Rules preventing income shifting - a comparison

Dual income tax systems tax labour and capital income separately. Such systems were introduced in Sweden, Norway and Finland in the early 1990s. There are several arguments in favour of dual taxation, but there is also one problematic issue: how to treat business income for tax purposes. Business income does often have both a return on capital and a compensation for labour aspect. When the marginal tax rate on labour exceeds the marginal tax rate on capital, the tax system must, in practice, include splitting rules that determine how much of the income should be taxed as labour income and how much as capital income. In Sweden, these rules have become known as the 3:12 rules.

Sweden, Norway and Finland have designed the splitting rules in very different ways. One purpose of this review is to describe the historical development of the rules in the three countries. Another purpose is to describe the trade-offs that must be made when designing income splitting rules.