An OECD Tax Working Paper published on 28 August 2023 looked at the different tax treatment of labour and capital income, examining especially the position of higher earners.

A number of governments tax labour and capital income in different ways, in line with the general view that capital should be taxed more favourably than labour. There is however evidence to suggest that capital income should be taxed more, especially as capital income sources are more frequently held by higher wealth individuals.

The working paper looks at how far OECD tax systems give rise to differential tax treatment between labour and capital income and highlights the features of taxation systems that cause the differences in tax treatment. The study looks at effective tax rates (ETRs) after taking into account the various provisions in the tax law including tax rate thresholds, deductions, exemptions, credits and other adjustments required.

The paper examines ETRs that take into account only the taxes paid by individuals and also looks at ETRs that take into account the taxes paid by both firms and individuals. Examination of these ETRs indicates that capital income from shares is typically taxed at lower ETRs than wage income at the personal level. This situation is likely to benefit high income earners.

In most tax systems individuals pay lower effective tax rates on dividends or on capital gains on shares than on wage income. Often capital income is taxed at flat rates that are generally lower than tax rates on wage income. Dividend or capital gains income may also be fully or partially exempt from taxation or they may attract tax credits that are not available to income from wages. If a country taxes wages at progressive rates, but taxes capital income at flat rates, the gap between the ETR on labour and on capital income also increases with income levels. Therefore people on higher income levels may receive more preferential tax treatment of capital income compared to labour income.

If taxes paid by businesses are taken into account, the difference in tax treatment of labour and capital income is smaller. Taxation at the level of the firm including employer social security contributions and corporate income tax both add to the tax burden on labour and capital. However, after taking account of firm-level taxes, the tax treatment of capital income is still more favourable than tax on labour income in many OECD countries, although it is smaller than when looking only at taxes paid by individuals. There are significant differences between countries, and in some countries the tax burden on capital is higher than on labour.

The OECD is looking more broadly at the taxation of high earners and how they can take advantage of the preferential tax treatment of different sources of income. There will also be more detailed work on capital gains taxation and at incentives for income deferral. Future work by the OECD will look at potential policy trade-offs that must be faced by governments; and will look at reform options to promote growth and fairness.