The Nordic Model - Embracing globalization and sharing risks

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USA Ireland United Kingdom Portugal Greece Spain Luxembourg Italy Norway Netherlands Austria Finland France Sweden Denmark Germany Belgium 0 10 20 30 40 50 60 70 % Figure 5.3 Total tax wedge on labour in selected countries, 2003 Source: Ministry of Taxation, Denmark (2004) . In general, it would be worthwhile to undertake the activity, and without taxes this would take place; the employer would earn a profit of 40 and the worker would get a compensation of 100 (or they could share the surplus of 40 in some other way). But with a tax wedge of 60 per cent, the activity is either unprofitable for the employer or insufficiently rewarding for the employee (or both). The tax wedge prevents some activities from being undertaken (that would be worthwhile in the absence of taxation). The larger the tax wedge, the larger this effect is – increasing the tax wedge to, say, 65 per cent would imply that all activities yielding an output between 160 and 165 are no longer worthwhile. Actually, an increase in the tax wedge from 60 to 65 per cent harms economic activity more than an increase from 40 to 45 per cent. 4 The important message here is that taxation of income does not leave economic activity and total income unchanged – the greater the tax, the smaller the total income generated in the economy. Moreover, this effect is stronger the higher the level of taxation at the outset. This implies a difficult policy dilemma: incomes are taxed to finance the welfare state, but higher taxes make the cake shrink. Welfare services: rising costs and increasing demand · 95
One may ask why this problem arises. If we all understand that taxes are needed to finance the welfare state we support, why is there a problem? The reason is that individual tax payments have no direct effect on the services the tax payer can access. This is precisely one of the defining characteristics of the Nordic model, namely that entitlements are unrelated to tax payment. Another way of expressing this is that the effect of one individual contributing a little more or less in taxes is negligible as it is shared with 5 million other inhabitants. However, when the whole population contributes less it adds up and has significant implications for total finances. The effect of taxes on distortions therefore implies that it is not costless to levy taxes. The cost of raising one euro of public revenue is effectively larger than one euro. This is so since the cost includes both the direct effect of the euro going to the public sector, and the cost in terms of the economic activity squeezed out due to the tax. If a tax of one euro reduces incomes by, say, 20 cent, then the true cost of raising one euro to the public sector is euro 1.20; namely, the one euro paid directly and the indirect income loss of 20 cent. Available estimates are highly uncertain but suggest that the (marginal) cost of public funds for Finland and the other Nordic countries may indeed be much higher than the direct costs because of the increase in efficiency losses. 5 A problematic aspect of taxation is that it makes the price of leisure lower to individuals than it is to society. An individual considering the option of enjoying more leisure (shorter working hours, more vacation, earlier retirement) will lose the net income after all taxes, or the consumption that the net wage would buy. To society the cost of leisure is the total income lost, including the tax revenue of the public sector. Hence, the tax wedge causes a difference between the cost of leisure to the individual and to society; leisure is less costly to the individual deciding on his or her leisure than it is to the society at large. The above may seem to leave a puzzle for understanding the Nordic countries: if taxes are potentially so harmful, how come overall labour force participation is high, and how can these countries be among the richest countries in the world? There are many explanations for this (and yet the issue may not be fully understood). There is a “common pool” problem in that the individual does not factor in the consequences of his/her decision for the society at large The costs to the economy of collecting 1 euro in taxes is significantly larger than 1 euro Taxes on labour makes leisure unduly attractive relative to work How can the Nordic economies do reasonably well at these tax rates? 96 · The Nordic Model
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The Nordic Model Embracing globaliz
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ETLA B232 ISBN 978-951-628-468-5 IS
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THE AUTHORS Torben M. Andersen is P
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CONTENTS PREFACE THE AUTHORS 1 INTR
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8.5 The future of public services -
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Globalization is primarily an oppor
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ices financed by taxes, which are h
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14, respectively, out of a total of
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are the effects of technical change
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- and, particularly, their effect o
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not contesting economic growth as t
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1.6 AN EFFECTIVE WAGE BARGAINING PR
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etter be tried in individual cases
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The scheme of the social contract c
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is worthy and realistic. But the de
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supportive interaction of openness
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The financial deregulations in the
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horizontal axis). These indices are
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does can nowadays be seen, in a bro
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employment increases in the public
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are not at the top of the league, t
Page 45 and 46: ENDNOTES 1 Wikipedia refers to popu
Page 47 and 48: consider employment and productivit
Page 49 and 50: from the mid-1980s. Finland has gra
Page 51 and 52: % 7 6 5 4 3 2 1 0 IT expenditure, %
Page 53 and 54: As technological change is to a sig
Page 55 and 56: 3.3 SOCIAL EQUALITY Economic effici
Page 57 and 58: 0.9 0.8 0.7 Net Fin Den 0.9 Composi
Page 59 and 60: ANNEX: GROWTH ACCOUNTING The Nordic
Page 61 and 62: sources of GDP growth in the EU15,
Page 63 and 64: 11 These decompositions have been c
Page 65 and 66: 4.1 THE WELFARE STATE AS A SOCIAL C
Page 67 and 68: The extent, coverage and quality of
Page 69 and 70: % % 80 80 60 60 40 20 0 OECD max Fi
Page 71 and 72: % 80 Total Old age % 80 60 60 40 40
Page 73 and 74: tem is seriously affected. Today, t
Page 75 and 76: Historically, however, the share of
Page 77 and 78: More children. Since the problem is
Page 79 and 80: Actually higher growth may make the
Page 81 and 82: dependency ratio driven by the baby
Page 83 and 84: 82 · The Nordic Model
Page 85 and 86: to handle much bigger fields today,
Page 87 and 88: Table 5.1 Projections of public hea
Page 89 and 90: 5.4 AN EASY FIX - BRING SERVICES BA
Page 91 and 92: Box 5.1 Growth and the welfare stat
Page 93 and 94: it implies that the long-run defici
Page 95: The level of taxation is already hi
Page 99 and 100: globalization may contribute to bot
Page 101 and 102: able to pay to seek private solutio
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Page 105 and 106: ily policies that Nordic demographi
Page 107 and 108: absolute and relative terms than hi
Page 109 and 110: in the participation decision of th
Page 111 and 112: Table 6.2 The activity rate, aggreg
Page 113 and 114: Thus, responsible unions should res
Page 115 and 116: als take part in various unemployme
Page 117 and 118: Box 6.2 What is the Danish “flexi
Page 119 and 120: ENDNOTES 1 In his history of the ec
Page 121 and 122: particularly noteworthy in a euro a
Page 123 and 124: 7.2 COORDINATION AND DECENTRALIZATI
Page 125 and 126: also depends on the business cycle.
Page 127 and 128: ut not in any dramatic way (cf. fig
Page 129 and 130: displays higher nominal rigidity th
Page 131 and 132: model stem from an age in which the
Page 133 and 134: mostly in the years 1980-2000. For
Page 135 and 136: Table 8.1 Government expenditure by
Page 137 and 138: ure. This selection bias alone will
Page 139 and 140: that everyone gets their worth as m
Page 141 and 142: 8.3 THE CASE FOR GOVERNMENT PROVIDE
Page 143 and 144: maximizing firms tend to focus exce
Page 145 and 146: than zero based budgeting) are impe
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sectors, place at or above the medi
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The demands for objectivity limit w
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assessed case by case. The importan
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c. Vouchers Vouchers are issued by
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mechanically in the political debat
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ENDNOTES 1 The private sector inclu
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The biggest hurdle to overcome for
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ment has a higher return when spent
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REFERENCES Adema, W. and Ladaique,
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Jonung, L. and Hagberg, T. (2005):
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Is there a Nordic model? What are t
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