Taxation effects on economic growth

Nothing to see here, move along.

Has heavy taxation hurt the Danish and Swedish economies? If so, how much?

Begin with GDP per capita. America’s is higher than Denmark’s or Sweden’s. But that’s a legacy of the distant past. Growth of per capita GDP in the three countries has been virtually identical, both in the five decades since 1960 when the divergence in tax levels began and in the three decades since the 1970s (shown in the chart) when the tax difference has been most pronounced.
(Here and throughout I use 2007, the peak year of the pre-crash business cycle, as the end point. Adding the crash and its aftermath would improve the standing of Denmark and Sweden relative to the U.S.)

The standard line in economics is that they don’t care about distribution, only growth and efficiency. This would lead to the conclusion that economics is indifferent between high and low rates of taxation, because these affect only distribution, not productivity. So, to avoid this problem, the notion that incentives affect productivity was born; people want to work longer hours, but they look at the marginal return on the last extra hour worked and the high rates of tax they have to pay on it, and decide not to bother, so the economy stagnates. However, searches for empirical evidence of this effect has produced nothing, or effects so small as to be meaningless.

As is so often the case, though, ideology trumps evidence, and the idea that high tax rates hurt economic growth is frequently touted as the conventional economic wisdom. There may be good reasons to prefer higher or lower rates of taxation, but the effect on growth shouldn’t be on the list.

I think you’ve got the argument wrong. The argument that high tax rates dissuade business activity, from what I’ve understood, is not that it affects individual worker productivity, but that it affects the creation and siting of businesses as a whole, or that it reduces revenue available to businesses to hire additional workforce. I don’t think I’ve ever heard anybody argue that some guy on a line somewhere is trying to figure out what to do with his Thursday night and then opting not to work overtime because the marginal benefit once tax rates are factored in aren’t high enough.

I’ve definitely heard both arguments made, and they effectively have to be (and can be) refuted separately.

The “macro” argument is refuted with national case studies, especially in Scandinavia, and more generically, by our best guesses about the Laffer curve, the micro argument with reference to psychological research.

Yeah, honestly income taxes don’t seem to make so much difference so long as they’re evenly applied (which isn’t the same thing as them being flat, with Italy being a prime example). You figure if every worker is taxed at the appropriate rate and pays, and if every retailer is still trying to sell to them, prices (or preferences) should adjust to a rate consistent with workers being able to maintain the same consumption bundle as prior because workers are still the primary consumers in the national economy. Moving to a new country requires a lot more time, money and moxy than your average worker has, which is why changing your country of residence is usually correlated to earning at a higher rate – it’s not a causative effect, it’s that someone with the balls to pick up and move that far away probably also has the balls and skills to do well in their new home.

Corporate taxes make a bigger differences because, given a sufficiently high differential, companies of a sufficient size and organizational complexity will attempt to avoid it through regulatory arbitrage or moving plants. So doing things like setting up an HQ in the Caymans and paying tax to that regime, or setting up new plants in states that have the lowest tax and regulatory burden. Most companies won’t move out of a high tax state or nation because most companies are utterly dependent on local or regional markets and moving would destroy their ability to sell, but the ones that can will consider it given the right incentives.

So given all that, the best situation in terms of revenue generation for most nations and states is a high personal tax rate and a low corporate one. It provides new employers an incentive to move in, and captures a lot of the gain from their employees when they do.