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Sep/15/2007
A Tax System that Maximizes the Wealth of a Nation
Last week I wrote about why wealth redistribution is not a particularly good idea. Norway has a tax system that deals with the goal of maximizing welfare and evening out consumption in a much better way.
No one really has a good explanation on why social democratic Scandinavia is so rich, especially since a market liberalistic approach should generate quicker growth (according to theory). I think the answer is partly that we evade from social democracy in favor of capitalism in some critical areas, and use the socialist approach where it is better for the nation's productivity.
The Norwegian tax system has a very clear distinction between labor and capital. The tax burden of capitalists is not too different from other Western countries. Capital gains are taxed 28% and wealth is taxed ~1% annually. And there are plenty of loopholes, so that wealth tax is usually avoided by the rich. Capital gains on stock profits can be postponed if you trade using your personal company. The tax is first calculated when you take out a dividend, and even here is a few percent of your company's value tax free every year. The rules are plenty, and thus are the corresponding possibilities for lowering taxes numerous. There is to much to write here, but in general the richer you are, the lower percentage you pay because of the use of company structures and lawyers.
The labor tax is another chapter. An anecdote from my macroeconomics teacher illustrates this point:
An American professor came visiting a Norwegian colleague while he was building a sauna. The American just couldn't understand why he was making it himself. Did the Norwegian professors really get paid so badly he couldn't afford a carpenter? Well, the answer was both yes and no. No, the wages were quite good. Yes, even quite high wages could not buy much labor. The Norwegian came up with a calculation that stated this problem. After income taxes, VAT and the employer's tax, a gross $4 has to be made in order to leave the carpenter with $1.
Such taxes make it very expensive to hire for instance carpenters, lawn cutters, and to eat at restaurants or to catch a taxi. The Big Mac index states that fast food is twice as expensive in Norway as in the US. Tiny Iceland is the only more expensive country.
These prices force Norwegians to eat very little at restaurants, make their own coffee and to do most car repairs and house work themselves. This makes two implications:
1. Labor is allocated more to industries that increase the wealth of the nation (i.e. exports -> higher GDP) than in servicing each others.
2. Everyone is doing more work in addition to their paid work than with a neutral tax system.
The conclusion is that a very small minority of capitalists can invest and create wealth freely, while the majority is - through the tax system - working together for a better society with the price of worse personal consumption options.
Maybe I could say that the Norwegian tax system reduces efficiency but increases effectiveness.
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