Sweden has had its period of envy-driven politics. The idea that those who have a great deal have somehow acquired it at someone else’s expense has long influenced parts of the political debate. Taxing “the rich” can be a compelling political message, but all tax policy has consequences.
When Sweden combined a wealth tax, inheritance tax, gift tax and high taxes on capital, many large fortunes left the country. Entrepreneurs and capital owners moved to countries that were more favourable to capital.
These taxes were subsequently abolished. Sweden still has an extensive welfare state, but it finances it through a tax system that is considerably more favourable to entrepreneurship and capital formation than it was in the past.
The experience is clear. When Sweden made its tax system more competitive, many wealthy people returned, while more high-net-worth individuals chose to remain in the country.
As early as the 1930s, Social Democratic Finance Minister Ernst Wigforss recognized that capital is not the enemy of workers. On the contrary. The more capital that is available, the cheaper it becomes to finance productive investment. It is these investments that have made the working class wealthier.
It is not that people work significantly harder today than they did during the Industrial Revolution. The difference is that each hour of work has become more productive through better education, technology and capital.
It is also worth noting that those with the highest earned incomes already account for a very large share of state income-tax revenues. The top ten percent of income earners pay the majority of state income tax, while the top one percent accounts for a significant share of those revenues.
A so-called millionaire’s tax is now being discussed once again. Its precise design will depend on future political decisions. But the direction is clear: higher taxation of those who own substantial assets.
The question, however, is whether this is really a policy that benefits those with the lowest incomes.
Fairness is an attractive political message. But tax policy should not be judged solely by how fair it appears on paper. It must also be judged by the amount of prosperity it actually creates.
It sounds reasonable that people with a greater ability to pay should contribute more. This is why there are often proposals to tax capital gains in the same way as earned income. But before such a reform is implemented, we should ask a fundamental question:
Are capital gains the same thing as income? The answer is no.
Income is generated by a productive asset. Your work generates wages. Shares can generate dividends. Government bonds generate interest. As long as the underlying asset remains, it can continue to generate taxable income.
A capital gain is something different. It arises when a capital asset changes hands. Consider a simple example.
You find a seed, plant it, and it grows into an apple tree. The tree is your capital. Every year it produces one hundred apples. The apples are your income.
One day, someone offers you 10,000 kronor for the tree. The buyer believes that, through better management, he can increase its production to two hundred apples a year. Tax is paid on the higher income generated by the tree. Society benefits from the transaction because the productive asset has been transferred to someone who can use it more efficiently.
Suppose the sale is taxed at the same rate as earned income. If the entire sale price in this simplified example is taxed as income, half of the 10,000 kronor disappears in tax. Instead of having 10,000 kronor to reinvest, you are left with only 5,000 kronor. You may therefore decide not to sell.
The result is not greater fairness. The result is that the tree remains with the less efficient owner. Fewer apples are produced, incomes fall, and the government ultimately receives less tax revenue.
This illustrates why many countries tax capital gains differently from ordinary income. The primary purpose is not to favour investors, but to avoid productive assets becoming locked in with owners who are no longer the most capable of developing them. Economic growth depends on capital being able to move to those who can use it most productively.