Since 2001, the Netherlands has taxed a notional return on assets. The Supreme Court ruled in 2021 that this violates the European Convention on Human Rights (ECHR). Last June, the Supreme Court also rejected the bridging act introduced by the government as a temporary solution to the Box 3 problem.

Aart Gerritsen is an associate professor at the Erasmus School of Economics. He researches public policies dealing with the fair distribution of resources, such as the tax system and the minimum wage.

What exactly is Box 3 again?

“Simply put, the state taxes income from labour and capital. You earn money through work, and that is taxed through wage tax. This is done in Box 1. You can also have income from capital: your own home, pension assets, your own business and savings or investments. Returns on savings and investments are taxed in Box 3.

“It’s not the actual return on these assets that is taxed in Box 3, but a notional return. Until 2017, the Tax and Customs Administration assumed that every taxpayer made a 4 per cent annual return on their assets, which was then taxed at a rate of 30 per cent. In other words, you had to pay 1.2 per cent tax on your assets whether you actually made the notional return or not.

“As of 2017, the government has made the notional return dependent on the size of the assets, but it remains notional. Notional returns were introduced to simplify taxation. However, the Netherlands is the only OECD country that doesn’t raise taxes based on actual returns, so it can’t be that difficult. Banks can provide the necessary information to the Tax and Customs Administration.”

What was the ruling of the Supreme Court?

“In the 2021 ‘Christmas Ruling’, the Supreme Court found that the system violates the European Convention on Human Rights. The Court gave two reasons for this ruling. First, the system creates too great a financial incentive to engage in risky investment. You won’t make a 4 per cent return on savings, so you have to put your assets into riskier investments to earn that notional percentage.

“Second, the system discriminates between people with the same assets, but different returns. If you’re unlucky and your return is below the notional percentage, you’ll be taxed relatively more heavily than someone who gets lucky and makes a higher return. This is unfair. The Supreme Court therefore held that the government should compensate the injured parties and change the tax system.”

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Image credit: Bas van der Schot

Do you agree with the ruling?

“The notion that the system provides an incentive to engage in more risky investment doesn’t make economic sense. Taxation in Box 3 is effectively a wealth tax. The tax you pay only depends on how much wealth you have. The tax burden remains the same no matter how you invest this wealth or how much risk you take, so the system doesn’t affect your choice to invest or save at all.

“I’m much more sympathetic to the second argument, that it’s unfair to tax people making different returns equally. Generally, there’s a consensus in the Netherlands that those with the broadest shoulders should bear the greatest burden. If you make a higher return on your assets, it makes sense for you to pay the tax man a little more. Partly for this reason, economists have been calling for far-reaching reforms since the current system was introduced.”

What has been the fallout of the Supreme Court ruling?

“The tax system had to be overhauled. To that end, the State Secretary for Tax Affairs and the Tax Administration introduced a bridging act in 2022. Until we can switch completely to taxing actual returns, the Tax and Customs Administration now distinguishes between different types of assets. Savings are taxed at a lower notional return, while investments are taxed at a higher notional return.

“This temporary solution is closer to a tax on actual returns. However, it remains problematic because it’s still based on notional returns, which is why the Supreme Court ruled last summer that the bridging act violates the ECHR as well.

“The Supreme Court also ruled that legal redress was in order. This takes the form of compensation for people who made a lower actual return than the notional return. Following the Christmas Ruling, only those who objected needed to be compensated as from 2017. Last summer’s ruling extends the right to compensation to all those affected as from 2021.”

What do all these compensations cost?

“In 2022, the state already set aside 2.8 billion euros to compensate objectors as a result of the Christmas Ruling. The latest Budget Memorandum estimates that a further 9.8 billion euros must be added to that amount: 6.4 billion for 2017-2024, 1.7 billion for 2025 and 1.8 billion for 2026. These estimates assume that the new Box 3 system will start in 2027, but that now seems unlikely.

“These are truly staggering amounts. By comparison, the total tax revenue from Box 3 was about 4 billion euros in 2020. That means the government stands to lose three full years of Box 3 revenue.”

Compensation for those affected by the childcare allowance affair is estimated at 9.3 billion euros. I hear a lot of fuss about that amount. Box 3 compensation involves much larger amounts, but no one seems to care about that. What is your view?

“Perhaps there’s still a perception in the public mind that the victims of the allowance affair did something wrong. Box 3 compensation comes across as a simple miscalculation by the Tax and Customs Administration – something that merely needs to be rectified administratively.

That’s not really fair. Box 3 compensation effectively means money being funnelled back to the wealthiest people in this country – the very people we want to tax more heavily in a progressive tax system. As more than half of the Dutch have no or insufficient assets to pay tax in Box 3, this compensation will increase the gap between the rich and the poor. In that respect, I’d rather compensate those affected by the allowance affair.”

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Image credit: Bas van der Schot

People who paid too much tax in Box 3 will get a refund. Should we then also expect those who made a higher actual return than the notional return to start paying back the excess money to the state?

“No, I suspect it would be legally difficult to introduce such an additional tax demand. People based their savings behaviour on the tax on notional return at the time. The government can’t just retroactively change the rules so that people suddenly owe more tax.

All this means is that the compensation only works one way. That, too, is not really fair. Wealthy people who have overpaid taxes are considered ‘injured parties’. But if you’re part of the rest of society and you’ve underpaid taxes, you’re not treated the same way.

On top of that, one-way compensation actually creates an incentive to engage in more risky investment. By compensating for bad luck but not taxing for luck, the government makes it more financially attractive to take more risk. Ironically, that’s precisely something the Supreme Court found undesirable about the old system.”

Investing in the AEX produced an average return of about 11 per cent over the past five years, while the flat-rate yield on investment was about 6 per cent. The state treasury is actually losing huge revenue in that regard, right?

“Absolutely. At the moment, the flat-rate yield is chosen so that it corresponds more or less to the average return on risky investments. This roughly means that as many people benefit from having made a higher return than the notional return as there are people who make a lower return than the notional return. As a result, what the government has to pay in compensation roughly corresponds to what it loses, because people with higher returns remain taxed only at the notional return.”

Last summer, the Supreme Court held that the temporary bridging act was still not in line with the ECHR. What do you make of that?

“I had mixed feelings about the 2021 Christmas Ruling. Experts had been calling for a tax on actual returns for decades, but those calls were never heeded. With the Christmas Ruling, the Supreme Court forced the government to introduce such a tax. That can be seen as an accomplishment.

“On the other hand, it also led to a compensation for wealthy objectors that goes against the principle of equalisation of incomes. Moreover, having to defend the viewpoint that this tax goes against human rights is a tough sell. In effect, this is a tax on wealth. Although I feel it’s an awkward policy in economic terms, it seems to me that the government should have the right to introduce such a tax.

“Last summer’s ruling is just bad news for the economy. It will lead to yet more compensations that broaden the income gap. That’s bad enough as it is, but these compensations also take up a lot of capacity from the Tax and Customs Administration – capacity that it won’t be able to spend on implementing a new tax on actual returns. As a result, new legislation has now been delayed by another year to 2028, leading again to more than a billion in compensation.”

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