The Nordic Model - Embracing globalization and sharing risks

A rise in tax rates will
increase the efficiency
loss – more than proportionally
International tax competition
will magnify
the distortionary effects
of high tax rates
One important reason is that tax distortions cannot be assessed
independently of how the public money is spent. The money
may contribute to expand incomes if it is spent on, say, education
or day-care facilities, whereas this effect is smaller or absent if the
money is spent on, say, cultural activities (even though there can
be other good reasons to spend money on culture). Another issue
is the role of institutions. Labour markets are or have been highly
centralized and therefore key decisions on wages and working hours
have not been taken by individuals but rather by central actors,
who may well have taken into account that the price of leisure
is higher to society than it is to the individual. (We will return to
this issue in the next chapter.) Moreover, many policies have been
designed so as to support the “work line”; various elements of the
social safety net are conditional on the individual actively looking
for a job, and workfare policies have the same aim.
As noted above, the costs or efficiency losses of taxes are
an increasing function of their level. This has one very important
implication. Even though it has been possible in the past to
counteract some of the distortionary effects of taxation, it will be
increasingly difficult to do so if the tax rates are raised. Hence, one
cannot assess the effects of increasing taxes by simple looking at
how taxes in the past have affected economic activity. Moreover,
labour markets are also becoming more decentralized, and hence
one of the important counteracting forces to the distortionary
effects of taxes is becoming weaker.
Last but not least, globalization may also affect both the scope
for taxation and the distortions. Tax-base mobility is increasing and
may erode certain tax bases. (A partial response to this is to shift
taxes to other less mobile tax bases, like real estate.) Second, even
if people are not becoming more mobile, it is a fact that production
and thus employment may more easily relocate than before. This
implies that the negative consequences for economic activity of a
high tax burden on labour are going to increase.
Needless to say, it is difficult to assess with any precision the
consequences of higher taxes. However, the distortionary effects
of taxes are almost certainly larger, the higher the tax rate. It is
becoming increasingly difficult to counteract these distortions
via labour market policies and centralized wage bargaining. And
Welfare services: rising costs and increasing demand · 97