A common perception is that Nordic nations have stumbled over a secret recipe, in which high taxes have little if any negative consequences. This does not find support in the research. Numerous studies have shown that the high levels of taxation are damaging to the Nordic economies. Hidden or not, the tax burden matters.
A study published by the European Central Bank, for example, finds that Sweden is on the tip of the Laffer curve when it comes to average taxes on incomes. This means that increasing taxes further on labour would have such a damaging effect on the economy that revenues would not increase. Tax rates in Denmark and Finland are also shown to be close to this extreme case (Norway is not included in the analysis).
For capital taxation, Denmark and Sweden are shown to be on the wrong side of the Laffer curve. This means that capital taxes in the two countries are so damaging that reducing them would actually lead to more money being collected by the tax authorities (Trabandt and Uhlig 2010).
Several other studies support the idea that Swedish taxes are at, or close to, the tip of the Laffer curve (see, for example, Holmlund and Söderström 2007). For instance, economist Åsa Hansson calculates the efficiency loss for each additional Swedish krona levied and spent by the government. This loss can, according to Hansson, be up to three additional krona if the money is spent on welfare payments which reduce the incentives for work (Hansson 2009).
To understand why taxes can have such significantly negative effects on the economy, one can consider the situation of a Swedish worker paying the maximum marginal tax rate and consuming his earnings. A payroll tax of 32 per cent is paid on the gross wage. There is then an average municipal tax of 32 per cent and a state tax of 25 per cent. Finally, there is an average consumption tax of 21 per cent. A government report has calculated that the total effective marginal tax rate is 73 per cent. This is above the estimate of the top of the Laffer curve in the same report, indicating again that a lower tax rate could in fact lead to higher public revenues (Pirttilä and Selin 2011).
A number of Danish studies point in the same direction. The think tank CEPoS in Copenhagen has, for example, calculated the effects of reducing the top marginal tax rate on labour from 56 to 40 per cent.2 The total effect of increased working hours among the affected groups would correspond to adding between 20,000 to 55,000 extra individuals to the labour force (Lundby Hansen 2011).
Lastly, it is important to bear in mind that the estimates relating to the effect of taxes are based on short-term and medium-term consequences. Economic research supports the notion that taxes also affect long-term decisions, relating to choice of career, investment in education and the number of hours worked (see, for example, ohanian et al. (2008) as well as Rogerson (2009)). The long-term benefits of tax cuts in the Nordics are likely to be even greater than the above-mentioned estimates indicate.
The popular notion that high taxes have not impaired economic development in Nordic nations is simply not true. Affluent Nordic nations would be even more affluent with a lower tax burden.