The paradox Sweden’s ‘lower’ taxes – explained

The paradox Sweden's 'lower' taxes - explained
Tax cuts have long been the hallmark of Sweden's Moderate Party. Why then, is the party no longer campaigning on a promise to reduce taxes further? Liberal commentator Nima Sanandaji explains.

The Swedish election debate continues along a predictable, slightly boring, track. Except of course that a major transformation has occurred. The Moderates are no longer campaigning on the promise to reduce taxes; historically their most important issue. These days Anders Borg boasts about the fact that public expenditure has remained steady at somewhat over 50 percent of GDP since the 2006 election. How does this historical shift make sense?

Economically, it really doesn’t. Consider the situation if you are a Swedish wage earner paying the highest marginal tax rate, colloquially referred to as “värnskatt” in Swedish, which applies to income over 591,600 kronor ($92,300). If you earn 50,000 kronor a month, you actually cost your employer around 66,000 kronor per month, as the company must pay the state a 32 percent employer's fee over and above your salary.

Put another way, it costs a company 132 kronor to pay you 100 kronor in salary. That 100 kronor is then reduced by a municipal tax of 32 percent and a state tax of 25 percent, leaving you with 43 kronor. Subtract from that the average consumption tax of 21 percent charged on top of the price of goods and services and you are left with around 36 kronor, a mere 27 percent of the 132 kronor it actually costs to employ you. The other 73 percent of the sum, 96 kronor, ends up in the state's coffers. Perhaps not the greatest economic incentive for work?

Researchers and government experts are well aware of the fact that taxes tack up on each other, and that the true tax rates in Sweden are considerably higher than the visible taxes. This is why the government concluded in a recent report that the "highest current marginal tax wedge on income is roughly 73 percent in Sweden".* In the same report, government experts acknowledge that the high level even defies the very purpose of taxation. If the marginal tax were to be reduced, it would making working more economically attractive. So much so that the effect would be that as much, or even slightly more, taxes would be collected at a lower rate. The same conclusion has also been reached by other researchers.

In some countries, only a small handful of taxpayers pay the maximum rate. In Sweden, around one tenth of full-time workers reach that level. Even those with lower incomes often pay an effective total marginal tax rate of around 50 percent. So one might think that at least one of the two major political parties would campaign on reducing the level of taxation. But whilst Social Democrats actually want to increase the highest marginal tax rate – something expected to reduce public revenues – the Moderates are happy with status quo.

Although this situation might be puzzling, it makes perfect political sense. The reason is simply that politicians have hidden the true level of taxation. In 1903, Italian economist Amilcare Puviani predicted the development of modern welfare states by noting that politicians would hide the cost of the state whilst drawing attention to its benefits. Sweden's development has proven him quite right.

In the mid-1960s, Sweden was a country with a tax rate around 30 percent, one of the highest living standards in the world, and good welfare. But over the years, the situation changed. by the end of the 1980s, taxes had reached more than 50 percent of the economy. But the visible taxes, those that the citizens can see being levied on their wages, remained constant at around 30 percent. The entire shift towards a high tax state was explained by massive rises in hidden taxes, or more precisely the employer’s fee and the VAT. Consecutive Social Democratic governments had effectively hidden the real tax rate.

When the centre-right government came to power in 2006, they gradually began lowering the tax level – but making the mistake on focusing on the visible rather than the hidden taxes. And they made no efforts to make the indirect taxes more visible. Today Sweden has a seemingly low tax level. Although the true tax level remains quite high. And thus it makes little political, but very much economic, sense for the Moderates to move away from the idea of reducing taxes.

*NOTE: To be a little technical, the reason is that the employer’s fee, although the name suggests otherwise, is effectively a tax that burdens the employee. The employer’s fee is, in a very complicated way, connected to benefits in the social security system for the worker, not least in terms of higher future pensions. However, a high wage earner who earns slightly more is burdened by the employer’s fee without getting additional benefits in the social security system.

Nima Sanandaji, a Swedish writer of Kurdish origin with a PhD in polymer technology, has written numerous books and reports about subjects such as integration, entrepreneurship, and women's career opportunities. His recent book, published by Sweden's Reforminstitutet think tank, is entitled Krympande eller växande städer ('Shrinking or growing cities'). He is a regular contributor to The Local.

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