SWEDISH TAX POLICY:
RECENT TRENDS AND
FUTURE CHALLENGES
A report to
Expertgruppen för Studier i Offentlig ekonomi
by professor Peter Birch Sörensen
Presentation at ESO seminar
in Stockholm, May 31, 2010
Main themes of the report
• What were the guiding principles of Swedish tax
policy during the last twenty years?
• How big is the income loss (loss of economic
efficiency) caused by deviations from neutral
and uniform taxation?
• How could the income loss be reduced without
sacrificing the goal of equity in taxation?
Chapter 1: The Swedish tax system in
international context
Evolution since 1990:
• The total tax-to-GDP ratio has been roughly
constant in the OECD but has fallen by several
percentage points in Sweden
• The total average tax rate on labour income has
been roughly constant in the OECD but has
fallen in Sweden
Chapter 1: The Swedish tax system in
international context
• Sweden relies more heavily on the personal income tax
than the average OECD country
• Social security taxes and the VAT generate about the
same share of total revenue in Sweden as in the
average OECD country
• Excise taxes, property taxes and the corporate income
tax contribute a smaller fraction of total revenue in
Sweden than in the EU15 area
Chapter 2: The Tax Reform of the Century
• Very ambitious reform: tax shifting amounting to 6% of
GDP
• Guiding principles: neutrality and uniformity of taxation;
dual income tax to account for inflation
• Significant tax base broadening combined with large tax
rate cuts
• Corporate income tax rate almost cut in half, financed by
tax base broadening
• Uniform VAT
• Cut in marginal and average tax burden on labour,
financed in part by higher property tax
Chapter 2: The Tax Reform of the Century
• Unfortunate timing of the reform: in the
short term it exacerbated the recession of
1992-93
• In the long term, the 1991 reform has
improved economic efficiency by reducing
tax distortions to labour supply, investment
and portfolio composition
Chapter 3: Trends in Swedish tax policy
since the Tax Reform of the Century
•
•
•
•
•
Introduction of Earned Income Tax Credit
Selective cuts in social security taxes
Abolition of inheritance tax and wealth tax
More lenient taxation of closely held companies
Tax deduction for purchases of household services
Major departures from the principles of the 1991 reform:
• Reintroduction of a differentiated VAT
• Värnskatten
• Property tax reform of 2008
Chapter 4: The deadweight loss
from taxation in Sweden
• Purpose of chapter: to estimate the loss of
economic efficiency (”the marginal deadweight
loss”) caused by an increase in taxes on
•
•
•
•
labour income
savings income
business income
consumption
Measuring marginal deadweight loss
Marginal deadweight loss from tax increase (DWL) =
Additional burden on taxpayers
= "static" revenue change (R s )

additional revenue to the government
  R d
= "static" revenue change (R s ) + "dynamic" revenue change (Rd )
R s  revenue change in the absence of behavioural responses
R d  revenue change caused by behavioural responses
DWL R d
Degree of "self-financing" 

s
R
R s
Calculating the dynamic revenue effects
of a tax change
• Calculation of dynamic revenue changes requires
estimates of the elasticities of labour supply, savings and
investment plus estimates of initial effective marginal tax
rates plus national income accounts data on the size of
tax bases
• Novelty: the calculation of dynamic revenue changes
accounts for the interaction among tax bases
• Because of substantial uncertainties, the main scenarios
in the report make conservative assumptions on the size
of elasticities (sensitivity analysis is also carried out)
Degree of self-financing (DSF)
associated with a tax rate cut (%)
Cut in effective
marginal tax
rate on1
Labour income
Contribution to DSF from higher revenue
from taxes on
Labour Consumption
Business
Savings
income
income
income
18.2
4.8
0.4
0.6
Total
DSF
24.0
Consumption
12.1
3.2
0.3
0.4
16.0
Business
income
Savings
income
18.2
4.8
5.8
0.6
29.4
14.2
3.7
0.3
17.2
35.4
1. The numbers indicate the effect of an identical cut in the marginal tax rate for all taxpayers.
Chapter 4: The deadweight loss
from taxation in Sweden
Robust findings:
DSF (consumption tax)
< DSF (labour income tax)
< DSF (business income tax on normal return)
The estimated DSF for the savings income tax is more
uncertain, but the high value of the DSF suggests that
the principle of dual income taxation is well motivated
Chapter 5: Taxes on consumption
and pollution
Issues treated in the chapter:
• optimal design of the VAT
• optimal design of the excise taxes (”sin” taxes
and ”green” taxes)
The chapter offers an estimate of the deadweight
loss from the non-uniform VAT
How should the VAT be designed?
Lessons from the theory of optimal taxation:
• A differentiated VAT is an inefficient way of
redistributing income compared to a progressive
income tax and targeted income transfers
• A differentiated VAT with relatively high (low)
indirect taxes on goods that are consumed
jointly with leisure (work) can offset the tendency
for the income tax to discourage labour supply
Beyond optimal tax theory:
The case for a uniform VAT
• We lack the information needed to implement the optimal
differentiated VAT rate structure
• Optimal taxation would require frequent tax rate changes
due to changes in tastes and technology
• A uniform VAT is easier to administrate and less
susceptible to fraud
• A differentiated VAT may distort product innovation
• A differentiated VAT violates horizontal equity
• A differentiated VAT invites lobbyism
Estimated efficiency gain from a move to a uniform VAT ≈
9.4 billion SEK = 0.64% of private consumption (2008 level)
Chapter 6: The taxation of labour income
Issues treated in the chapter:
• Effective marginal tax rates on labour income in
Sweden
• Lessons for Sweden from the theory of optimal
labour income taxation
• The degree of self-financing associated with
alternative ways of cutting labour income taxes
in Sweden
Would an abolition of the värnskatt
pay for itself?
Top marginal tax rate (including social security tax) in
percent of the employer’s gross labour cost:
• Excluding consumption taxes: 66.9%
• Including consumption taxes: 75.1%
Estimated DSF for a cut in the värnskatt:
• Elasticity of taxable income = 0.1 → DSF = 1.23
• Elasticity of taxable income = 0.2 → DSF = 1.85
The taxation of labour income:
Summary and policy proposals
• An abolition of the värnskatt would almost certainly pay
for itself
• The DSF associated with an increase in the progressivity
threshold is also likely to be quite high
• The introduction of the Earned Income Tax Credit
(jobbskatteavdraget) was well motivated, but the
interaction of the EITC with the standard deduction
(grundavdrag) is very complex. A simplification could be
achieved by making the standard deduction independent
of income
Chapter 7: The taxation of income
from saving and investment
Main distortions in the taxation of savings income: the
current tax system favours
• retirement savings
• savings in owner-occupied residential property
• savings in assets with a high capital gains component
The current system of business income taxation implies tax
distortions to
• the overall level of investment
• the choice of organizational form
• the choice between debt and equity
• the choice between long-lived and short-lived assets
The taxation of savings income
• Estimated efficiency loss from current tax
subsidy to retirement savings ≈ 3.4 billion SEK
(2008 level)
• Suggested solution: a uniform 25% capital
income tax rate on all capital income, including
the imputed return to retirement savings
The taxation of residential property
• The combination of a low property tax rate with
deductibility of mortgage interest payments favours
owner-occupied over rental housing and housing
consumption over other consumption. Resulting
efficiency loss ≈ 7.4 billion SEK (2008 level)
• Suggested solution: replace the current municipal
property tax, the current tax on realized capital gains on
owner-occupied residential property and the stamp
duties on transactions in such property by a flat property
tax rate of 1% on a realistic assessment of the market
value of the property (apply the same tax rules to rental
property).
The taxation of capital gains
• Problems with current tax regime: the deferral of tax until
the capital gain is realized implies a tax subsidy and
creates lock-in effects. At the same time imperfect loss
offsets may hamper risk-taking
• Suggested solution: tax all capital gains on listed
shares as they accrue (with full loss offset) and tax the
unrealized gains on unlisted shares resulting from the
retention of corporate profits on a current basis, with an
obligation for the company to pay the tax on the
shareholder’s behalf.
The taxation of corporate income
• The current corporation tax falls on the normal
return as well as on ”pure” profits
• In a small open economy, it is inoptimal to levy a
source-based tax on the normal return (labour
bears all of the burden)
Solution:
• Introduce an Allowance for Corporate Equity
(ACE): Allow companies to deduct an imputed
normal rate of interest on their equity (neutral
treatment of debt and equity)
The taxation of closely held companies
• Problem with current rules: non-neutral tax treatment of
proprietors and active shareholders in closely held
companies
Suggested solution:
• Reform the 3:12 rules to secure that any income up to a
cap given by the normal return to business equity (the
ACE) is taxed only once at the capital income tax rate,
whether it is realized or not. Income above the normal
return should be taxed as labour income when it is
realized in the form of a dividend or a capital gain, with a
credit for the corporation tax already paid
Implication: Equal tax treatment of proprietors and active
shareholders
The taxation of business income
Problem: the current asymmetric tax treatment of profits
and losses hamper risk-taking (”Heads, I win; Tails, you
lose”)
Suggested solution:
• Liberalize the rules for offset of business losses, e.g., by
allowing business losses to offset other tax liabilities for
the same year such as VAT, Pay-As-You-Earn income
tax and fringe benefits tax
Further proposal: reduce the corporate income tax rate
from the current 26.3% to 25%, corresponding to the
proposed capital income tax rate
Effects of the main reform proposals on public revenue
and economic efficiency (billion SEK, 2008 level)
Reform element
Move to uniform
VAT
Abolition of
värnskatt
Move to uniform
25% savings
income tax
Static
revenue
effect
Dynamic revenue effects (efficiency effects)
Effect of move to Effect of change in
uniform taxation level of taxation
Total dynamic
revenue effect
Total net
effect on
revenue
0
+9.4
0
+9.4
+9.4
-3.3
0
+3.1 to +6.2
+3.1 to +6.2
-0.2 to +2.9
+3.0
+3.4
-0.8 to -1.1
+2.3 to +2.6
+5.3 to +5.6
+13.8
+7.4
-1.1 to -2.2
+5.2 to +6.3
+19.0 to +20.1
-9.0
+7.2
+1.6 to +2.7
+8.8 to +9.9
-0.2 to +0.9
Cut in corporate
income tax rate to
25%
-4.0
0
+0.7 to +1.2
+0.7 to +1.2
-3.3 to -2.8
Total effect
+0.5
+27.4
+3.5 to +6.8
Property tax reform
Allowance for
Corporate Equity
+30.9 to +34.2 +31.4 to +34.7
Do the efficiency gains come at the
expense of equity?
• The abolition of the värnskatt will benefit the top income
earners, but the analysis in Chapter 8 of the report
shows that the property tax reform and the reform of
capital income taxation will have a progressive
distributional impact
• In the long run, the gain from the ACE will accrue to
workers in proportion to their earnings
• In the long run, a broad-based tax system with a low
loss of economic efficiency is the best safeguard of the
welfare state arrangements that ensure an equitable
distribtution of income
Supplementary slides
Calculating the base for ACE
Equity base in previous year
+ taxable profits in previous year (gross of the ACE)
+ exempt dividends received
+ net new equity issues
- tax payable on taxable profits in previous year
- dividends paid
- net new acquisitions of shares in other
companies
- net new equity provided to foreign branches
= Equity base for the current year
Neutrality of the ACE
i  rate of interest = imputed rate of return
  rate of depreciation for tax purposes
Present value of total allowances triggered by one unit of investment:
i 
 1: Equivalent to full expensing
i 
Note: the present value of allowances is independent of the rate of
depreciation for tax purposes  no distortion from accelerated
depreciation. Any mismeasurement of profit is offset by a corresponding
change in future ACE allowances
Setting the imputed rate of return
under the ACE
• Full neutrality requires that the imputed return be
equal to the shareholders’ discount rate
• With full loss offsets, the tax saving from the
ACE is a risk-free cash flow, so the imputed rate
of return should then be the risk-free interest
rate
• With imperfect loss offsets, rough neutrality
could be achieved by setting the imputed return
equal to the average corporate bond rate
• Neutrality could be improved by allowing
companies to offset tax losses against other
taxes (e.g. VAT, pay-as-you-go income tax)
Taxing closely held corporations
(fåmansföretag)
• Dividends and capital gains up to the level of the ACE
allowance should be taxed as capital income
• Retained profits up to the level of the ACE should be
taxed as capital gains at the shareholder level; with a
corresponding step-up of the basis value of shares
• Dividends and realized capital gains above the ACE
should be ’grossed up’ and taxed as labour income, with
a credit for the underlying corporation tax
• The ’normal returns’ from closely held companies should
be taxed at the standard capital income tax rate at the
shareholder level
• The wage-based allowance should be abolished
Implication: (roughly) identical tax treatment of
proprietorships and closely held corporations
The problem with the wage-based
allowance for closely held companies
Distortion of input choice: Penalty on capital that substitutes for
labour; subsidy to capital which is complementary to labour
METR on investment financed by
New equity
Retained earnings
Debt
-20.9
53.0
30.0
Marginal ratio of employee wage
bill to capital stock: 0
9.3
53.0
30.0
Marginal ratio of employee wage
bill to capital stock: -0.05
21.3
56.4
37.4
Marginal ratio of employee wage
bill to capital stock: +0.05
-7.0
48.9
20.7
No wage-based allowance
Source: Own calculations, based on 2007 tax rules
The taxation of capital gains on shares
in widely held corporations
• Shares in listed corporations: taxation of gains upon
accrual (mark-to-market)
Shares in widely held unlisted corporations:
• Step up the basis of shares each year by the minimum of
the company’s retained profit and its ACE allowance and
impose standard capital income tax on the increase in
basis value
• If a share is sold at a price exceeding the stepped-up
basis value, the additional gain is taxed as capital
income at the standard rate
• If a share is sold at a price below the stepped-up basis
value, the loss is deductible against other capital income
(or entitles the taxpayer to a tax credit against the tax on
labour income)
Advantages of capital gains tax regime
for unlisted shares
• No valuation problem: capital gains tax liability is
based on the company’s taxable retained profits
• No liquidity problem: tax is only liable in so far as
the company earns positive taxable profits. The
company can pay the flat tax on behalf of
resident individual shareholders
• Taxation of additional realized gains ensures
taxation of gains stemming from higher expected
future earnings and loss offset protects against
overtaxation
Chapter 4: The deadweight loss
from taxation in Sweden
• Marginal deadweight loss from a tax increase = the
amount taxpayers would be willing to pay to avoid the
extra tax – the net revenue gain
• The amount taxpayers would be willing to pay to avoid
the extra tax = static revenue gain
• Net revenue gain = static revenue gain – dynamic
revenue loss
Hence:
• Marginal deadweight loss from a tax increase = dynamic
revenue loss
Chapter 4: The deadweight loss
from taxation in Sweden
• Note: dynamic revenue loss from tax increase =
dynamic revenue gain from tax cut. Hence
Marginal deadweight loss from tax increase
Static revenue gain from tax increase

Dynamic revenue loss from tax increase
Static revenue gain from tax increase

Dynamic revenue gain from tax cut
Static revenue loss from tax cut
 Degree of self-financing (DSF )