Debunking Utopia
Page 6
Economists Geranda Notten and Chris de Neubourg have calculated the poverty rates in European countries and the United States using the same way of measuring poverty. They have shown that the absolute poverty rates in Denmark (6.7 percent) and Sweden (9.3 percent) are indeed lower than the American level (11 percent). For Finland, the rate (15 percent) is somewhat higher than in the United States.12 But let’s move from comparing apples with oranges to comparing apples to apples. The poverty rate of the Nordic Americans is, as the following table shows, between half and one-third of the average American level. Thus, the American capitalist system has allowed people from the Nordics to achieve lower poverty compared to the citizens of the Nordic countries. This is not an observation restricted to a single group. Scandinavian Americans, Swedish Americans, Finnish Americans, Norwegian Americans and Danish Americans all have lower poverty levels than in the Nordic countries themselves.13
POVERTY RATE WITHIN THE UNITED STATES (FAMILIES)
ETHNICITY
PERCENT
ALL AMERICANS
11.7
SCANDINAVIAN AMERICANS
5.1
SWEDISH AMERICANS
5.1
FINNISH AMERICANS
5.1
NORWEGIAN AMERICANS
4.7
DANISH AMERICANS
4.2
American Community Survey. Based on 2013 data.
So, what does this all tell us? To begin with, the comparison illustrates the point that culture matters. Many politicians, academics, and journalists believe that Nordic countries have admirable social outcomes simply because they have large welfare states. This book has previously shown that these countries reached these good outcomes before transitioning to large welfare states. In this chapter we can draw the conclusion that those of Nordic origin who live in the American system combine low poverty and low unemployment with high living standards. More specifically, Nordic Americans have around 50 percent higher living standard, half the unemployment rate, lower poverty, and higher high school graduation rates than their cousins in the Nordics. The case for adopting a Nordic social democratic model, as it is put forward by the Left in America, suddenly doesn’t seem so convincing once we realize these facts. If anything, it is the American system that seems to shine brighter.
Nordic Americans have around 50 percent higher living standard, half the unemployment rate, lower poverty, and higher high school graduation rates than their cousins in the Nordics.
I am not the first to make this observation. Many years ago, Nobel Prize–winning American economist Milton Friedman was talking to a Swedish economist, who told him, “In Scandinavia, we have no poverty.” Friedman cleverly replied, “That’s interesting, because in America, among Scandinavians, we have no poverty, either.”14 Although both economists somewhat overstated the case (there is some poverty in Scandinavia, and also limited poverty also among Scandinavian Americans), they both made accurate observations. And their observations tell us something: There may very well be good reasons to admire different aspects of Nordic policy, such as their income distribution or parental leave programs. But the main ingredient of Nordic success is without doubt culture rather than social democracy.
5
HOW CAN THE NORDICS TAX SO MUCH?
MANY VISITORS TO THE NORDICS ask the same question: how come people here are willing to pay such high taxes? This is not something that only nerds obsessed with politics, such as myself, ponder. Regular Americans, who otherwise have little appetite for discussing political economy, are often astonished by the fact that Danes and Swedes pay half of their hard-earned cash to the government. After all, Danes and Swedes are in most regards culturally similar to Americans, and few Americans would be willing to do the same. In part, the explanation is of course that the Nordic people get more government services and pay high taxes in return. But then again, politicians on the left in the United States have long proposed to combine more taxes with more generous welfare policies. So far, voters have largely rejected this trade-off. Why don’t Americans accept Nordic-style taxes when offered Nordic-style welfare? The obsession that American politicians, journalists, and intellectuals on the left have with the Nordics is to a large degree about this question. The Left wants to transfer more money to the tax agency in the United States but finds little support for this. The best solution that they have come up with is to turn America into Denmark.
To begin with, we can observe that, yes, taxes are indeed higher in the Nordics. In fact, they are punishingly high for those with a good income. Danish researcher Henrik Jacobsen Kleven has elaborated on this issue in his research. He wrote, “The top marginal tax rates are about 60–70 percent in the Scandinavian countries as opposed to only 43 percent in the United States.” This comparison, however, only captures part of the difference. Nordic countries also have generous public benefit programs, some of which are given to working families but withdrawn from those who have a high income. So, if you increase your income, you pay more taxes and get less public transfers. Therefore, a Nordic person increasing her or his income by a hundred kronor could in certain situations gain only around twenty kronor, with the remaining eighty kronor going to the pockets of the government. By contrast, Kleven calculates that in the United States around sixty-three dollars are typically left in the pocket of the high-income worker, while thirty-seven dollars go to the government.1
If we introduced Nordic-style social democracy, does it suddenly become possible to heavily tax people without reducing prosperity?
Some people believe that the Nordic experience proves that punishingly high taxes are a viable policy. Is it true that Denmark and Sweden have stumbled upon a magical economic system wherein taxes simply stop mattering? If we introduced Nordic-style social democracy, does it suddenly become possible to heavily tax people without reducing prosperity? The answer is, of course, no. Remember how in the last chapter we found that Nordic Americans have a level of prosperity that is about 50 percent higher than that of their cousins in the Nordic countries? The best explanation for this significant gap is the higher Nordic tax rates. In most other areas of economic policy, the Nordic countries are as competitive as the United States. For example, they are open to trade, investments, and entrepreneurship. The main thing holding them back is the tax burden, which punishes hard work, education, and business ownership.
American economist Arthur Laffer is famous for explaining that when taxes are increased by a dollar, this doesn’t mean that the government will gain an additional dollar. The reason is that taxes affect our decisions. When people face higher rates, they work fewer hours and less intensely. Young people choose not to study, or to study easier subjects to earn degrees. Firms invest less and competition is reduced. Taxes in effect shrink the economic output. So, when they are increased by a dollar, perhaps revenues will only increase by eighty cents. Or, if taxes are increased from an already high to an even higher level, the effect of raising them might be so severe that revenues only increase by fifty cents. At some theoretical point, taxes will be so high that if they are raised, the revenues will not increase at all.
That taxes affect our decisions is widely known. However, the idea that there is a tipping point at which increasing them actually leads to no change in revenues, or even to reduced revenues, is often taken as a theoretical notion. When would taxes in reality become so damagingly high? A study by the European Central Bank found that this tipping point is not just some whacky theory. Sweden already seems to have reached it. According to the study, the average tax on labor in the country is at the point where raising it would lead to very little if any increase in revenues. On the other hand, reducing taxes a little would lead to the same, or almost the same, amount being collected by the government. Tax rates in Denmark and Finland are also shown to be close to this extreme case. For taxation of capital, both Denmark and Sweden are shown to be on an even more extreme point: where more taxes lead to fewer revenues.2
Several other st
udies point in the same direction.3 For instance, economist Åsa Hansson has calculated the efficiency loss for each additional Swedish krona levied and spent by the government. She explains that if the government collects an additional krona from a person who is already paying a high tax rate, the economy is negatively affected since work and entrepreneurship are punished. If the additional money collected by the government is spent on transfer programs that are an alternative to work, the economy is again damaged since people are encouraged to rely on the public rather than their own work incomes. Taken together, these effects are calculated to shrink the Swedish economy by three kronor for each krona collected and distributed by the government.4
To understand how taxes can have such a negative effect on the economy, consider a Swedish earner who is paying the maximum marginal tax rate and consuming her or his earnings. A payroll tax of 32 percent is paid on top of the gross wage. Then, an average municipal tax of 32 percent and a state tax of 25 percent are collected. Finally, an average tax of 21 percent is added on top of the value of goods and services consumed. A government report has calculated that the total effective marginal tax rate, including all these taxes, amounts to 73 percent.5 The report, published by the Swedish government, admits that the rate is so high that lowering it is expected to lead to more rather than less revenues.6 So, the next time your friend doubts that tax cuts sometimes can in fact increase revenues, remind her or him that Swedish economists writing on behalf of the government say it is so.
In a report for the Confederation of Swedish Enterprise, professor Lennart Flood and economist Peter Ericsson similarly conclude that the high marginal taxes in Sweden reduce the number of available jobs substantially while being so damaging that they have little if any success in raising government revenues.7 Danish studies point in the same direction.8 The transition toward punishingly high rates has been anything but smooth. Danish think tank CEPOS (Center for Politiske Studier) calculates that increased taxes have over time crowded out direct household spending. Therefore, the private spending of the average Danish citizen dropped from being the sixth highest in the world in 1970 to being the fourteenth highest in 2011. According to CEPOS’ report, Sweden experienced a fall from eighth to sixteenth position during the same period.9 So, if anything, the lesson from the Nordics is that taxes truly can be quite damaging if allowed to reach high levels. But this only makes the question of why the people in the region are willing to pay such high rates even more puzzling.
If we return to the study by Danish researcher Henrik Jacobsen Kleven, we find an interesting answer: “Scandinavia features higher levels of trust than anywhere else in the world. This evidence is consistent with the notion that social cohesion is larger in Scandinavian countries, which may explain their willingness to pay large taxes.”10 The unusually high levels of trust in the Nordics – which, as we have previously seen, have historical roots and exist among Nordic Americans as well as the Nordics themselves – make it possible to levy high taxes. Philipp Doerrenberg and his coauthors gave a similar explanation in a paper titled “Nice Guys Finish Last: Do Honest Taxpayers Face Higher Tax Rates?” In this case, the title tells it all. The researchers found that governments exploit groups with high relative levels of tax morale by taxing them more.11 So, yes, it makes sense to say that Nordic people are willing to pay more taxes since they receive more from the government than Americans do. But there is also another explanation: again, culture. In societies that lack Nordic tax morale, it will likely be quite difficult to have tax rates as high as in Denmark and Sweden. It is certainly possible in theory to introduce Danish tax levels in the United States. But should we really expect the public to pay these rates?
There is also another explanation that is worth keeping in mind: taxes are hidden from the general public in the Nordics. You can try this for yourself. Ask a Swede why people with normal wages in the country are paying around half of their income to the tax agency. You might be rewarded with a puzzled face. Most Swedes think that normal earners are merely paying around a third of their income in taxes. The true rates have cleverly been hidden from sight. A historical perspective can help us understand the development of hidden taxes in the Nordics. Before policies steered to the left in the late 1960s, the tax levels in the region were around 30 percent of GDP – quite typical of other developed nations at the time. Up to this point in time, most taxation occurred through direct taxes, which showed up on employees’ pay stubs. However, politics started changing. Over time, an increasing share of taxation was to be raised through indirect taxes.
The most important form of indirect taxation is the employer’s fee. This is a tax on labor, which has a very similar effect as the income tax. The difference is that it is called a fee rather than a tax, and that its name suggests that the employer rather than the employee is paying it. In effect, when somebody receives a wage of 10,000 kronor in Sweden, the employer has to pay additionally around 10,000 kronor to the government. Half of this is the tax on labor, and the other half is the employer’s fee. On their pay stubs people see that their official wage is around 15,000 kronor, out of which 5,000 have been paid in taxes. The other 5,000 kronor, which has been paid to the tax authority, is often not even included on the pay stub. Of course researchers and government records acknowledge that the employer’s fee is an indirect tax on labor, but people who don’t know the fine print of the tax system are largely unaware of the fact that both direct and indirect taxes on labor exist. Thus, many ordinary citizens think the tax on labor is around a third of the income (5,000 kronor out of 15,000) rather than the actual rate of around half the income (10,000 kronor out of 20,000). Another form of an indirect tax is the value-added tax (VAT). In the United States, a sales tax is added to sold goods and services. Nordic countries used to have the same system. Over time they have moved toward a VAT, wherein the tax is hidden in the final price of the goods or service.
The four graphs that follow show the evolution of taxes in the Nordic countries over time. They all paint a similar picture: politicians in the Nordic countries did not introduce large welfare states by raising the direct taxes. Instead they hiked revenues by expanding indirect taxes. Interestingly, all of this had been predicted a long time before it actually happened. In 1903 Italian economist Amilcare Puviani explained that politicians would have incentives to hide the cost of government by levying indirect rather than direct taxes. By doing so, the public would be fooled into underestimating the true cost of having a large public sector.12 Nobel Prize winner James Buchanan has expanded on the idea that it is easier for politicians to raise taxes that are hidden rather than visible ones.13 Another Nobel Prize winner who has raised the same issue is Swedish economist Bertil Ohlin. In 1973 he wrote an article in a leading Swedish daily paper, explaining how the government at the time was systematically hiding the true tax level. Ohlin described how the Social Democrats in Sweden had realized that the general public were not keen on embracing higher taxes, and had thus chosen to hide the true rate.14
On average Swedes believed that taxes on work and consumption amounted to 40 percent of the wage of an average worker. The true level at the time was 60 percent.
HIDDEN AND VISIBLE TAXES IN FINLAND
HIDDEN AND VISIBLE TAXES IN DENMARK
HIDDEN AND VISIBLE TAXES IN NORWAY
HIDDEN AND VISIBLE TAXES IN SWEDEN
In a survey conducted in 2003, the Swedish public was asked to estimate the total amount of taxes they paid. Respondents were reminded to include all forms of direct and indirect taxation. On average Swedes believed that taxes on work and consumption amounted to 40 percent of the wage of an average worker. The true level at the time was 60 percent.15 In 2015 the survey was repeated. Now the tax level had been reduced to 52 percent. The average respondent believed it to be 34 percent.16 So, both surveys found that a third of the actual tax burden was hidden from the general public. This all shines a new light on Nordic-style social democracy. It is only a half-truth that the people in this part
of the world are willing to put up with high taxes in return for generous welfare. If politicians hadn’t hidden the tax bill, it would have proven quite difficult to raise the level. It remains to be seen if American politicians manage to copy this Nordic strategy of hiding the true burden of government or not. Taxes in America are, for all their flaws, still quite visible. Will they remain so for long?
Part 3
THE FAILURE OF NORDIC SOCIALISM
6
NORDIC FREE-MARKET SUCCESS AND THE FAILURE OF THIRD-WAY SOCIALISM
A FEW YEARS AGO, U.S. National Public Radio ran a story “about a country that seems to violate the laws of the economic universe.” The country has “one of the lowest poverty rates in the world, low unemployment, a steadily growing economy and almost no corruption” although it has high taxes. That country is Denmark.1 A popular myth among American liberals is that the Nordic countries somehow manage to defy standard economic logic by prospering despite large welfare systems and state involvement in the economy. Social democrats in the Nordics are also fond of this myth. Sweden’s former social democratic prime minister Göran Persson has compared the country’s economy to a bumblebee: “With its overly heavy body and little wings, supposedly it should not be able to fly – but it does.”2 In reality, however, there is nothing mysterious about Nordic prosperity. These countries grew rich when they combined freemarket policies with low taxes and limited state involvement in the economy. A turn toward socialism crippled growth, while a new wave of market reforms again opened up for increased prosperity. In fact, it is difficult to find a region on Earth whose history shows us as clearly as the Nordics the importance of sound economic policies.