Comparing American and Swedish Tax Systems

The last few days I have had several different people linking me this text by Tom Heberlein about how the Swedish Tax System is better than the American dito. The text is pretty anecdotal and he draws on examples from his life rather than academic rigour, but he nevertheless makes fairly valid points.

I think, however, Heberlein like so many of us expats that have fallen in love with another country, tend to over-stress the positive side of our new home while not noticing the negatives. I certainly do in regards to Australia. That makes his comparison overlook a couple of important things, and so I'd like to show where he goes wrong - and, of course,  where he goes right. Aptly so, since I'm working on my kindness and on embracing my enemies.

First a few caveats. Don't get me wrong, I don't believe taxation serve a particularly useful function in society, neither on economic nor moral grounds. Secondly, I think Heberlein's biggest mistake is the same most people in politics make; that there are two (or more) mainstream options to choose from, within which politics has to exist - there can't be anything outside of those narrow constraints. In other words, there are many other ways of organising societies and taxation systems than a Swedish and an American system, but a lot of people (Heberlein included) tend to assume that two or three existing mainstream systems are the only ones on offer.

Three of Heberlein's points (#1: Not so high taxes, #2 Pre-filled Tax Forms, #5 Cash over deductions) are fairly uncontroversial claims. Swedish tax systems are not the confiscatory and seriously harmful schemes they were in the 70s. On the contrary, Sweden's has moved in direction of lower taxes, easier business environment and a freer economy for two decades, whereas the U.S. has done the exact opposite. Evidently, efficient Tax Authorities means that the deadweight-losses imposed by taxation and the rent-seeking behaviour that comes from the process of gathering it, is kept to a minimum. Not to mention, as Heberlein accurately points out, the effort involved in simply filing your tax return. From what I understand, the American version is a nightmare, whereas Swedish Tax files are straight-forward and super-simple for most people.

This obviously allows the Swedish government to levy higher taxes with less harmful impact than would have been the case if its American Uncle tried to take 43% of the economy in taxes. And so it can indulge in spending it considers important, such as absurdly subsidising any and every form of university education. The last argument (#5 "Cash over Deductions") is a case in point; swift, easy, transparant as opposed to the many U.S. deductions that requires administration (both from individual and from IRS) to a much larger extent than the Swedish system.

Where Heberlein goes wrong is however more interesting. Scandinavian countries are among the most efficient capitalist countries in the world - which is the only reason they can carry such a high burden of taxation in the first place. Sweden scores much higher than the U.S. in most components of Economic Freedom Index, pulled down only by its massive government sector.

Heberlein argues that Sweden replaced its property tax with a semi-flat "property-fee" instead - which is true, but had massive critiques due to its regressive nature; it placed a larger burden of taxation of poorer households and was essentially a "subsidy" on the massive property taxes paid by the upper-income households before the tax reform.

The biggest problem with Heberlein's claim, however, is the different ways in which countries decide to tax their citizens; he rightly points out that income taxes are only slightly higher in Sweden (he pays Swedish income tax of roughly 31% vs 22% for his American incomes). Problem is, the largest share of Swedish income taxes are payroll taxes, with magnitudes of around 30-40% of pre-tax income. Those taxes are hidden from the employee, and acts as a massive increase in labour costs - which shows up as a consistently higher rate of unemployment, especially among unskilled sections of society. Moreover, as he points out, VAT taxes are much higher in Sweden, but less noticeable since they are already included in sales prices, but nevertheless distorts the economy and makes everyone (particularly low-income earners) worse off. Together with the payroll tax, those taxes have seriously distortive effects on Swedish society. As Swedish economist Sanandaji argues:

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. (p. 50)

Sanandaji continues, and shows that the high-tax regime in Sweden damages the very reason Sweden grew wealthy in the first place: high degree of social trust and an impressive work ethic, combined with very capitalist institutions. Moreover, what Heberlein doesn't show is that your average Swedish person is likely to be poorer than your average American - in absolute, PPP-adjusted terms something like 15% poorer. For instance, if Sweden would join the U.S. as a 51st state, it would be among the poorest quarter of states, only having higher incomes than the 12 poorest states in the U.S. Blogger Daniel Mitchell concludes:

Take the example of Sweden. That country has robust school choice and a partially privatized social security system. Moreover, Nordic nations in general have lower business tax burdens and investment tax burdens than the United States. And Denmark and Sweden have both taken some modest steps to restrain government spending, so even in the realm of fiscal policy you can find some admirable developments.

In conclusion, nobody said the American tax system was optimal - far from it. And it is possible to organise taxation practices in way more efficient ways, ways that create less damage than it does in the U.S. For this, Swedish taxation is a case in point.

Having said that, it doesn't follow that the same outcomes would be observed if the U.S. tax code was rapidly shifted to a Scandinavian-style tax code, and so is emphatically not a reason to impose them (see Sanandaji). There is however quite a strong case for the U.S. to adopt some Swedish-style measures, such as protection for private property, simpler tax forms and tax filings or lower corporate taxation (22% vs American 40%-something...).