Undercover Economist

Tax: a Scandinavian solution

‘With tax, our politicians seem determined to make the process as clumsy and painful as possible’

If a politician was a surgeon, faced with the task of amputating your leg, we can well imagine how it would go. First he’d deny that he planned to amputate the leg. Then he’d pass a law making it illegal to amputate the leg. Then he’d say that he’d amputate an investment banker’s leg instead. Finally, he would blame the mess handed to him by the previous surgeon and would begin to rub away at your toes with a cheese grater.

So it is with taxes. It’s no fun paying them but public spending must be paid for somehow. Yet our politicians seem determined to make the process as clumsy, painful and disingenuous as possible.

This may be because politicians see taxes purely in political terms. They believe that the deep problem with taxes is that people do not like paying them, which is why they say, instead, that the taxes will be levied only on multinational corporations, investment bankers and tax dodgers of all stripes. Politicians placate angry voters with tax exemptions and deductions. All this is politically understandable but has the effect of making the taxes much more damaging than they need to be.

The true problem with taxes is quite different. It is that in an effort to pay less tax, people do some extraordinary things. Most obviously and controversially, they’ll adopt odd legal labels that have the effect of reducing their tax bill. Some are fiendishly complex international schemes, playing different tax treaties off against each other and generating corporate profit that each tax authority deems is someone else’s problem. Others are quite simple. All of them are unfair, and all of them generate paperwork.

A second problem, less fussed-about but probably more serious, is that people will change their behaviour rather than just the legal description of that behaviour. For example, some new mothers who want to work will stay at home rather than hire childcare out of heavily taxed income. The mother doesn’t get the career she wanted, and the taxman doesn’t get the tax revenue. Nobody wins.

Two articles in last year’s Journal of Economic Perspectives explore how governments might get more serious about raising taxes. One, by Gabriel Zucman, emphasises that the complexity and inconsistency of different tax systems allow wealthy individuals and multinational companies to exploit cross-border loopholes and avoid tax. Zucman’s calculations suggest that US companies are increasingly booking their profits in what he calls “the main tax havens”, jurisdictions that housed about 2 per cent of US corporate profits in 1984 but 18 per cent in 2013.

But one way to look at the problem of levying high taxes is to ask who has solved it. The answer: Denmark, Norway and Sweden. US tax revenue is about 25 per cent of GDP, the UK and Germany at about 35 per cent, and the Scandinavians at about 45 per cent, according to economist Henrik Jacobsen Kleven. Somehow the Scandinavians have managed to raise large sums from their citizens without destroying their economies. How?

That’s the question that Kleven sets out to answer and, of course, the answer is partly cultural. It is also partly about the comprehensive tax reporting in Scandinavia, which makes outright evasion very difficult. Norwegian tax returns are published for all to examine. (No wonder Gabriel Zucman dreams — perhaps implausibly — of a global financial registry to help track down tax dodgers.)

Not everyone will feel delighted about an all-seeing government determined to invade privacy in the name of higher taxes. But there are other elements of Scandinavian taxation that any government might want to emulate: Scandinavian countries minimise the distortions of their tax system by avoiding the bad habits of politicians in other countries.

Chief among these habits is targeting a narrow tax base. The US tax system is full of ad hoc deductions and exemptions. The UK system needlessly excludes swaths of the economy from tax. Rather than charge a 10 per cent rate of VAT on everything, the UK government charges a 20 per cent rate of VAT on roughly half of what consumers spend. The Danes have a much broader VAT base, and a higher rate too.

The simplest way to broaden the tax base is to dismantle barriers to getting a job. Scandinavian governments subsidise education, transport and care for children and the elderly, all of which help people to work who might otherwise find themselves stuck at home. As a result, even high taxes do not keep them out of the labour market.

That makes sense. If the surgeon really is going to amputate your leg, having a prosthetic replacement would be wise.

Written for and first published at ft.com.

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