax deduction: leads to lower entrepreneurial growth

The Centraal Plan Bureau (CPB) has voiced criticism on the self-employed tax deduction in its current form. In the CPB Policy letter, the CPB has investigated both the self-employed tax deduction and the SME-profit exemption for economic justification.

According to the CPB self-employed professionals are more flexible than employees and therefore respond stronger on tax incentives. From this point of view fiscal preferential treatment of self-employed professionals can be defended and an argument can, therefore, be made for a lower tax rate for self-employed professionals. A distinction should be made between the average tax rate and the marginal tax rate. In this the marginal tax rate is the rate that you pay over every extra earned euro.

Fiscal measures and the effects on the marginal rate

Research has shown that the income of self-employed professionals is more sensitive for the marginal rate than for the average rate. The self-employed tax deduction, narrowing the base income, has a smaller effect on the marginal tax rate than 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 deduction works digressively. Which means; The more profit a self-employed professional makes, the lower the self-employed tax deduction will be. This discourages growth, in part 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 suited to stimulate innovation and employment. Lower taxes for ‘outsider on the labour market’ that become self-employed professionals from this group can be justified. Outsiders on the labour market are, among others, people low in productivity, older job-seekers and occupationally disabled people. The CPB is of the opinion that reshaping the self-employed tax deduction to a deduction that is aimed to lessening the interference in the choice between self-employed professionals and employees, because the difference in the average tax burden between self-employed professionals and employees is reduced.

Origin self-employed tax deduction

The self-employed tax deduction was implemented in 1971 as a temporary investment deduction for small entrepreneurs. Several years later this deduction was converted in a tax free extraction. In 1983 the hour standard and the age standard were added. The most important reasons for the implementation, continuation and expansion of the self-employed tax deduction are: Income support for small entrepreneurs (this is also the oldest reason). The self-employed tax deduction does justice to several functions of the profit income; consumption, investments. Furthermore the self-employed tax reductions reservations contributes to comparable fiscal treatment of the entrepreneur in the income tax and the director and majority shareholder. (Source: Weekblad Fiscaal Recht, 22.01.’04). An argument can be made that the third reason has been entirely absorbed by the SME-profit exemption, that has been created specially to level the differences between the rates for entrepreneurs in the income tax and corporate tax as much as possible.

 In addition, the in 1988 implemented small-scale investment tax deduction offers fiscal benefits and that all politic parties in the election program for the Lower house of Parliament (tweede kamer) want to include social facilities for self-employed professionals, which makes the function of the profit income mostly consumption. The argumentation that the self-employed tax deduction continuous to exist for small entrepreneurs ties in with the proposition of the CPB to reshape the self-employed tax deduction, which would only be applicable to people low in productivity.

Reshaping of the self-employed tax deduction

Although FNV Self-Employed Professionals (Federation of Dutch Unions) has responded critically on the CPB report, they are not dismissive towards reshaping the self-employed tax deduction. FNV Self-Employed Professionals also wants that generating profit will play a more important role and not the worked hours. In this manner the improvement for  entrepreneurship is encouraged. Dutch politician have plans to alter the hour standard of the self-employed tax deduction to a turnover standard, in which the entire deduction is acknowledged to entrepreneurs with a turnover above €10.000,- a year and half of the self-employed tax deduction to entrepreneurs with a turnover below €10.000,- a year. Lupacompany does not have a positive perspective on this change into the turnover standard. We think that the reshaping is hard to check in practice, complex and sensitive to fraud. Furthermore, the problems brought up by the CPB are not solved by this reshape.