TAX POLICY IN THE NORDIC COUNTRIES

TAX POLICY IN THE NORDIC COUNTRIES

Also by Peter Birch S rensen PUBLIC FINANCE IN A CHANGING WORLD (editor)

Tax Policy in the Nordic Countries Edited by Peter Birch SfZ}rensen Professor of Economics University of Copenhagen De1lmark

Editorial matter and selection Peter Birch SlIlrensen 1998 Text Macmillan Press Ltd 1998 Softcover reprint of the hardcover 1st edition 1998 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London WIP9HE. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 1998 by MACMILLAN PRESS LTD HoundmiIIs, Basingstoke, Hampshire RG21 6XS and London Companies and representatives throughout the world ISBN 978-1-349-13824-1 ISBN 978-1-349-13822-7 (ebook) DOI 10.1007/978-1-349-13822-7 A catalogue record for this book is available from the British Library. This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. to 9 8 7 6 5 432 I 07 06 05 04 03 02 01 00 99 98

Contents List of Tables List of Figures Preface Acknowledgements Notes on the Contributors vi viii ix xii xiii Recent Innovations in Nordic Tax Policy: From the Global Income Tax to the Dual Income Tax Peter Birch S9Jrensen 2 Taxation of Income from Small Businesses: Taxation Principles and Tax Reforms in the Nordic Countries Kare Petter Hagen and Peter Birch S9Jrensen 3 Corporate Tax Policy in the Nordic Countries Krister Andersson, Vesa Kanniainen, Jan Sodersten and Peter Birch S9Jrensen 72 4 Financing the Nordic Welfare States in an Integrating Europe Kare Petter Hagen, Erik Norrman and Peter Birch S9Jrensen 138 5 Nordic Tax Policy Towards the Year 2000 and Beyond Peter Birch S(Jrensen 204 Index 231 28 v

List of Tables 1.1 Marginal income tax rates in an average municipality in the Nordic countries 3 1.2 The tax treatment of 'early' versus 'late' spenders under the income tax 7 1.3 The tax treatment of 'early' versus 'late' earners under the income tax 7 1.4 Investment in human capital versus financial investment under the conventional income tax 10 2.1 The 'gross' versus the 'net' method of splitting income from self-employment 48 2.2 Loss-offset rules for proprietors in the Nordic countries 66 3.1 Utilization of tax allowances in large Finnish and Swedish corporations 1979-91 79 3.2 Corporate tax systems in 1996 83 3.3 Estimated elasticity of manufacturing investment with respect to the cost of corporate capital, 1965-90 103 3.4 Corporate tax rates and tax bases in the Nordic countries, 1996 105 3.5 Methods of double tax relief in the Nordic corporate tax systems, 1996 107 3.6 Personal tax rates on corporate source income, 1996 108 3.7 Marginal tax wedges on corporate investment in machinery in the mid-1990s 111 3.8 Marginal effective personal tax rates on income from domestic shareholding and from domestic government bonds in the mid-1990s 115 4.1 Taxation and public expenditure as percentage of GDP, 1993 143 4.2 Composition of tax revenue in 1993 145 4.3 Effective average tax rates on labour, capital, and consumption, 1982-92 147 4.4 Total average tax rates on labour income, 1994 (single person) 149 vi

List of Tables vii 4.5 Effective average and marginal tax rates (per cent of gross labour cost) for a single average production worker, 1994 151 4.6 Composition of revenue from indirect taxes 153 4.7 Net indirect taxes as a percentage of the industry's GDP, 1989 154 4.8 Changes in key statutory tax rates 1980-90 162 4.9 V AT rates in the Nordic countries and in the EU as at 1 August 1995 166 4.10 Selected excise tax rates, 1995-96 167 4.11 Extent of cross-border shopping 169 4.12 Estimated maximum distance Irish shoppers will travel to take advantage of Irish-UK price differentials 170 4.13 Estimated price elasticities of domestic demand for alcoholic beverages in the UK before and after the opening of the single market 171 4.14 A verage annual migration flows between Scandinavia and the European Community 173 4.15 Scandinavian emigrants 1981-89 distributed by education level and destination region 174 4.16 Estimated effects of taxation on pre-tax real wages for a given level of real after-tax unemployment benefits 179 4.17 Alternative measures of the burden of corporate taxes in 1991 185 4.18 Direct and indirect foreign portfolio investment by the household sector 188 4.19 Effective marginal tax rates on the return to domestic saving in 1993 189 4.20 Property tax revenues in per cent of total tax revenue 194 5.1 Unemployment rates in the Nordic countries and in OECD Europe 206 5.2 'Green' taxes as a percentage of GDP, 1993 207 5.3 Excess unemployment for unskilled workers, 1992 213 5.4 Skill composition of employment in Denmark, 1991 219

List of Figures 3.1 Determination of domestic and foreign ownership of outstanding shares in domestic corporations 130 3.2 The effect of shareholder tax relief targeted at domestic shareholders 131 3.3 The effect of shareholder tax relief granted to foreign as well as domestic shareholders 132 3.4 The effect of shareholder tax relief targeted at domestic shareholders when the initial domestic ownership share is close to 100 per cent 133 4.1 Cantonal tax rates and the share of high-income taxpayers across Swiss cantons, 1990 164 5.1 Alternative carbon tax schemes 211 viii

Preface This volume grew out of an inter-nordic research project on 'Tax Policy in Small Open Economies', organized and sponsored by the Nordic Economic Research Council in the period 1990-3, and involving about 25 Nordic tax economists. The background for the project was the hectic tax reform activity in the Nordic countries in the early 1990s and the feeling among Nordic policy-makers that the ongoing process of European economic integration might call for further changes in the Nordic systems of public finance. A selection of the more theoretical and technical studies resulting from this inter-nordic research project has already been published in a 1994 special issue of the Scandinavian Journal of Economics on 'Tax Policy in Small Open Economies'. The present volume brings together a number of the more applied and policy-oriented studies of recent tax policies in the Nordic countries. We believe that these studies may be of interest not only to Nordic readers but also to a wider international audience. There are several reasons for this. First, the recent Nordic tax reforms involved a shift from a traditional global income tax to a new system of 'dual' income taxation combining a low proportional rate of tax on capital income with progressive taxation of income from other sources. The dual income tax is an ambitious effort to deal with many of the traditional problems of capital income taxation, and an attempt to adapt the Nordic tax systems to a world of growing capital mobility. A study of the dual income tax may therefore be relevant to policy-makers in other countries struggling with similar problems. Second, although the Nordic tax reforms of the 1990s have followed the philosophy of tax-cut-cum-base-broadening which became popular in many other OECD countries during the second half of the 1980s, the Nordic countries have tended to go further in this direction than any other OECD country. For instance, within a few years corporate income tax rates in the Nordic area were almost cut in half. As another example, the base-broadening measures involved in the Swedish tax reform of 1991 amounted to 6 per cent of gross domestic product, whereas the much celebrated US tax reform of 1986 'only' implied a reshuffling of 1-2 per cent of GDP. International observers interested in the practical implementation of the principle of tax-cut-cum-base-broadening might therefore gain additional insight from a study of the Nordic tax laboratories. ix

x Preface Third, the Nordic countries are generally considered as the world's most ambitious welfare states. At the same time these countries are highly open to international trade and capital flows. The Nordic fiscal systems are therefore particularly exposed to the pressures on the welfare state emanating from the process of international economic integration. For academics and policy-makers studying the problems of the European welfare states, it might thus be useful to take a closer look at recent experiences in the Nordic countries where the internationalization of the economy is often seen as an important constraint on tax policy. Rather than getting lost in minor institutional details, the studies in this book focus on the main rules and principles embodied in the new Nordic tax systems. We try to explain and discuss the reasons and motives for the choices made by Nordic tax policy-makers, and we attempt to evaluate the Nordic tax reforms in a non-technical manner in the light of recent advances in the theory of taxation. In particular, we try to show how problems and issues arising in the tax reform process have stimulated academic research, sometimes generating new insights which should be of interest outside the Nordic area. We also point to some cases where academic research seems to have influenced the making of practical tax policy. In so far as we do delve into the finer details of the tax systems, we try to single out areas where the Nordic countries appear to have contributed genuine innovations in tax policy. Finally, we do not limit ourselves to a discussion of the policies which were actually implemented; we also consider and discuss some policy options which were not adopted, and several new policy proposals which are currently being debated. Each chapter of the book is self-contained and can be read independently of any other chapter. However, we hope (and believe) that the chapters taken together form a coherent whole, each dealing with an important aspect of tax policy, but each supplementing the other. Chapter 1 describes the main features of the new Nordic system of dual income taxation and discusses the theoretical as well as the practical arguments for and against this unconventional tax system. Chapter 2 analyses the special problems involved in the taxation of income from small enterprises, with particular emphasis on the problems arising under the new system of dual income taxation where the income of active owner-managers has to be split into a labour income component and a capital income component. In Chapter 3 we turn to the problems of corporate income taxation, analysing the sweeping Nordic corporate tax reforms of the early 1990s in the perspective of recent theoretical and empirical research by Nordic tax economists. Chapter 4 seeks to identify the pressures on the Nordic fiscal systems arising from the ongoing integration of the European economies and

Preface discusses various options for Nordic tax policies in a world of growing mobility of tax bases. Chapter 5 likewise attempts to look into the future, considering some of the most innovative or controversial proposals for further adjustment and reform of the Nordic tax systems which have recently emerged in the Nordic tax policy debate. Much of the inspiration for the chapters in this book arose out of stimulating discussions with our Nordic colleagues in the inter-nordic workshops and conferences on 'Tax Policy in Small Open Economies' held during the period between 1990 and 1993. Special thanks are due to the then secretary of the Nordic Economic Research Council, Peter Stenkula, who enthusiastically supported our project along the way and took responsibility for all the practical aspects of organizing the successful workshops which led to this book. Thanks are also due to Peter Stenkula's successor, Michael Lundholm, for very efficient and loyal assistance in the final stages of the work on the book. Many colleagues offered valuable comments on earlier versions of the various chapters. These commentators include Richard Bird, Robert Haveman, Jeffrey MacKie-Mason, Agnar Sandmo, Gustav Teir and Barbara Wolfe. Particularly extensive and detailed comments were given by Sijbren Cnossen and Jens Holger Helbo Hansen. Helbo Hansen and Outi Kroger also provided important factual information for several chapters, and Lars Feld of the University of St Gallen kindly supplied data material on Switzerland. Of course, none of these persons should be held responsible for any remaining errors or shortcomings. As the editor responsible for the completion of this volume, I am grateful to the members of the Nordic Economic Research Council and to Mr Tim Farmiloe of Macmillan for the extreme patience with which they have awaited the final manuscript. Thanks are also due to the Council and to the Danish National Research Foundation for funding a substantial part of the research effort which I invested in the book. Like most other European countries, the Nordic countries have entered a period of fiscal austerity. Regrettably, this means that the publicly funded Nordic Economic Research Council ceased to exist by the end of 1996. It is our hope that this volume will be seen as an example of the fruitfulness of bringing Nordic economists together to undertake joint applied research on problems of common interest. We believe that this kind of activity can and should continue in the future. xi Copenhagen, January 1997 PETER BIRCH S0RENSEN

Acknow ledgements The authors and publishers are indebted to the following: Kluwer Academic Publishers for permission to use, in Chapter 1, material from Peter Birch S~rensen, 'From the Global Income Tax to the Dual Income Tax: Recent Tax Reforms in the Nordic Countries', International Tax and Public Finance, May 1994, vol. 1, pp. 57-80, now revised and expanded; and Kluwer Law International for permission to use, in Chapter 2, material from Kare Petter Hagen and Peter Birch S~rensen, 'Taxation of the Self Employed under a Dual Income Tax', in Sijbren Cnossen (ed.), Towards a Dual Income Tax? - Scandinavian and Austrian Experiences, Foundation for European Fiscal Studies, Erasmus University Rotterdam, 1996, now revised and expanded. xii

Notes on the Contributors Krister Andersson is Senior Analyst. Skandinaviska Enskilda Banken. Stockholm. Kare Petter Hagen is Professor of Economics. Norwegian School of Economics and Business Administration. Vesa Kanniainen is Professor of Economics. University of Helsinki. Erik Norrman is Lecturer. University of Lund. Jan Sodersten is Professor of Economics. Uppsala University. Peter Birch Sffrensen is Professor of Economics. University of Copenhagen. and Senior Research Fellow. Economic Policy Research Unit. Copenhagen. xiii