Dual Income Taxation and Developing Countries

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The dual income tax combines a progressive tax on labor income and a lower flat rate tax on income from capital. Denmark, Finland, Norway, and Sweden adopted dual income taxes to address a set of tax challenges that arose in the late 1980s and early 1990s. Although developing countries face much different economic, political, and tax environments from the Nordic countries, the dual income tax may be the right solution to the different set of challenges facing many developing countries. Providing separate tax rates for labor and capital income allows countries greater flexibility in addressing tax competition while retaining progressive tax rates for labor income. A dual income tax regime may also allow developing countries to rationalize the taxation of income from active business operations under the personal and corporate tax systems and the taxation of passive investment income under the personal tax system. Developing countries could also use the move to a dual income tax system as an opportunity to make broader reforms in their personal, corporate, and payroll tax systems. Finally, recent tax reforms in Russia, Ukraine, and several countries in Central and Eastern Europe have led to flat tax regimes that generally apply a single tax rate to all types of income above some zero0bracket amount. We contend that a dual income tax may provide policymakers in developing countries with an attractive alternative that addresses tax competition concerns while maintaining a progressive tax on labor income.