Nordic lessons on AOC’s 70 percent tax proposal

Rep. Alexandria Ocasio-Cortez (D-N.Y.) recently floated an idea of much higher maximum marginal tax rates on CBS’ 60 Minutes. She spoke of a marginal tax rate as high as 70 percent for people earning more than $10 million.

This would not mean a total tax rate at anywhere near 70 percent, but those lucky few earning more than $10 million a year would have to pay 70 percent on every dollar exceeding $10 million.

{mosads}To many, this kind of marginal tax rate may sound like socialism and not the American way, but in reality, marginal taxes were 70 percent for the highest levels of household income from the 1960s to early 1980s. Among other things, those tax revenues funded NASA mission to fly man to the moon.

Today, marginal tax rates are much lower in the U.S., but other countries have experience with marginal tax rates well over 50 percent for incomes much lower than $10 million. In the Nordic countries, like Sweden and Finland, marginal tax rates can be close to 60 percent for people earning $100,000.

These tax rates are not against economic theory either, many high profile economists think that marginal tax rates could be higher. As an example, Nobel laureate and tax expert Peter Diamond has estimated that the optimal tax rate for top earners could be as high as 73 percent.

The rationale is that an extra dollar is worth a lot less in satisfaction to people with very high earnings than to those with low incomes. Consequently, a policy that makes the few richest a bit poorer will barely affect their life satisfaction, since they will still be able to acquire more or less what they want. A poor person needs every cent for his or her daily life.

According to theory, the marginal tax rate should not rise all the way to 100 percent because that would eliminate any incentive to work more to earn money, which would hurt the economy.

Sweden does actually have a history with marginal tax rate in excess of 100 percent. Swedish children’s book author Astrid Lindgren wrote a satirical story called “Pomperipossa in the World of Money” in response to the 102 percent marginal tax rate that she faced in 1976.

For every extra 100 note she earned, she had to pay 102 to the government. The following heated tax debate was an important factor in the election defeat of the Swedish Social Democratic Party in 1976, the first time that happened in 40 years. Swedes continue to be taxed heavily; the maximum marginal tax rate is close to 70 percent.

In this light, AOC’s proposal does not sound so alien after all. High marginal tax rates have existed in the U.S. and are commonplace in Europe. High marginal taxes are not without faults even in the Nordic countries, however.

High taxation in general, leads to active tax planning, especially among entrepreneurs, which transforms earnings to capital income, which faces much lower tax rates than top earners’ income rates.

High-earning professionals may also move abroad after lower taxes, which may cause significant but hard-to-identify brain drain and tax-base erosion over time. Finnish Formula One drivers tend to live abroad in places like Monaco, where taxes barely exist.

High rates at middle-income levels may also discourage supply of labor. Many voters in general elections also think that it is unfair that one should hand well over half of extra earnings to the government. These reasons have kept the highest marginal rates usually well below 70 percent in European countries.

On the other hand, high taxation has not prohibited the Nordic countries from becoming successful market economies with high capacities for innovation. High taxation is necessary to finance the Nordic style welfare services and nearly free education.

Top marginal tax brackets are not the key to financing the welfare state, however, because the extra revenue from a few really high-earning individuals is peanuts compared to the taxes paid by the middle class or value added tax on sales.

According to other news sources, citing federal data, only 16,000 Americans earn more than $10 million a year. That includes superstar athletes, few entertainers, top financiers and entrepreneurs.

{mossecondads}If their earnings would face AOC’s 70 percent marginal tax, the government could book an additional $72 billion, which would be roughly 2 percent addition to total tax revenues.

That would work some way toward balancing the federal budget, but extremely high tax rates for the ultra-rich might as well imply rising employment for tax specialists and less revenue for the government.

The welfare state with high taxation is alive and works reasonably well in the Nordic countries, but it may be difficult to implement it in other countries, especially if they are much larger, like the U.S.

Decisions to use the tax revenues are done close to the tax base in the Nordic countries, which makes people trust their money will be spent wisely. Nordic people would not generally like the idea of handing much tax authority to European Union bureaucrats in far-away Brussels.

Pasi Kuoppamäki is the chief economist of Danske Bank A/S’s Finland branch.