The reasons for an IRPEF reform with fewer tax rates and greater fairness

The IRPEF was meant to be the country’s major progressive tax, designed to distribute the tax burden according to citizens’ ability to pay: instead, it has slowly become the very opposite. Today, it is an increasingly limited, increasingly convoluted and, above all, increasingly unfair tax. It affects almost exclusively those on an employee’s salary or those living on a pension, both of whom have tax deducted at source. All other sources of income – capital gains, annuities, rental income, flat-rate schemes and financial income – exist on the fringes of the system without truly being part of it, taxed at separate, proportional rates that are almost always more lenient.

Meanwhile, the number of income tax bands has been reduced to three. And at this stage, the next step might even be just one: two tax bands, or perhaps just one. In Italy, you only have to utter the words ‘flat tax’ for people to immediately cry foul, claiming it’s a handout to the rich. But the point is that the rich – the truly wealthy – already pay, for the most part, proportional taxes on the income that really matters: dividends, capital assets and annuities. It is mainly teachers, office workers, technicians and pensioners who pay the full IRPEF rate. In short: the lower and middle classes who cannot move anything, hide anything or negotiate anything.

The tax was originally designed with numerous brackets, rates and redistributive aims. Then, as often happens in Italy, every government added its own patchwork of amendments: allowances, deductions, special schemes, bonuses, exemptions, sector-specific discounts and changes to tax rates. In the end, the system is no longer recognisable. It has become a patchwork that is often incomprehensible even to specialists. And the effects are bizarre: in certain income brackets, the effective marginal tax rates reach such levels that they actually discourage any increase in income itself. People work harder to earn almost nothing extra. A madness that no one would have designed rationally.

Meanwhile, the tax base has been eroded bit by bit. At first, a few exceptions were justified by practical necessities. But then the exception became the rule. The flat-rate tax, substitute schemes, lump-sum arrangements and so on: all have contributed to hollowing out personal income tax from within. Vito Tanzi called them ‘fiscal termites’, and it is hard to find a better definition. Since 1973, they have been working silently within the tax system, devouring its progressivity without the need to formally abolish it. The result today is plain for all to see. The three IRPEF rates fall almost exclusively on income from employment and pensions. On top of this come regional and municipal surcharges, which transform the levy into a sort of territorial loyalty tax. Those who, on the other hand, live on income from financial investments, property or self-employment enjoy much lighter tax burdens. And the paradox is that it is precisely employees and pensioners who end up bearing the brunt of the cost of universal public services, with healthcare at the forefront. So it is not just taxes but also public spending, because we have forgotten what the great figures of the twentieth century taught us.

For this reason, reducing tax rates is not necessarily a favour to the wealthiest. If anything, the opposite might be true, provided it is accompanied by the substantial elimination of the vast maze of tax deductions that has built up over the years. Because here too, the rhetoric says one thing and reality shows another: tax deductions, building bonuses, sophisticated tax relief schemes and deductible expenses are largely used by those on medium-to-high incomes. Low-income taxpayers do not renovate villas using the superbonus and rarely claim deductions for private school fees or other expenses. A simpler system, with one or two tax rates that are the same for all income levels and an adequate tax-free allowance, could prove far fairer than the current one. Not least because the real injustice today lies not so much in the nominal tax rate, but in the fact that the type of income determines one’s tax treatment. Those with diversified income can plan, shift and optimise their tax position. Those living on a monthly salary cannot.

It is often argued that having few tax bands spells the end of progressivity. Technically, this is not true. A proportional tax with an exemption threshold remains progressive: those on low incomes pay little or nothing; those on high incomes pay more, both in absolute terms and on average. Progressivity does become less pronounced, it is true, but it can be reinforced on the public expenditure side, which is where the state actually decides who to help and who not to help. Not only is it possible to envisage an additional variable allowance (or deduction) to strengthen the protection of low incomes and horizontal equity.

The real question, if anything, is another: does it still make sense today to envisage a highly progressive personal income tax system as was envisaged sixty years ago? Probably not, although in theoretical and ideal terms it would be correct to say yes. Unfortunately, we have to face reality. Globalisation has made capital mobile, rendered many tax bases intangible, and made digital platforms extremely powerful. Nation states are finding it increasingly difficult to tax what moves quickly, whilst they can easily tax what remains static: employment income, pensions, assets and property. This is not an ideological choice. It is a historical constraint. This is why the OECD and the IMF have been insisting for years on the same formula: broadening the tax base and reducing tax rates. Not out of kindness towards the wealthiest, but because systems that are too complex and too burdensome end up fostering tax evasion, tax arbitrage and even greater inequalities. Continuing to defend theoretical models devised in the 1970s whilst the tax landscape has changed radically amounts to chasing an unattainable ideal of fairness.

Of course, reducing tax rates comes at a cost. And a country with Italy’s level of public debt cannot afford to harbour illusions. The funding should come primarily from the abolition of a large proportion of tax expenditures and from the fight against tax evasion. This would be not only a financial necessity but also a measure to clean up public finances. Because, over time, tax expenditures have become a formidable political tool: small privileges distributed to specific groups, sectors, clienteles and lobbies. This does not mean that Italy’s tax problem is limited to personal income tax (IRPEF). In a country where private wealth is high and heavily concentrated, the issue of inheritance will have to be addressed sooner or later. Italy taxes inheritances far less than other OECD countries, such as France. But the central issue remains the same: personal income tax must once again become a tax for everyone, not just for employees and pensioners. Fewer tax rates, a broad tax base, fewer hidden privileges and the same rules for different levels of income. This is not the reform we might have hoped for in relation to the ideal personal tax structure envisaged in the 1970s. It is, much more modestly, an attempt to restore a degree of order and justice to a system which, today, retains of fairness little more than rhetoric.