Economic survey of Denmark 2008: Tax reform, hours worked and growth

 

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The following OECD assessment and recommendations summarise chapter 4 of the Economic survey of Denmark published on 19 February 2008.

 

Contents                                                                                                                                    

Tax reforms to promote labour and skill supply should continue

Having one of the highest tax-to-GDP ratios among OECD countries makes it very important for Denmark to constantly consider how to refine the tax structure in order to reduce distortions to the supply and allocation of production factors, not least labour. Indeed, the co-existence of high employment rates and low average hours worked also reflects the income tax schedule as labour market contributions, income and consumption taxes combine to create a marginal tax wedge of over 70% from just above average full time earnings. In 2008, the in-work tax credit will be enlarged but, to compensate those not working, there will also be a one-off increase in the level of all income benefits, attenuating the incentive effect of the larger in-work tax credit. To strengthen employment incentives, the in-work tax credit should rather be combined with benefit reductions, as done in Sweden. In 2009, the threshold from where the middle tax is paid will be moved up to be exactly the same as for the top tax, thus improving work incentives for a fifth of the labour force.

 

Meanwhile, the 15% top tax, which generates a 70% marginal tax wedge for four out of ten full-time employed, has not been cut despite bringing only modest revenue worth 1% of GDP. Estimates of dynamic effects from cutting the highest marginal tax wedge indicate that the rise in the tax base from a less distorted choice of hours worked at the margin would bring back over half of the initial revenue loss. The degree of self-financing could in fact be even higher in the long run when considering the full range of dynamic gains in terms of greater effort, better skill formation, young people starting studies and work earlier, less difficulty in attracting and retaining talented staff from abroad, less do-it-yourself activity, less artificial fringe benefits and the associated possibilities for making capital taxation more neutral. Consequently, if focused on bringing down the high marginal rates, then a financed tax reform is capable of enhancing individual economic welfare, by reducing distortions, as well as contributing to fiscal sustainability and thereby helping to finance public consumption growth in the long run. Given the uncertainty about the size and timing of the dynamic gains, a prudent approach to financing should be adopted. Reducing the high top marginal income tax rate or, as a second-best option, raising the threshold from where it is paid should therefore have priority – but unless cuts are fully financed also in the short run, then it should wait until the risk of macroeconomic overheating has subsided.

 

The top marginal tax wedge on labour is amongst the very highest in the OECD


 

 

 

How to obtain this publication                                                                               

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.The complete edition of the Economic survey of Denmark 2008 is available from:

Additional information                                                                                                  

 

For further information please contact the Denmark Desk at the OECD Economics Department at eco.survey@oecd.org.  The OECD Secretariat's report was prepared by Jens Lundsgaard and David Turvey under the supervision of Stefano Scarpetta. Research assistance was provided by Lutécia Daniel.

 

 

 

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