Tax and Growth: What Direction should Sweden Take?

 

Lecture by Angel Gurría, OECD Secretary-General, at Stockholm School of Economics

Stockholm, 22 April 2008


Good afternoon Ladies and Gentlemen,
I am delighted to be here with you at the Stockholm School of Economics; an institution that has been contributing to the economic progress of Sweden for nearly 100 years.


It is also a pleasure to come to talk about taxes and growth, a very relevant policy area for all countries in these difficult times of global financial turmoil and economic slowdown; but particularly important for Sweden, as the Swedish government has just embarked on ambitious tax cuts that could significantly strengthen the growth capacity of the Swedish economy.


As you know, the OECD makes periodical assessments of the economy and the economic policies of each of our member countries, as well as of a growing number of non-member economies. Based on a systematic dialogue, a constant exchange of policy experiences and sound statistical analysis we draw on the best practices of our members to help governments in refining their policies to improve their economic performance and social progress.


Our work on taxation has been growing in importance to become one of the big success stories of the OECD. We work very hard to set standards in the international tax world. But we have also developed important knowledge and comparative statistics on national taxation environments which are helping member and non-member countries to turn their tax policies into sources of competitiveness and growth. 


Finding the right direction for tax policies is not a trivial task, because policymakers have to balance many concerns. Tax revenues are needed to finance public spending priorities in infrastructure, education, health and other areas which are important for economic growth and social cohesion; but tax systems also must be growth-friendly while being fair and not excessively complex.


At the OECD, our “Tax and Growth” approach is based on a simple but important assumption: tax systems should not be used as an instrument to guide business decisions or put human lives at the service of GDP growth; rather, tax systems should be neutral and let firms and human beings flourish and realise their full potential.


A tax and growth strategy is about preventing taxes from distorting the basic growth drivers. Corporate executives should not spend their time thinking about taxes, but about how they can innovate to improve the products and services they offer customers while using resources efficiently. Building an open business environment where firms compete on equal terms is the best way to achieve that.

Now, let me talk to you about how taxation is evolving across the OECD countries, with special reference to Sweden.

New trends in taxation in OECD countries


Over the last decades, there has been a steady increase in the tax-to-GDP ratio across most of the OECD. This is a striking trend indeed. However, there are signs that this tendency has largely come to an end. The Swedish tax-to-GDP ratio, for example, remains among the highest in OECD but it is already falling.


If we look at the composition of tax revenue, most OECD countries extract the bulk of revenue from three main sources: personal and corporate income taxes, social security contributions and taxes on goods and services.


The fiscal policy mix varies among countries; however, our studies reveal that most countries have increased their reliance on value added taxation. The United States is now the only OECD country without a value added tax. Social security contributions have also become more important in our member countries, raising nearly as much revenue in the OECD countries as the personal income tax.


Our comparative analysis projects that Sweden relies more on income taxes and social security contributions and less on consumption taxes than the average OECD member. This is cause for reflection, as our research reveals that consumption taxes are more growth friendly than labour taxes.


Personal and corporate income tax reforms have been on the political agenda in most OECD countries for many years. Most often the driving forces behind the reforms have been the need to provide and maintain an attractive investment climate, to encourage work and to avoid tax-induced distortions. Since the mid 1980s, we have seen OECD governments cutting corporate and personal income taxes, with Europe taking the lead.


These trends can also be seen in Sweden. The tax reform in the early 1990’s cut corporate rates substantially; today the 28% rate is in line with the OECD average. The top personal income tax rate has been reduced to its current 57%, but it still remains one of the highest rates in the OECD.


In a few countries, tax reforms have also aimed at reducing disincentives to participate in the labour market for certain groups by introducing so called “in-work benefit policies”. These benefits or tax credits, like the one introduced last year here in Sweden, aim at encouraging work incentives at lower incomes by reducing the tax burden.


Environmental concerns are also on the agenda in most countries and there is general consensus that taxes are an efficient instrument to address the challenges of climate change and pollution. In this area, Sweden is already well advanced: today environmentally-related taxes amount to around 3% of GDP, which is well-above the OECD average.


There are important differences in the use of taxes on property. Only a few countries, like the United States and the United Kingdom, raise substantial revenue from property taxes. As you know, Sweden recently abolished the central government’s housing tax.

Taxes matter for growth

Getting the right mix among these taxing alternatives can have a strong impact on the efficiency of our economies and therefore on growth.


The distortionary effects of collecting revenue from different sources can be very different. It is highly likely that there could be efficiency gains from replacing part of the revenues from income taxes with revenues from less distortionary taxes such as consumption or property taxes. 


Our recent work on “tax and growth” suggests that corporate taxes are most harmful for growth, followed by personal income taxes, and then consumption taxes. Finally, recurrent taxes on immovable property seem to be the least harmful for growth. This is why we would have not recommended abolishing the Swedish housing tax (as you did last year).


The way taxation is designed within each of the broad tax categories also matters, beyond the distribution between the categories. For example, providing reduced rates of corporate tax for small firms does not seem to increase their contribution to the economy.

These findings are explained by an important fact: Tax is increasingly relevant to the firm’s location decisions.


The removal of non-tax barriers to cross-border activities, new communication technologies, and the development of regional economic blocks have all made capital (including intangible capital), skilled professionals and consumption increasingly geographically mobile; but also increasingly sensitive to tax differentials.


The American banker who moves from New York to London, the Swedish pharmaceutical company that shifts its headquarters from Stockholm to Zurich, the IT company that centralises its intangible assets in Luxembourg, the Austrian consumer who buys software from a Singapore-based outlet, are all examples of the increased mobility of the tax base.


Although I do not believe that any of these decisions are driven just by tax considerations.  If tax were the only determinant of these location decisions, we would see a massive outflow of activities from high-tax to low-tax countries, which clearly has not been the case.


Companies look at long-term profitability in making decisions as to where to locate. And this, in turn, depends on factors like access to markets, availability of qualified labour, political stability and unit costs. Tax is one of these factors and companies will, other things being equal, prefer a low tax to a high tax jurisdiction. But as we know, other things aren’t equal. A relatively high-tax country which uses its revenues to provide a first-class infrastructure, a well-educated labour force, and a well-functioning health and pension system will be more attractive than a low-tax country which has none of these productivity enhancing features.


Ireland’s success proves this point.  Its success has less to do with its tax regime than with the fact that it has well-qualified English speaking, flexible and relatively cheap (at least until recently) labour force in a geographically convenient location.  Clearly tax helps, primarily by promoting Ireland as a business-friendly environment, but Ireland first got the fundamentals right.


Within integrated economic areas like the EU, we can expect – and this is confirmed by recent economic studies – that tax is set to become a more important factor determining where companies and individuals locate their activities.  And, of course, tax will remain one of the major factors that determine how a company structures and finances its investments.

The impact of taxes on investment decisions


Most of the debate on tax competition for investments focuses on the corporate income tax, particularly the headline rate of tax. But other taxes may also be important in influencing location decisions. VAT can also be a competitive factor. Look at how Luxemburg has used its low VAT rate –the lowest in the EU– to entice service activities to locate there. Non-profit related business taxes can also play a role.


But it is not just the tax system that counts: it’s also the way in which the system is administered.


In today’s rapidly changing environment, corporations increasingly expect tax administrations to provide predictability, certainty, consistency and to engage business in the formulation of new rules. Again, there is no reliable index, but if you asked business across Europe I think you could pretty quickly get a consensus on which countries are seen as tax-friendly and which are not.


To respond to an increasingly competitive environment many governments have decided to cut down corporate and personal income taxes. Actually, it’s been a long time since I heard a Finance Minister say he or she was going to increase these rates. And I expect that this trend will continue.


Several governments have also reviewed taxes on capital. Some countries, including Sweden, have abolished or reduced capital gain taxes; the number of countries with net wealth taxes has fallen significantly (to less than eight); estate and inheritance taxes have either been eliminated or thresholds raised, property tax burden on business lightened.

Taxes on labour: a hand-break for growth?


Now what about taxes on labour? We believe that, after corporate taxes, taxes on labour are the most harmful for economic growth. Letting people keep more of the value they create encourages labour supply, skill formation and entrepreneurship.


Here in Sweden, making the labour market inclusive and getting more people into employment is the government’s key priority – and something the OECD endorses. Starting from a situation where one in five adults is out of work receiving income support, it is important to combat labour market exclusion; not just for economic reasons, but also for human and social reasons. The number of persons excluded from the labour market has still not fully come down to where it was before the crisis of the early 1990s.


As you know, Sweden last year joined the group of countries, such as the US and the UK, which use in-work tax credits to boost employment. As in other countries, this will certainly draw more people into employment. However, the compressed Swedish wage distribution makes the in-work tax credit extremely expensive: in fact, the cost of the in-work tax credit as it applies now in 2008 is as large as the total revenues from the central government personal income tax: 1½ per cent of GDP.


Looking ahead, reductions in the highest marginal rates should have priority: the combination of social contributions, income and consumption taxes, drives the effective marginal tax wedge above 70%. This is quite extreme by international standards! Cutting this very high rate would make a large contribution to average hours worked and the incentives to acquire skills and human capital. Moreover, it would enhance the reward for entrepreneurship and make Sweden a more attractive location for highly skilled and internationally mobile professionals.


Currently a third of the full-time employed are facing a tax wedge above 70%, but the majority don’t pay very much. This reflects the narrow Swedish earnings distribution. Raising the threshold from where the state income tax is paid by, for example to 100 000 Swedish crowns, would halve the number of taxpayers facing the above-70% marginal wedge, while forgoing only a quarter of the state income tax revenue. In addition to this, there would be dynamic gains via hours worked, skill formation etc.

An international framework for tax and growth


To get the full benefits of tax competition, we need internationally accepted rules on what is fair and what is unfair competition. And these rules have to apply to as many countries as possible (Sweden is not competing just with Denmark and Germany, but also with Korea, Mexico, China and India). Both the OECD and the EU have adopted a positive approach to tax competition, realizing that tax competition is an economic reality of the 21st century.


There is one form of tax competition that is neither fair nor growth enhancing: that is competition which is based upon secrecy and non co-operation. Some countries use excessively strict bank secrecy rules as a way to encourage residents of other countries to evade tax in their country of residence. This is not acceptable in today’s highly integrated financial markets. The OECD has developed international rules to counter tax abuses but also to improve corporate governance and combat corruption.


Some economists have argued that tax havens are good for growth because they enable corporations to lower their effective tax rates and that they enable high tax countries to maintain the competitiveness of their MNEs.  But this is like saying that we want to stimulate growth at any price, including encouraging illegal acts. If governments are concerned that their tax systems are putting their companies at a competitive disadvantage, then the correct response – as Sweden has done – is to redesign their tax systems, rather than to turn a blind eye to non-compliance.

The political economy of tax reform


Let me conclude with some advice that could help Sweden advance in the political economy of its tax reform.


When collecting about half of the national income as taxes, like Sweden does, a number of distortions tend to arise where taxes hold businesses and people back from doing what would be socially good. To some extent, these distortions are worth accepting, if the revenues are financing public expenditures that are deemed to be socially good. Simply cutting taxes without being realistic about how to reform public spending in socially acceptable ways doesn’t work, as it would leave a fiscal deficit for the future. And definitely, going back and forth with tax cuts now followed by tax hikes later is not good for business.


That is why it is so vital to focus on reducing taxes at those points where the distortions are the largest. It is easier said than done because. Because tax policy easily gets captured by narrow special interests lobbying for exemptions and caveats, which end up complicating the system. Some wide interest groups, like home owners, manage to secure tax advantages due to their heavy weight in the electorate.


What many in this world admire about the Nordic countries is their levels of social trust and cohesion. What Sweden needs to do is to use this social capital to overcome specific interests and focus on tax reforms that enhance economic growth. In the end, this is what allows you to sustain the famous Nordic welfare state.


Any significant tax reform requires a confluence of two factors that do not often come together: a broad-based popular sentiment that “things have to change”, and a leadership that is able to translate this broad dissatisfaction into a concrete programme that crystallizes the issues and points to their solution. The Swedish government is conscious that reform can have political costs and is still moving forward. This reflects in a way a long term project and for that it should be given recognition.


The OECD is ready to help Sweden to turn this tax reform into the most effective vehicle of economic growth and social progress for the benefit of the Swedish people.


Thank you very much.

 

 

 

Countries list

  • Afghanistan
  • Albania
  • Algeria
  • Andorra
  • Angola
  • Anguilla
  • Antigua and Barbuda
  • Argentina
  • Armenia
  • Aruba
  • Australia
  • Austria
  • Azerbaijan
  • Bahamas
  • Bahrain
  • Bangladesh
  • Barbados
  • Belarus
  • Belgium
  • Belize
  • Benin
  • Bermuda
  • Bhutan
  • Bolivia
  • Bosnia and Herzegovina
  • Botswana
  • Brazil
  • Brunei Darussalam
  • Bulgaria
  • Burkina Faso
  • Burundi
  • Cambodia
  • Cameroon
  • Canada
  • Cape Verde
  • Cayman Islands
  • Central African Republic
  • Chad
  • Chile
  • China (People’s Republic of)
  • Chinese Taipei
  • Colombia
  • Comoros
  • Congo
  • Cook Islands
  • Costa Rica
  • Croatia
  • Cuba
  • Cyprus
  • Czech Republic
  • Côte d'Ivoire
  • Democratic People's Republic of Korea
  • Democratic Republic of the Congo
  • Denmark
  • Djibouti
  • Dominica
  • Dominican Republic
  • Ecuador
  • Egypt
  • El Salvador
  • Equatorial Guinea
  • Eritrea
  • Estonia
  • Ethiopia
  • European Union
  • Faeroe Islands
  • Fiji
  • Finland
  • Former Yugoslav Republic of Macedonia (FYROM)
  • France
  • French Guiana
  • Gabon
  • Gambia
  • Georgia
  • Germany
  • Ghana
  • Gibraltar
  • Greece
  • Greenland
  • Grenada
  • Guatemala
  • Guernsey
  • Guinea
  • Guinea-Bissau
  • Guyana
  • Haiti
  • Honduras
  • Hong Kong, China
  • Hungary
  • Iceland
  • India
  • Indonesia
  • Iraq
  • Ireland
  • Islamic Republic of Iran
  • Isle of Man
  • Israel
  • Italy
  • Jamaica
  • Japan
  • Jersey
  • Jordan
  • Kazakhstan
  • Kenya
  • Kiribati
  • Korea
  • Kuwait
  • Kyrgyzstan
  • Lao People's Democratic Republic
  • Latvia
  • Lebanon
  • Lesotho
  • Liberia
  • Libya
  • Liechtenstein
  • Lithuania
  • Luxembourg
  • Macao (China)
  • Madagascar
  • Malawi
  • Malaysia
  • Maldives
  • Mali
  • Malta
  • Marshall Islands
  • Mauritania
  • Mauritius
  • Mayotte
  • Mexico
  • Micronesia (Federated States of)
  • Moldova
  • Monaco
  • Mongolia
  • Montenegro
  • Montserrat
  • Morocco
  • Mozambique
  • Myanmar
  • Namibia
  • Nauru
  • Nepal
  • Netherlands
  • Netherlands Antilles
  • New Zealand
  • Nicaragua
  • Niger
  • Nigeria
  • Niue
  • Norway
  • Oman
  • Pakistan
  • Palau
  • Palestinian Administered Areas
  • Panama
  • Papua New Guinea
  • Paraguay
  • Peru
  • Philippines
  • Poland
  • Portugal
  • Puerto Rico
  • Qatar
  • Romania
  • Russian Federation
  • Rwanda
  • Saint Helena
  • Saint Kitts and Nevis
  • Saint Lucia
  • Saint Vincent and the Grenadines
  • Samoa
  • San Marino
  • Sao Tome and Principe
  • Saudi Arabia
  • Senegal
  • Serbia
  • Serbia and Montenegro (pre-June 2006)
  • Seychelles
  • Sierra Leone
  • Singapore
  • Slovak Republic
  • Slovenia
  • Solomon Islands
  • Somalia
  • South Africa
  • South Sudan
  • Spain
  • Sri Lanka
  • Sudan
  • Suriname
  • Swaziland
  • Sweden
  • Switzerland
  • Syrian Arab Republic
  • Tajikistan
  • Tanzania
  • Thailand
  • Timor-Leste
  • Togo
  • Tokelau
  • Tonga
  • Trinidad and Tobago
  • Tunisia
  • Turkey
  • Turkmenistan
  • Turks and Caicos Islands
  • Tuvalu
  • Uganda
  • Ukraine
  • United Arab Emirates
  • United Kingdom
  • United States
  • United States Virgin Islands
  • Uruguay
  • Uzbekistan
  • Vanuatu
  • Venezuela
  • Vietnam
  • Virgin Islands (UK)
  • Wallis and Futuna Islands
  • Western Sahara
  • Yemen
  • Zambia
  • Zimbabwe