Summary of “How Can Scandinavians Tax So Much?”

Introduction

As many reading this well know, Scandinavian countries (Denmark, Norway, and Sweden here) face famously high tax rates. Top tax rates are in the range of 60–75% [and kick in at much lower incomes, as shown below].

  1. Low tax evasion
  2. Low tax avoidance
  3. Public provision of goods that increase labor supply
  4. Social motivations

1. Third party information and tax evasion

Third party reporting is key to the Scandinavian system. Employers report taxes on employees, and the financial sector reports taxes on clients. Additionally, “tax enforcement benefits from information created by market transactions between the taxpayer and third-party agents. These are verifiable information trails created for non-tax purposes — credit cards, loan contracts, business partners, and so on — that potentially could be obtained by the tax authorities in order to construct true tax bases”. [The structure of value-added taxes similarly has an enforcement component built in.] These information trails increase as countries develop, so tax evasion is likely to get harder over time for a modernized system. This is especially relevant for folks like the self-employed, who otherwise have an easier time dodging taxes. Data from a field experiment backs up that information reporting matters a lot:

2. Tax bases, tax avoidance, and ETI

As I’ve discussed before, how much revenue you bring in from taxes relies on the ETI, or elasticity of taxable income. And, bigger tax bases and lower tax evasion lead to lower elasticities, and therefore raise revenues and lower economic distortions. “The more recent [ETI] estimates for Denmark fall in the range of 0.05–0.15, which is much smaller than the most-cited US estimates of around 0.4–0.5”. For reference, an ETI of 0.05 corresponds to a revenue-maximizing flat rate of 95%, compared to 67% for an ETI of 0.5 (formula proven here). But the estimates for the elasticity of broad income, which ignores tax expenditures that lower taxable income, are much lower in the US compared to ETI, while they are fairly close in Denmark. This suggests that the US’ high ETI is largely due to these expenditures. Research also finds that while these high top tax rates can lead top-earning foreign immigrants to move, the same is not true for natives, who make up the vast majority of the population.

3. Expenditure policies: Transfers and work subsidies

“The efficiency of a tax system cannot be fully understood without considering how the revenue is spent.” Scandinavian countries spend large amounts of money on childcare, elder care, transportation, and preschool. These are examples of welfare benefits that encourage work, rather than discourage it. If it’s easier for you to get to work and have time to work, you’re more likely to work. Cheap education, also well-funded, increases labor supply in the long run too. It’s fairly easy to gather data on labor participation rates and taxes to measure elasticity along the extensive margin (basically, how much taxes discourage working at all, vs. the intensive margin of how much taxes discourage working for a higher pay or longer hours). Shockingly, increased taxation is POSITIVELY correlated with labor participation for 20–59 year olds, especially for women. This suggests that the effect of the aforementioned government spending in increasing participation must be large. [And I’m sure the Nordics’ spending on active labor market policies serves a role too!]

4. Social and cultural influences

Some suggest that the tax and welfare policies of Nordic countries are only possible due to a uniquely trusting and generous culture. While “Scandinavia features higher levels of trust than anywhere else in the world”, this could be a result of these very same policies. [While the authors discuss “willingness to pay taxes that finance redistribution to the poor”, Nordic countries generally have more universal welfare programs, which are likely not thought of as redistribution to the poor.] Overall, 10–15% of the Scandinavian population think poor people are lazy, compared to 60% of Americans. The overall tax rate in a country is positively correlated with what the authors call a social capital index, measuring civil participation, voting, and crime levels all together. It should be noted that it’s hard at a glance to determine causation between these factors [though the history of labor movements in these countries I think are instructive here, something I tend to write about in the future].

Conclusion

The success of Nordic taxation isn’t an accident. It’s backed by reliable ways to report income and collect taxes, and good economic theory on what goods the government should provide. There may be current cultural differences that separate out the Nordics as well, but what came first is a question outside the scope of this paper. [Personally, I find it shocking that the authors don’t mention the strong role that unions play. Union membership is high in the Nordics, and they increase solidarity, voting, and political knowledge.]

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