by Jim Rose in applied price theory, economic history, politics - USA, Public Choice, public economics Tags: Denmark, growth of government, Norway, optimal tax theory, Scandinavia, size of government, Sweden, welfare state

Efficient taxes gather more revenue and therefore are capable of funding a larger public sector with less political resistance from groups who are net taxpayers. The so-called neoliberal reforms of the 1980s and 1990s actually saved the welfare state by putting it on a revenue raising structure that provoked less political resistance.

A switch to more efficient taxes through tax reforms allows governments to raise the same amount or larger amount of revenue for the same level of political resistance from taxpayers. This is because less revenue and output is wasted by discouraging labour supply, investment, savings and investment in capital with high marginal rates of tax on narrower tax basis. Everyone gains from converging on more efficient modes redistribution.

The Nordic countries have been on to this application of optimal tax theory to expanding the size of government and the welfare state for a long time. The Nordics have high but flat taxes on labour income, low taxes on business income and a high, broad-based consumption tax be it called a VAT or GST as illustrated by a just published Tax Foundation report.

To begin with, the USA has a smaller government because it relies more income taxes than on consumption taxes.

Governments in Europe switched towards consumption taxes such as the VAT or GST because this allowed them to raise a large amount of revenue with broad-based taxes at low rates. A VAT or GST exempts exports and business to business transactions from taxes so that reduced taxpayer resistance.

Scandinavian income taxes raise much more revenue than in the USA because they are rather flat. That is, they tax most people at these high rates, not just high-income taxpayers. The top tax rate in the Scandinavian countries cuts in at about one and a half times average income or less rather than eight times average income as in the USA.

Flat high tax "How do Scandinavian countries pay for their govt spending?" bit.ly/1KZ7jOs @JimPethokoukis http://t.co/33oRg8Ozqh—

Old Whig (@aClassicLiberal) June 11, 2015

The marginal income tax rates including this top income tax rate cuts in a low level of income is also rather high in the Nordic countries relative to the USA’s top income tax rate with the exception of Norway.

Nonetheless the Nordic countries are alert to not killing the goose that laid the golden egg. Company taxes are relatively low in Scandinavian countries as compared to the USA so that businesses do not flee to other jurisdictions.

Top marginal tax rates on dividends and capital gains are not above-average in the Nordic states but their taxes on less mobile tax bases such as from labour and consumption are much higher.

A large welfare state such as those in the Nordic countries require a significant amount of revenue, so the tax base in these countries must be broad. This also means higher taxes on consumption through the VAT or GST and higher taxes on middle-income taxpayers.

Business taxes are a less reliable source of revenue because of capital flight and disincentives to invest. Thus, the Nordics do not place above-average tax burdens on capital income and focus taxation on labour and consumption.

via Sources of Government Revenue across the OECD, 2015 | Tax Foundation and How Scandinavian Countries Pay for Their Government Spending | Tax Foundation.