Reforming America’s social safety net is a key pillar of the Biden economic agenda. The proposed reform has two particular features: policy ideas from Europe and financing from Americans—specifically wealthy Americans.
The president and some in his party have advocated for a system modeled on those of Scandinavian countries, which are well known for their broad social safety net and public funding for services such as universal healthcare, higher education, parental leave and child care.
However, high levels of public spending require high levels of taxation. In 2021, Denmark’s tax-to-GDP ratio was 46.5%, Norway’s was 38.6% and Sweden’s was 42.6%. By comparison, in 2021, the U.S. tax-to-GDP ratio was only 25.5%. To provide expanded public services in the U.S. that match the levels of Scandinavian countries, higher levels of taxation would be required.
Some policymakers and pundits think Americans could enjoy these services too, if only well-to-do Americans paid more taxes. Put another way, they believe a wealth tax is the Scandinavian secret to a wide social safety net. In reality, it’s not. So, what tax system do Scandinavian governments use to raise enough revenue for their generous social welfare programs? The short answer is broad-based labor and consumption taxes.
In the U.S., only 16.8% of tax revenue as a percentage of GDP comes from individual income taxes. This is marginally lower than 2020 figures for Denmark (25.2%), Norway (22.5%) and Sweden (21.5%). These American revenues come almost exclusively from personal income taxes and social security contributions.
One way to analyze the level of taxation on wage income is the so-called tax wedge, which shows the difference between an employer’s cost of having an employee and the employee’s net disposable income. In 2021, the tax wedge for a single worker with no children earning a nation’s average wage was 35.4% in Denmark, 35.9% in Norway and 42.6% in Sweden.
By comparison, the U.S. tax wedge in 2021 was 28.4%. This means that if the United States wanted to follow the Scandinavian model, it would have to increase taxes on employees’ wages and reduce their net disposable incomes.
Social security contributions are levied on wages to fund specific programs and confer an entitlement to receive a (contingent) future social benefit. Social security contributions are largely flat taxes and tend to be capped.
Both Norway and Sweden levy high social security contributions, raising revenue amounting to approximately 10% of GDP. In the U.S., social security contributions (payroll taxes) raise revenue of about 6% of GDP. Only Denmark does not impose social security contributions to fund its social programs. Instead, it uses a share of its individual income tax revenue for these programs.
Top personal income tax rates are also rather high in Scandinavian countries, except in oil-rich Norway. Denmark’s top statutory personal income tax rate is 55.9%, Sweden’s is 52.3% and Norway’s is 38.2%. The top personal income tax rate in the U.S. is higher than Norway’s top rate, at 43.7% (federal and state combined).
Tax rates are not the most important feature of the Scandinavian income tax model, however—what matters is who pays those taxes. Scandinavian countries levy top personal income tax rates on upper-middle-class earners, not just those with very high incomes.
For example, in Denmark the top statutory personal income tax rate of 55.9% applies to all income that is more than 1.3 times the national average. If those tax rules applied in the U.S., everyone making more than $82,000 would face a marginal tax rate of almost 56%. This is a significantly lower income than President Biden’s promised threshold for not raising taxes on anyone making less than $400,000.
Norway and Sweden have similar income tax systems that apply very high rates to broad swaths of the income distribution. Norway’s top personal tax rate of 38.2% applies to all income over 1.5 times the average Norwegian income. Sweden’s top personal tax rate of 52.3% applies to all income over 1.1 times the average national income.
The U.S. levies its top personal income tax rate of 43.7% (federal and state combined) at 8.5 times the national average income, or around $530,000. Therefore, far fewer taxpayers pay the top rate in the U.S. than in Scandinavian countries.
In layman’s terms, to align with Scandinavian models, the U.S. would need to broaden its tax base and apply the top income tax rate to the upper middle class as well as the wealthy.
In addition to income taxes and social security contributions, all Scandinavian countries collect a significant amount of revenue from value-added taxes (VATs). VATs are similar to sales taxes in that they aim to tax consumption. However, VATs are assessed on the value added in each production stage of a good or service rather than only on the final sales price.
In 2020, Denmark collected 9.7% of GDP through its VAT, Norway 9.1% and Sweden 9.2%. All three countries have VAT rates of 25%. The U.S. does not have a national sales tax or VAT. Instead, there are state and local sales taxes. The average sales tax rate across the country (weighted by population) is about 7.4%. Due to the much lower rate, combined with a narrower base, U.S. sales taxes collect only about 2% of GDP in revenue.
For Scandinavian countries, corporate income taxes play a less important role in terms of revenue than do labor income taxes and the VAT. This is where the United States is in a similar position.
In 2020, Denmark and Sweden raised 2.6% and 2.8% of GDP, respectively, through corporate income taxes. Norway is usually the exception, with corporate revenue equal to 5.7% of GDP in 2019, because it charges companies a corporate income tax rate of 78% on extractive activities (e.g., exploring for and producing natural resources such as oil). However, due to temporary COVID-19 policy changes, Norway only raised 2.4% of GDP from corporate taxes in 2020.
By comparison, the United States raised 1.3% of GDP from the corporate income tax in 2020, though corporate tax receipts have rebounded strongly since then and are now near their historical trend of 1.7% of GDP.
All the Scandinavian countries’ corporate income tax rates are lower than the United States’ combined federal and state rate. In 2022, both Denmark and Norway had a statutory corporate income tax rate of 22%, and Sweden’s corporate income tax rate was 20.6%. The U.S. tax rate on corporations is slightly higher at 25.8%.
Scandinavian countries may offer social policy inspiration to U.S. politicians, but such a comprehensive social safety net requires high levels of taxation with a broad base that extends far beyond the wealthy. To raise revenue in the U.S. that follows the Scandinavian model, taxes—especially on the middle class—would have to be increased through a new VAT and higher social security contributions.
So, the next time a politician suggests reforming the American social safety net in line with the Scandinavian model, middle-class workers should ask if this model applies to the financing side of the equation as well as the benefits side. If so, the “free” social welfare programs won’t come without a cost to them.
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