Marginal tax rates of high income earners — Interview with Jacob Lundberg
Jacob Lundberg // 23 March 2017
Being a commonly significant factor in workers’ decisions on hours and promotions, a country’s marginal tax rate indicates more than the mere proportion of payment on the last euro earned. It indicates the incentives to work by its wedging effect between private and social returns to economic activity.
In a new EPICENTER briefing, Jacob Lundberg and Alexander Fritz Englund compare effective marginal tax rates on top incomes in 31 developed countries. With marginal tax rates between 75% (Sweden) and 36% (Slovakia), Lundberg and Englund conclude that marginal effective tax is particularly high in countries with high payroll taxes. Further, Nordic countries with high consumption taxes also tend to have high marginal effective taxes. On the other hand, these rates are rather low in Eastern European countries like Poland, the Czech Republic, and Slovakia.
To our privilege, co-author Jacob Lundberg has provided more insight on surprises, implications, and conclusions in the briefing.
EPICENTER: The briefing makes a strong case against high marginal tax rates, but are there more specific suggestions regarding low marginal tax rates? Could there be an optimal rate to both encourage workers and generate tax revenue?
Jacob Lundberg: The obvious policy recommendation is to reduce top marginal income tax rates. Often this can be done without large fiscal consequences as many European countries have a relatively small number of high-income earners. There’s no lack of precedent – for example the many Eastern European countries that have introduced flat taxes or Denmark, which cut the top income tax rate from 59 to 52 percent in 2010. Other policy options are to increase bracket thresholds so that fewer are hit by high marginal tax rates, or to reduce social contributions for high incomes, where the connection with social benefits is weak or nonexistent.
Evidence suggests that some European countries are on the wrong side of the Laffer curve for high incomes and thus would gain tax revenue by lowering tax rates. Even when this is not the case, there is a strong argument for lowering top marginal tax rates in order to encourage entrepreneurship and human capital accumulation.
E: The report argues that the marginal tax rate can also be labelled as a “tax wedge.” Is it possible to explain that term for a layman: why is it a wedge, and what does it cause?
J.L.: The tax system drives a wedge between what you produce and what you receive after taxes. In order to get incentives right we want everyone participating in the economy to get back about as much as they are contributing to the economy. If the taxman takes a big chunk of what you have produced, you might choose to take time off instead.
E: In general terms Sweden is considered to be a country where tax on the biggest earners is high. Was it a surprise to see Sweden top the list when the study was compiled, or what you would have presumed to be the case?
– It’s well known that Sweden has the highest marginal tax rate – 60 percent – when considering the income tax only. We were a bit surprised to note that a lot of countries have no or low payroll taxes for high incomes, while Sweden has had a high uniform payroll tax rate since 1983. Sweden’s payroll tax rate of 31 percent is a big part of the explanation why the effective marginal tax rate is as high as 75 percent, the highest of all countries.
– It is argued in the study that taxation is costly to society (and thus, negative), but Swedish society is founded on the belief that having taxes of the lower levels in other countries should be sacrificed for the greater collective good of better public services. Is the study’s position that Sweden should change its outlook on tax and that the current approach is misguided?
– It’s actually possible to finance a Nordic-type welfare state with flat taxes only. The reform that we propose – removing the central government income tax paid by the richest tenth of Swedes – would lower taxation of high incomes to the average of the 31 countries we have looked at, but only cut the tax-to-GDP ratio by a percentage point or so. In addition, this reform would most likely be entirely self-financing as taxpayers respond to lower marginal tax rates by increasing their incomes.
– There is also a phrase in the study which says that with “high marginal tax rates…the tax system punishes specialization, which is the foundation of a modern economy.” By extension then, does the study argue that Sweden’s economy is not modern?
– Sweden’s economy is advanced, much thanks to good policies on areas other than taxation and the labour market – for example, openness to trade and a good business climate. However, there is a lot of untapped potential. For example, as it is now, many doctors and lawyers mow their own lawns. It would be better if they hired low-skill workers to do this and spent more time at work instead.
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