Taxing in Scandinavia

Jim Stanford and Stephen Gordon are keeping me busy today. Another missive from Jim Stanford in the Globe prompted this post from Stephen that leads to some interesting points of comparison between the Nordic model and the Canadian status quo:

Welfare states can be competitive

Jim Stanford sets aside our shared scepticism about the WEF competitiveness rankings to make two points in his column in today’s Globe and Mail:

Get real about Canadian competitiveness:

Nine of the 15 countries ahead of us on the WEF list collect higher taxes than Canada. Indeed, the Scandinavian welfare states cleaned up this year: Finland was second in competitiveness, Sweden was third, Denmark fourth, and Norway and Iceland also placed ahead of Canada.

Governments in these countries rake in 50 per cent or more of their respective GDP.

This is a point that deserves to be made more often (see, for example, here). There’s no reason to think that we have to choose between social programs and economic growth.

But he misses a crucial element of the Nordic model:

You’d never know from this weak effort that Canada’s corporations received bigger tax breaks since 1999 than any other stakeholder: The average effective corporate income tax rate fell to 25 per cent from 35 in that time (eating up $20-billion of the total tax cuts our governments delivered).This utter lack of correlation between taxes and competitiveness, however, did not stop Canadian business commentators from ascribing our weak performance to (what else?) high taxes, and demanding still more cuts. The National Post’s coverage was prototypical: The headline decried high taxes, and the article carried on the good fight — never even mentioning that Finland, Sweden, and Denmark took three of the four top spots.

You might be led to believe from this that corporate tax rates in the Nordic countries were higher than in Canada. This would be a wrong conclusion to draw. Here are the 2006 corporate tax rates for the 4 Nordic countries and Canada (2000 rates in parentheses):

Canada: 36.1 (44.6)
Denmark: 28.0 (32.0)
Finland: 26.0 (29.0)
Norway: 28.0 (28.0)
Sweden: 28.0 (28.0)

Notwithstanding the round of cuts in the past few years, Canada’s corporate tax rates are still higher than in the Nordic countries.
Stephen Gordon makes an important point because progressives are increasingly looking to the Nordic countries because they are successful real-world examples that we might want to emulate. But though the total tax take is much higher than in Canada, the tax mix is different. In particular, corporate taxes are lower, value added taxes higher. My take on the literature is that high taxes as a share of GDP is less of an issue than how the taxes are raised and how the proceeds are spent, ie what matters is the tax mix not the tax share of GDP.

This presents a challenge to progressive thinkers in the Canadian context who traditionally would be more inclined to support higher corporate taxes and lower value added taxes. The catch is that in Scandinavia higher value added taxes have been part and parcel of a social bargain with labour: they accept higher regressive taxes because the money raised is funnelled back into pro-growth social expenditures.

UC Davis’s Peter Lindert reviews this dynamic in Growing Public: Social Spending and Economic Growth since the Eighteenth Century (or check out the shorter essay online, “Why the Welfare looks like a Free Lunch”). He considers why the welfare state has not had the negative effect on growth that many economists assume it should. He argues that the actual experience of countries with large public sectors has been towards implementing pro-growth taxation and spending policies.

On the tax side, these governments have tended to tax capital lightly to avoid capital flight. They also tend to rely more on consumption taxes, particularly those for gas, alcohol, and tobacco. These are regressive taxes, but are considered to be more efficient by many economists because they do not distort decisions about saving and consumption over time. More importantly, these regressive taxes were introduced as part of a social bargain that the proceeds would fund beneficial social transfers.

The flip side of taxation is public spending. On the spending side, welfare state countries have invested in public health care and child care systems that have pro-growth impacts. They have also provided positive incentives for workers on social assistance to enter the labour market by allowing them to keep a large share of additional earned income. Benefits are phased out at a higher income level, whereas countries like Canada and the U.S. have tended to impose very high marginal tax rates on additional income received by social assistance recipients.

See also this recent post from New Economist on the Danish “flexicurity” model, which has been praised by many but requires up-front investments in labour market training that many countries may not accept because the benefits accrue outside the standard political cycle (the same challenge exists in regard to the economic benefits of early learning and child care programs).