Tax cuts and inequality

Last week the Løkke Rasmussen administration presented a proposal for tax reforms called Job Reform Phase II.  The measures are intended to provide tax relief to various income groups and give greater incentives to work. They inevitably provoked controversy about how much was necessary and who benefits most.

One of the basic issues under debate on tax reform has been whether to reduce or abolish the high marginal tax rate in order to prompt high earners to work more or to reduce the rate on the lowest income group in order to bring more people into the labor force. The Liberal Alliance party had made the former its cause and had been virtually holding the government hostage with the demand. Leading economists have also endorsed the position, saying it would be revenue-neutral. The Danish People’s Party, the largest party supporting the administration, on the other hand, has demanded tax relief for low-income workers. So who won?

Take-home pay

One of the key measures was an adjustment of the employment deduction. People in the lowest income bracket would get a new deduction of DKK 4,500 ($720). The rationale is that this would make it more appealing for a segment of the population to work instead of receive transfer payments. The government estimates that the measure would reduce this segment from 50,000 to 21,000 people.

At the same time, the ceiling on the employment deduction would be removed, and this would benefit people in the highest tax bracket (with a marginal rate of 56%). There are several other measures, most of which also seem to benefit high earners, such as an acceleration of the increase in the threshold of the highest income bracket, a reduction on the tax on car purchases (to 100%) and a more favorable treatment of pension contributions.

Malleable statistics

In a simplified scheme, the administration estimates the tax savings for four income groups. It emphasizes that the lowest segment would receive the largest percentage reduction, 7.1%. The middle segments would receive about 3.8%, and the highest segment 5.7%. The absolute amounts, of course, paint a different picture. The lowest group gains about $800 and the highest (represented by an income of about $165K) gains $4,300. So the question is whether the administration is trying to sneak a tax break for the rich into the package without actually changing the marginal tax rate. And the real question is whether doing so is good or bad.

Other organizations calculate the effects differently, of course. The Economic Council of the Labour Movement estimates that the top ten percent would receive an additional $1,900 in disposable income and the lowest ten percent would receive $48, not even taking into account supplementary factors such as the tax on cars. Such estimates are always debatable. It’s difficult to make comparisons partly because of a panoply of other taxes and duties, such as 25% VAT.

Gini out of the bottle

The criticism from the left is that the measures would increase inequality. According to Cepos, the leading conservative think-tank, the reforms would increase inequality more than any other since 2001. They would raise the Gini coefficient by 0.46, from a level of about 28.8. This has elicited many protests and denunciations not only from opposition politicians but also from cultural figures. The actor Flemming Jensen, for example, launched a broadside on Facebook accusing the administration of betraying Denmark’s heritage of solidarity and equality and promoting a neoliberal “law of the jungle” that is creating a caste system while the number of homeless increases, hospitals are forced to reduce costs and so on. In a subsequent interview, he concluded that no one in Denmark needs an income of more than $160K: “Why the hell would we?” Imagine how that would play in a country with heroes like Zuckerburg and Bezos.

The administration acknowledges the rise in equality and calls it insignificant. It argues that putting more people to work and raising all disposable incomes inevitably increases inequality but the level in Denmark would remain one of the lowest in the world (the Gini coefficient for the US, in comparison, is one of the highest, at around 46-48). Finance Minister Kristian Jensen said that he has been to town hall meetings around the country and no one has ever asked about the Gini coefficient; they ask rather how the government will enable businesses to hire more people. But they were probably his party’s own constituents. The Danish People’s Party is against the abolition of the deduction ceiling.

The secret to happiness?

This debate goes to one of the central issues of the research on comparative happiness internationally. The happiest countries generally have very low inequality, but is equality the direct cause of happiness, the most important single factor, or a derivative effect of other factors? If it is a causal factor, is there a limit to its beneficial effects? It is possible that, for historical, political and demographic reasons, the socialist tendencies in Western Europe that have brought relative equality and happiness in the prosperity since World War Two are no longer able to sustain them in the current low-growth global economy.

But that’s a theoretical question. The political reality is that the populations of social democracies are split. The so-called “welfare coalition” of welfare recipients and civil servants generally favors higher taxation and a larger public sector. Those in the private sector would rather keep more of their gross earnings. There is a constant tug-of-war and a tinkering with the tax tables whenever the governing majority shifts between a center-left and center-right coalition. Although Denmark’s economy is somewhat stagnant, it is fundamentally sound. The country has the luxury of being able to take or leave the proposed reforms, which may have more symbolic value than practical consequences. Perhaps sooner than we think, robotics and AI will shift the debate on the labor market and inequality to how to implement universal basic income.