Income Shifting within a Dual Income Tax System: Evidence from the Finnish Tax Reform of 1993

Dual income tax systems can suffer from income that shifts from progressively taxed labour income to capital income, which is taxed at a lower, flat rate. This paper empirically examines the 1993 Finnish dual income tax reform, which radically reduced the marginal tax rates on capital income for some, but not all, taxpayers. We measure how overall taxable income and the relative shares of capital income and labour income reacted to the reform. We find that the reform led to a small positive impact on overall taxable income, but part of the positive response was probably offset by income shifting among the self-employed.