Proposals for flat rate income taxes have offered substancial benefits in increased economic efficiency, horizontal equity, and simplicity of administration and compliance. However, even with provisions of tax reflief at lower incomes, flat taxes would shift the distribution of the tax burden away from those at high incomes and onto persons at middle incomes. Many countries have significantly flattened their personal tax rate schedules and broadened their tax bases in recent years. Yet every country has stopped short of a fully flat tax rate on account of the distributional impacts.

This study explores the possibilities for exploiting most of the benefits of a flat tax while retaining a distribution pattern closer to that of existing tax systems. A dual rate tax structure is proposed to confine the upper-bracket rate to a minority of the taxpaying population. The dual tax has to deal with the problem of tax relief for persons at lower incomes without complicating the marginal rate structure at the bottom of the scale. Most flat tax proposals have failed to address this problem, and the analysis provided for tax relief in this study is equally applicable to flat and dual rate systems.

Other key aspects in designing the personal tax interact vitally with the rate structure. This paper considers the tax base, the tax unit, and various timing and operational issues. In most of these dimensions, a well-designed dual tax can achieve benefits similar to those of a flat tax without sacrificing the distributional objective.

Particular attention is given to design of the surtax, composition of the tax base, and interactions between the rate structure and implementing the tax base. The study applies its analysis to the tax system of New Zealand, which embodies a dual tax rate on a broad income base more than that of any other country. The limited potential for further gains from applying a flat tax can also be seen from experience in New Zealand.