The OECD Centre for Tax Policy and Administration has published as a Taxation Working Paper a study entitled: “The average personal income tax rate and tax wedge progression in OECD countries”.

The tax wedge could be defined as the difference between before-tax and after-tax wages. It therefore reflects the net amount received by government as a result of the income tax and other deductions, net of cash benefits paid out. The tax wedge may also be defined more generally as the inefficiency introduced into the market as a result of taxation of a particular product or service.

The study looks at the degree of progressivity of income tax on wage earners, taking into account their social security contributions and the standard cash benefits received. The study looks at different types of family and the combined effect on each type. The calculations have been performed for singles without children; one-earner married couples; single parents with two children and one-earner married couples with two children.

The pattern revealed by the study indicates decreasing tax progressivity across income levels. As might be expected this is not uniform across all OECD countries. The progressivity of the combined system depends on the way in which the income tax, social security contributions and child benefits are structured.

The degree of progressivity of each element in the system is itself complex. For example, the progressivity of the personal income tax depends not just on the level of the tax rates and the difference between the top and bottom rate but also on other provisions such as personal allowances, deductions from taxable income, exemptions and tax credits. Some of these items, such as working tax credits, may depend on the level of income within a family, while other aspects of the system such as allowances may depend on whether there is a dependent spouse and on the number of children in a family.

Other elements of the calculation such as social security contributions and benefits paid to families give rise to different complexities. Benefits paid to lower income families according to factors such as the number of children in a family often tend to taper off at a certain income level. These benefits basically increase the progressivity of the combined system by reducing the overall tax burden on poorer families. Where they are reduced according to income, however, they may give rise to higher marginal tax rates at the income levels where they taper off, squeezing the middle income range and decreasing progressivity at that level.

In some of the countries analyzed the combined tax imposed became regressive as soon as the ceiling for social security contributions had been reached. Social security contributions tend to impact all taxpayers on their lowest tiers of income and therefore have a flattening effect on tax progressivity. The burden of these contributions tends to decrease as higher levels of income are reached, making the combined tax system less progressive.

As mentioned above the child benefits paid to taxpayers were found to have the effect of increasing the progressivity of the tax systems, in particular at low income levels. The effect of such payments to people on lower levels of income was found by the study to outweigh the contrary effect of the burden of social security contributions. Some of the countries examined have increased the progressive nature of their tax systems by reducing the social security contributions payable at lower levels of income.

The result of the OECD study is that there is a clear pattern of progressive rates across the income levels examined. On average in OECD countries the highest tax progression is evident at the lowest income interval, with the level of progression decreasing at each higher income level, taking into consideration the results over all the types of family household studied. The lowest average rate progression is at the highest income level. This represents the general pattern across the OECD countries although as one would expect there are significant differences between individual OECD countries.

One finding of the study is that there are significant differences between the average personal income tax rate and the average tax wedge progression across the countries of the OECD. This is a consequence of the marked influence of the structure of social security contributions and cash benefits on the progressivity of the combined tax system. The lesson here is that it is too simplistic to draw conclusions about the progressivity of a tax system merely from looking at the personal income tax rates and bands.

This impact is of course different on different types of family. For households without children, the tax wedge progression is lower than the average personal income tax rate progression, except at the very lowest income level. These families generally are not paid tax benefits (as these are typically related to the number of children in a family) so the lower progressivity is a consequence of the social security contributions, that are typically levied at flat rates. At the point where a ceiling is imposed on social security contributions there may even be an overall regressivity in some countries in these circumstances.

For households with children, by contrast, the tax wedge progression is higher than the average personal income tax rate progression at all income levels except the highest. This reflects the effect of cash benefits given to these families which reduce the tax wedge at most levels of income and whose impact only disappears at the levels of income where these benefits have been tapered off or phased out. The study supports the conclusion that the progressive effect of the cash benefits is stronger than the flattening effect of social security contributions.