Second-widest gap behind Chile

In Luxembourg, work is taxed (far) more than capital

According to a study by the Chamber of employees, in Luxembourg net income from work is--thanks to tax policies--lower than net income from capital. Photo: Shutterstock

According to a study by the Chamber of employees, in Luxembourg net income from work is--thanks to tax policies--lower than net income from capital. Photo: Shutterstock

According to the Chamber of employees (Chambre des salariés), Luxembourg is the OECD country with the second-widest gap--after Chile--between the taxation of earned income and the taxation of capital income. And yet, the same tax rate is applied. So where does this disparity come from?

In the latest “EcoNews” newsletter from the the Chamber of employees (CSL), published on 18 September, comes a striking observation: in Luxembourg, the effective tax rate is 27% higher for earned income compared to capital income. In Ireland, for comparison, the difference is 16.8%. Of 37 OECD countries reviewed, only Chile has a wider gap.

The gap calls into question the principle of tax fairness, a favourite among politicians. In its analysis, the CSL notes that the two income types are taxed at the same rate, but that the “differentiation happens when moving from gross income to taxable income, since exemptions and allowances are granted for one form of income but not the other.” As a result, income from work is taxed more heavily than income from capital, since individuals, on their work income, don’t benefit from what CSL calls “tax giveaways.”

In more detail: for work-derived income, the transition from gross to taxable income is made by deducting social security contributions and obtaining costs which may not exceed €540. For capital income, however, the legislation provides for an allowance of €1,500 as well as a 50% exemption.

In terms of preferential treatment for capital taxation: seventh overall

According to OECD estimates, Luxembourg’s effective tax rate is 31.4% on work income versus only 4.3% on capital income. This is a significant difference that runs counter to the principle of horizontal equity; plus, at 27.1%, it’s well above the average gap worldwide, which is 10.9%.

This situation is a result of decision-makers’ efforts to make the country attractive and competitive internationally. But, as the CSL points out: “Even in Ireland, Luxembourg’s competitor as a financial centre, the gap is limited to 16.8%.” In other OECD countries, such as Norway, Denmark, Sweden and Spain, the situation is even the opposite, with work taxed taxed less than capital income. “Inequality in tax treatment is not an inevitability; it’s a political choice,” says the CSL in its analysis.

To the people who say that taxing capital is tantamount to taxing the same income--i.e. company profits--twice, the CSL says: doesn’t matter. “Even taking into account this double taxation of capital, it’s still valid to observe that work is more heavily taxed than capital--and that Luxembourg continues to be a bad pupil at the OECD level.” Indeed, the grand duchy ranks seventh on the list in terms of preferential treatment for capital taxation, at 10.5%. In around half of the OECD countries, earned income gets preferential treatment instead, and--as the CSL argues--plenty of these have competitive economies (e.g. the US, Japan, South Korea, New Zealand, Norway, Israel and Denmark.) 

Finally, the CSL observes a difference relating to capital gains realised on the sale of transferable securities. These are exempt from tax “if the holder was in possession of the financial securities for a period of at least ten months… two individuals with equivalent annual incomes are treated completely differently for tax purposes if one receives their income from work and the other from capital gains on the sale of financial assets.” Here, again, Luxembourg has the second-widest gap (31.4%), this time behind Belgium.

This article was originally published in Paperjam. It has been translated and edited for Delano.