Assessment of income tax averaging scheme

The Dutch Finance Ministry has recently had the income tax averaging scheme put through its paces. The Cabinet is to take the outcome of the assessment into consideration in its investigation into the scope for improving the tax regime, which it has announced for next spring and whose central plank has been defined as an exploration, from a broader perspective, of the scope for enhancing the tax regime in terms of practicality, efficacy and expediency.

The averaging scheme

The averaging scheme represents a facility which enables the progressivity disadvantage that comes with strongly fluctuating incomes to be compensated, by recalculating the aggregate “Box 1” income tax charge for three consecutive years on the basis of the average income earned during the relevant years. As no explicit mention was made at the time the scheme was first introduced to whether or not it was geared to particular categories of tax payers or to particular scenarios, the pros and cons of compensation using the averaging scheme in specific scenarios have to date remained unclear.

The recent assessment has looked into the degree of efficacy and expediency the averaging scheme offers. Some 50,000 Dutch tax payers make use of the scheme every year. Together they account for a total of 70 to 90 million euros, with the individual tax payer’s rebate by virtue of the scheme typically totalling 1,550 to 1,700 euros. Start-up entrepreneurs and intrinsically higher-income earners currently account for 30 percent of the scheme’s users, compared with 28 percent for those who are in the process of discontinuing their business together with intrinsically lower-income earners. The scheme’s utilisation rate fails to impress, given that 85 percent of all tax payers who qualify for the averaging scheme do not make use of it.

The introduction in recent years of the income-dependent general and employee tax reduction schemes has passed the averaging scheme by, even though these schemes have a potential impact on the extent of the progressivity disadvantage that is brought to bear on the tax payer, the averaging scheme not having been tweaked to make allowances for tax reductions of this nature. Moreover a two-tier system is being introduced from 2021 onwards, as announced in the 2019 Tax Plan, the upshot of which will be that only those who occasionally “hit” the top income tax bracket and some beneficiaries of state retirement benefits will be eligible for participation in the averaging scheme. This is expected to cause the number of potential users to suffer a 60 percent or so plunge.

So far the averaging scheme’s efficacy and expediency have failed to impress: the scheme’s meagre utilisation rate in combination with its relatively steep implementation costs and failure to acknowledge the income-dependent nature of tax reductions have to date resulted in just 15 percent of eligible tax payers finding their way to making use of the facility. This in conjunction with expected developments in the wake of the implementation of the two-tier system warrants serious reservations having to be expressed regarding the (future) effectiveness of the averaging scheme. The scheme’s assessors have identified two options: either involve the tax reduction phase-out in the averaging scheme or abandon the scheme altogether.

Dutch version: Evaluatie middelingsregeling