All Commentary
Monday, October 1, 2007

Are High Taxes the Basis of Freedom and Prosperity?

High Tax Rates in Nordic Countries Stifle Economic Development and Personal Freedom

In the November 2006 Scientific American, Jeffrey Sachs, economic consultant to governments and the UN, argues (yet again) for higher U.S. taxes and more government officials with ever-increasing powers over their subjects. These perennial and inevitable conclusions are hung (here) on a Nordic peg.

According to Sachs, F. A. Hayek, “the Austrian-born free-market economist, . . . suggested that high taxation would be a ‘road to serfdom,’ a threat to freedom itself.” There is now, however, “a rich empirical record to judge [this] scientifically.” “The evidence” (he says) comes from comparing the Nordic social democracies (Denmark, Norway, Sweden, Finland) with the Anglophone developed countries (Canada, the United States, Britain, Ireland, Australia, New Zealand).

The Nordics (he says) have met the challenge of “sustainable development”: they have reconciled “the . . . power of markets” with the reassurance and protection of (governmental) “social insurance.” They “combine . . . respect for market forces with . . . anti-poverty programs.” And “[t]he results . . . are astoundingly good” for households with the lowest incomes.

Thus Nordic income per head of working-age population is 4.5 percent higher than in the lower-taxed Anglophone countries. The Nordic unemployment rate is only slightly higher than the Anglophone rate (6.3 percent versus 5.2 percent). The Nordics have far higher budget surpluses as a proportion of GDP. In short, the Nordic territories “outperform” the Anglophones on average (in terms of these measures).

“Despite [their] high taxation,” the Nordic countries are highly dynamic: “they spend lavishly on higher education” and on R&D. While only 1.8 percent of Anglophone GDP goes to R&D, the Nordics spend 3.0 percent—two-thirds as much again. Sweden has the world’s highest ratio: “nearly 4 percent of GDP.” All, “especially Sweden and Finland,” have gained “global competitiveness” through the information-technology and communications revolution. In addition, the Nordics have “relatively low” taxes on capital.

In the Nordic areas 27 percent of GDP (on average) goes to “social purposes” via government; the Anglophone figure is only 17 percent. Nordic labor policies direct the “low-skilled” to “key quality-of-life areas such as child care, health, and support for the elderly and disabled.” The Nordic “poverty rate” is 5.6 percent—less than half that of the Anglophones, which is 12.6 percent.

Thus (according to Sachs) high taxes and high “social spending” have not “crippled prosperity” in the Nordic territories: “Von Hayek was wrong. In strong . . . democracies, a generous social-welfare state [is] a road to . . . fairness, . . . equality and international competitiveness,” not serfdom.

Now, Sachs, of course, speaks for U.S. government officials and their academic advisers. All have a vested interest in raising taxes and government spending and in increasing the numbers of government officials, evermore. Let us, however, “scientifically” take another look at the “rich empirical record.”

(What we’ll find: Scandinavia, especially Sweden, is an official’s dream come true. On average, over half of people’s income is confiscated. It is Scandinavia’s long-established integration into the growing international economy that has in fact continued to supply Scandinavians with their incomes, which officials then tax away.)

1. Between 1960 and 1990: Among OECD (Organization for Economic Cooperation and Development) countries, those with the largest government sectors (spending in excess of 60 percent of GDP) had the lowest growth rates. Those with the smallest proportion of government spending (less than 25 percent of GDP) had the highest growth rates—more than four times faster.

Between 1990 and 2005: the average overall tax burden came to 61 percent in Sweden, 58 percent in Denmark, and 55 percent in Finland.

2a. Between 1970 and 2003, in OECD rankings of economies: Denmark declined from third to seventh place; Sweden Finland rose from 17th place in 1970 to ninth in 1989, then fell back to 15th in 2003. fell from fifth to 14th.

2b. Over the same period (1970–2003) Ireland shot up from 22nd to fourth. In 1989 Irish taxes and government spending equaled 53 percent of its GDP. In 2006 this had fallen to 35 percent.

2c. In 2004: Irish productivity per working hour was nearly 26 percent higher than in Finland, just over 29 percent greater than in Sweden, and a whopping 43.2 percent above the Danes.

3. During 1995–2004: Compared with Sweden, the lowest incomes rose more than six times faster in Britain and more than eight times faster in Ireland. In 2004, 20 percent of Swedish households fell below the official “poverty line,” compared with around 18 percent in Britain and just under 15 percent in Ireland. In short, those with the very lowest incomes improved their position much, much more in lower-taxed Britain and Ireland than in higher-tax Sweden.

Over the same period, when the rise in the lowest incomes is compared with the average increase: Britain did 2.5 times better than Sweden, while Ireland was 2.35 times better. In other words, the lowest incomes came far, far closer to the average in low-tax Britain and Ireland than in high-tax Sweden.

4. Between 1981 and 2003: private-sector employment rose 56 percent in low-tax Ireland. There was a 12 percent rise in Denmark—in very low-productivity “employment” (see above, 2c.) But in high-tax Sweden and Finland, no new private-sector jobs were created. In other words, the government took the entire increase in the labor force over some 22 years. With the same number of people employed in the private sector and low growth rates overall, real incomes just about stagnated. From these stagnant real incomes, people had to pay ever-increasing taxes and support ever-increasing government officials and ever-increasing government spending.

5. According to a working paper prepared for the European Central Bank in 2003: Sweden, Finland, and Denmark have the most inefficient government sectors of all OECD countries in terms of the use of inputs. In Sweden the same level of output could be obtained for only 57 percent of the input. For Denmark this figure is 61 percent, for Finland, 62 percent. In other words, some 43 percent of the labor and other resources “used” in the Swedish government sector are—in effect—idle. The proportion effectively idle in the Danish government sector is 39 percent, and 38 percent in Finland.

In Sweden doctors saw an average of nine patients a day in 1975. In 2005 they saw four—or less than half as many. More than half of all patients have to wait 12 weeks to be examined and then at least as long again for treatment. In short, for most Swedish patients, from just making the appointment to seeing the doctor to actually getting treated, there’s a gap of some 24 weeks at least. (You’d better not fall sick in Sweden.)

6. Even in the later 1980s, Swedish doctors worked only some 57 percent of the hours that American doctors worked. And as early as the 1970s, doctors, dentists, lawyers, and so on worked only a few months each year—to avoid astronomical tax rates. By the 1970s retailers asked buyers: “With or without receipt?” while house painters, mechanics, plumbers, and more all operated largely in a cash economy. Books were already being published on avoiding tax for those on average incomes.

7a. The actual unemployment rate is disguised by classifying large numbers under other heads: (a) make-work in the government sector, (b) “early retirement,” (c) long-term “sick,” and (d) university “students” who are in fact avoiding open unemployment.

7b. The so-called “unemployment trap” is extremely high in Denmark and Sweden. When necessary expenses like transport, food, and so on are included, the lowest take-home pay is lower than the government payments received.

8a. All large Swedish companies, save one, were established in the late nineteenth century or in the late 1920s. Business taxes are very low, but they overwhelmingly favor larger established companies. Unincorporated-business income is taxed as heavily as personal income, but dividends and company incomes at much lower rates. Taxes on capital gains, however, are the highest in the world in Denmark and Finland.

8b. Labor mobility is low, which reduces productivity. People are stuck in unsuitable jobs. Labor input is also far less in practice: Some one-fifth of the workforce is absent, on average—double the proportion in the 1970s. In 1988 Swedes took an average of 26 days of sick-leave; this was still true in 2002. In addition, there are numerous other grounds for people to be absent with pay.

“One Size Fits All”

9a. The “welfare” state must operate on the principle of “one size fits all,” of course. Thus in Sweden the state supplies all childcare, schooling, medical services, and aged care, except for a minuscule proportion. But even here, “private” suppliers are paid from taxes. Swedish legislation virtually prohibits direct private purchase of alternatives.

9b. The tax system virtually forces women with children to work, so their children can go to state child care. This goes from preschool to after-school for older children. All this raises “employment” figures: Child-minders are “employed” while mothers at home are not.

“Private” childcare is state-funded and has to charge the same low fees as the state system. “Private” child-minders are also paid by the state. Officials can ban any adult from caring for children in his or her own home. Even family arrangements have to be reported under threat of prosecution; the proposed carer—even granny—is investigated (for a criminal record) and inspected annually.

9c. Up to 1992 there were virtually no private schools in Sweden. Then “vouchers” were introduced. “Private” schools are forbidden to charge fees. Thus taxes pay for all “private” schools, and they are prevented from competing on costs.

9d. The overwhelming bulk of people have to depend on state-supplied medical services. Government entities now buy an extremely small percentage of hospital services and aged-care services from “private” suppliers. The latter’s costs are lower, of course, and the entities’ employees are happier than when they were part of the government. Only a handful of the extremely wealthy have private health insurance.

9e. “Pensions” are paid from payroll taxes. There are both flat-rate and earnings-related pensions. In the 1990s Swedish officials required all employees, additionally, to pay a minute fraction of their incomes into “private” pension funds or into a government fund in default. All such payments are channeled through a new set of officials; payers and funds have no direct contacts at all. This minuscule “change” is seen by politicians, officials, their academic advisers, journalists, and so on as earth-shaking. It has just been announced that future state pensions will be well below those being paid currently. Only a handful of the wealthy have private pension plans with an insurance company.

9f. One aspect of the Swedish “welfare state” is particularly disturbing: the power that official “social workers” have over children. Children can be removed from parents and put into foster care for a wide variety of reasons. Disputes go before special administrative tribunals, not the ordinary courts. So the whole situation is stacked in favor of the official and against the parent. Foster parents receive tax-free payments from the state. In high-tax Sweden this is a huge advantage, which results in really good incomes.

A comparison with England underlines the power officials have in Sweden. In November 2001 some 21,500 employees of municipal social services in Sweden were assigned to “individual and family care.” This amounted to one children’s social worker per 414 people of all ages. In England in 2005 there were some 33,980 staff (full-time equivalent) who dealt with children and families. This came to one such official for every 1,484 people in England. Thus, pro rata, Sweden has nearly 3.6 times as many children’s “welfare” officials as in England. Are Swedes really some four times more prone to child abuse and neglect than the English?

Not surprisingly, when it comes to children forcibly removed from their parents and put into official care, Sweden runs well ahead, pro rata. In 2003 in Sweden there was one child in official hands for every 598 Swedes. In England in 2005 there was one child in “care” for every 836 residents. Thus—pro rata—there were 40 percent more children in Sweden who were officially taken away from their parents as compared with England. Are Swedish parents really 40 percent more incompetent and feckless than English parents?

State-Dominated Housing

10. Housing in Sweden: Government officials dominate here too. Only some 39 percent of all “dwellings” are owner-occupied. Some 21 percent are privately owned rental housing; 20 percent are rental housing provided by municipally owned companies; and 17 percent are cooperatives. The latter received state subsidies from the 1920s to the late 1990s. Municipal companies receive state subsidies from general taxation and some capital from municipal taxation. They pay only a “reasonable”—that is, subsidized—interest rate on this last. Their income is made up from rent and subsidies.

Thus around 37 percent of all “dwellings” in Sweden are built from taxation, largely or entirely. Only some 60 percent of housing is provided completely through private saving.

Anyone may rent a municipal flat—there are no income limits. Municipal companies are obliged by statute to provide housing for those with lower incomes. Swedish officials regard “income segregation” as undesirable so they accept higher-income tenants too.

In municipal housing, officials ask tenants to assign values to such things as the location; their living area; its standard, general amenities; convenience to state transport; and so on. Rents are set by negotiations between the municipal company and its tenants’ association, but rents also have to include an allowance for continued maintenance and cover the expenses of the highest-cost municipal company. Private rents are higher and are negotiated between landlords’ and tenants’ associations.

Private tenants may appeal their rents to an administrative tribunal. In 90 percent of cases the tribunal simply decides whether the rent is “reasonable.” In 10 percent of disputes the private flat is compared with a local municipal flat and 5 percent is then added to the private rent.

11. Exports: Norway is one of the world’s largest oil exporters from the oilfields deep under the North Sea. An American audience cannot know this, of course, so here Sachs is silent. In 2005, 68 percent of Norwegian exports consisted of oil and natural gas.

Sweden, Finland, and Denmark are overwhelmingly integrated into the global economic order. In 2005, foreign trade—exports and imports combined—equalled 90 percent of total output in Sweden; 80 percent in Finland; and 88.5 percent in Denmark. In short, all three territories are simply sectors of the world economy and have been since the late nineteenth century.

Thus their major export goods were developed mainly in the late nineteenth century and in some cases, very much earlier.

Let us take Swedish exports for the eight months from January to August 2006. Pharmaceutical goods, chemicals, metal manufactures, industrial machinery, optical goods—all together these equaled 28 percent of the total. Swedish firms have exported these items since the late nineteenth century. Timber and its products, iron ores, other minerals, and iron and steel together came to 22 percent. Sweden has exported these goods since the late fifteenth century at least. Telecommunications came to 14.3 percent. This includes telephones, made in Sweden since the late nineteenth century. “Transport equipment”—Volvos and Saabs—equaled 13.8 percent. Sweden has exported these since the late 1920s.

Advanced telecommunications also formed only a small percentage of Finnish exports in 2006; the bulk were already in place in the late nineteenth or early twentieth century. Electrical and optical products came to 24.5 percent; wood-pulp, paper, and wood products equaled 16.2 percent; basic metals, machinery, and equipment formed 26.2 percent.

The same picture is found in Denmark in 2005. Exports of foodstuffs (butter, cheese, bacon, fish, and so on), timber, and other primary products—important since at least the late nineteenth century—came to 15.8 percent. Medicines, pharmaceuticals, and chemicals came to 13.7 percent. Machinery and instruments—many items produced in Denmark since the late nineteenth century came to 26.4 percent. Textiles, clothing, furniture, and glassware—distinctively Danish—equaled 9.7 percent, energy, 10.3 percent. (For further reading, see Lorraine Mullally and Neil O’Brien, eds., Beyond the European Social Model, 2006, available online at htttp://

12. Thus it is by participating in a growing international economy that Scandinavians produce increasing outputs. These are largely taxed away and allocated by bureaucracy. People’s continuing toil puts growing resources into government officials’ hands.

As a government adviser, Sachs must naturally see officials’ activities as the source of all goodness, including international competitiveness. The causation is rather the other way about. Successful integration into the international economic order produces output that officials then tax and remove from the people. Then officials (under the relevant authorizing legislation) use the revenues to support themselves (and their families), and to spend money or disburse it to authorized recipients under various authorized headings, namely, pensions, other incomes, schooling, medical and hospital services, aged care, child and after-school care, and so on. From the standpoint of government officials, and therefore their academic advisers, this is a delightful paradise. Naturally, therefore, Sachs describes this as “a generous social-welfare state . . . fairness. . . equality . . . international competitiveness.” This is exactly how it appears to the officials involved.

Finally, my editor asks me: “Why do the Nordics put up with it? What about the high disincentives?” One answer is: precisely the almost complete integration into the international economy. The output comes from large and small firms integrated into international production. These firms and their employees can hardly vanish into an underground economy. They must remain visible. Even if the firms, as legal entities, acquire another “nationality”—as many have done—their operations and employees remain in Scandinavia. This is because of the skills and expertise built up over the decades and centuries. Swedish steel must continue to be manufactured in Sweden. Volvos made in Portugal lack some intangible something compared with Volvos made in Sweden. Bang & Olufsen made in Bulgaria sounds dubious; made in Denmark, it does not.

Moreover, heavy taxes are levied on individuals, not businesses. The incomes are captured at the point where there can be least escape.

  • Sudha Shenoy, PhD (1943–2008) was an economist and economic historian. From 1986 to 2004, she worked as a lecturer in economics at the University of Newcastle in Australia. She was an Honorary Associate in Economic History at the School of Policy and an adjunct scholar at the Ludwig von Mises Institute. Shenoy’s father was Professor Bellikoth Raghunath Shenoy, an eminent Indian economist who studied under Friedrich Hayek at the London School of Economics.