Capital Competes Internationally
There is another reality that tax policy cannot ignore. Capital is mobile. Entrepreneurs are mobile. Investors are mobile. Countries therefore no longer compete only for tourists and export markets. They compete for entrepreneurs, innovators and the capital that creates tomorrow’s companies and jobs.
Several European countries have adapted their tax systems to attract internationally mobile individuals. Ireland has long had a system under which, in certain circumstances, foreign income is taxed only when it is brought into the country.
Italy offers qualifying newcomers the possibility of paying a fixed annual tax on substantial amounts of their foreign income. Spain, through the so-called Beckham Law, has offered certain qualifying newcomers more favourable taxation than ordinary taxpayers. The United Kingdom has also introduced rules giving new arrivals four years of tax exemption on foreign income and capital gains.
The point is not that every country should copy one another. The point is that international competition for capital and talent is real. Sweden has already gone through this process.
For several decades, Sweden combined very high income taxes with wealth taxes, inheritance taxes, gift taxes and relatively high taxes on capital. Several successful entrepreneurs chose to leave the country.
When these policies changed and these taxes were abolished, Sweden once again became more attractive for entrepreneurship and investment. The result was not the disappearance of the welfare state. Rather, the welfare state was financed by an economy with a broader tax base, more successful companies and greater wealth creation.
Tax Rules Can Create or Destroy
A common argument against tax cuts for entrepreneurs is that they merely benefit those who are already successful. But tax policy is not only about today’s distribution. It is also about tomorrow’s opportunities.
Suppose a new rule were introduced: anyone who starts a business and creates at least 1,000 new full-time jobs over ten years would be allowed to sell the company free of capital gains tax.
Would this be costly for the government? Let us do the math.
A person outside the labour market who is looking for work may cost society an estimated SEK 240,000 per year in various forms of support. Suppose the new jobs are in the bottom quartile of the wage distribution and that employees earn SEK 30,000 per month. That amounts to an annual salary of SEK 360,000 and approximately SEK 60,000 in tax per person.
Each new employee would therefore have two economic effects for society: approximately SEK 240,000 in reduced costs and approximately SEK 60,000 in additional tax revenue. The combined social benefit would be around SEK 300,000 per employee. For 1,000 employees, that corresponds to SEK 300 million in a single year. Over ten years, the figure would be SEK 3 billion.
Assume, in addition, that each employee contributes SEK 5,000 to the company’s net profit. The company would then generate SEK 5 million in annual profit. At a valuation of 20 times earnings, the company would be worth SEK 100 million. The seller would save less than SEK 30 million in tax.
Even if the government completely waived capital gains tax on the sale, the cost would be significantly lower than the social benefit created through the new jobs.
This is a simplified example. But it illustrates an important principle: sometimes a tax reduction can generate greater revenues for society than a tax increase. The question is therefore not simply how much the government collects from a particular person or transaction. The question is what behaviour the tax system encourages.
What Is Fairness, Really?
When I took part in a panel discussion on the Swedish public television programme Pejling in the 1980s, I presented a line of reasoning, as someone knowledgeable about taxation, that I still believe is relevant today. A tax system can be formally equal for everyone while nevertheless providing people with very different opportunities.
Someone with a high income often has the ability to take advantage of tax deductions and plan their finances. Someone who must use their entire income for basic consumption does not have the same opportunity. The real inequality often arises before the tax system begins to redistribute income.
People have different circumstances and talents. Some have entrepreneurial ability. Some have academic aptitude. Others possess qualities that enable them to generate substantial incomes in different fields. These people are also often internationally mobile.
The challenge for a society is therefore not to eliminate all economic differences. The challenge is to create a system in which human ability is transformed into investment, businesses, jobs and a higher standard of living for more people.
No government can redistribute wealth that has not been created. The real test of tax policy is therefore not whether it looks fair on paper. It is whether, over time, it creates a richer society capable of financing the welfare and redistribution that citizens are rightly entitled to expect.