what can the united states learn from the nordic model? · age, more than 48 percent ... “the...

Some policymakers in the United States andEurope argue that it is possible to enjoy economicgrowth and also have a large welfare state. Theseadvocates for bigger government claim that the so-called Nordic Model offers the best of both worlds.

This claim does not withstand scrutiny. Eco-nomic performance in Nordic nations is lagging,and excessive government is the most likely expla-nation. The public sector in Sweden, Denmark,Norway, Finland, and Iceland consumes, on aver-age, more than 48 percent of economic output.Total government outlays in the United States, bycontrast, are less than 37 percent of gross domes-tic product. Revenue comparisons are even morestriking. Tax receipts average more than 45 per-cent of GDP in Nordic nations, a full 20 percent-age points higher than the aggregate tax burden inthe United States.

This bigger burden of government hurtsNordic competitiveness, both because govern-ment spending consumes resources that could bemore efficiently allocated by market forces andbecause the accompanying high tax rates discour-age productive behavior. A smaller state sector isone reason why the United States is more pros-perous. Per capita GDP in the United States ismore than 15 percent higher than it is in theNordic nations. The gap is even larger when com-

paring disposable income, private consumption,and other measures that reflect living standards.

Notwithstanding problems associated with alarge welfare state, there is much to applaud inNordic nations. They have open markets, low lev-els of regulation, strong property rights, stablecurrencies, and many other policies associatedwith growth and prosperity. Indeed, Nordicnations generally rank among the world’s mostmarket-oriented nations.

Nordic nations also have implemented somepro-market reforms. Every Nordic nation has alower corporate tax rate than the United States,for example, and most of them have low-rate flattax systems for capital income. Iceland even hasa flat tax for labor income. And both Iceland andSweden have partially privatized their socialsecurity retirement systems.

The Nordic nations offer valuable lessons forpolicymakers, but they do not fit the traditionalstereotype. Conservative critics correctly con-demn the large welfare states, but often overlookthe positive results generated by laissez-fairepolicies in other areas. Liberals, meanwhile, exag-gerate the economic performance of Nordicnations in an effort to justify welfare-state poli-cies, while failing to acknowledge the role of free-market policies in other areas.

What Can the United States Learn fromthe Nordic Model?

by Daniel J. Mitchell

_____________________________________________________________________________________________________

Daniel J. Mitchell is a senior fellow at the Cato Institute.

Executive Summary

No. 603 November 5, 2007��

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Introduction

Economic policy debates frequently revolvearound the experiences of other nations.Conservatives often cite Hong Kong whenthey advocate the flat tax, Ireland as evidencefor lower corporate tax rates, and Australiaand Chile to show the benefits of personalretirement accounts. Liberals often invoke theNordic nations as evidence that it is possibleto have a large welfare state without sacrificingtoo much growth.

Proponents of this view argue that theUnited States should emulate Sweden, Den-mark, Norway, Finland, and Iceland. The so-called Nordic Model (alternatively known asthe Swedish Model or Scandinavian Model) isoften cited by those who want an alternative tothe supposedly Darwinistic free-market sys-tem of the Anglo-Saxon world. For instance:

• A study published by a government-sub-sidized think tank in Brussels asserts,“The ‘Nordic’ and the ‘Anglo-Saxon’models are both efficient, but only theformer manages to combine both equi-ty and efficiency.”1

• Foreign-aid advocate Jeffrey Sachs claims,“The Nordic countries outperform theAnglo-Saxon ones on most measures ofeconomic performance.”2

• An article in the International HeraldTribune states, “European leaders want toknow how Sweden and its Nordic neigh-bors, so heavily laden with cradle-to-grave welfare systems, float high.”3

• The head of the Tax Policy Centre for theOrganization for Economic Cooperationand Development recently bragged thattaxes are twice as high in Sweden as theyare in the United States, but that eco-nomic growth is twice as fast.4

Some praise for the Nordic Model is under-standable. Compared to most other Europeannations, Nordic nations are doing well.Average annual growth rates over the past 10years range from 2.1 percent in Denmark to

4.3 percent in Iceland.5 Unemployment ratesare all below 9 percent, with Iceland enjoying ajobless rate of just 2.6 percent.6 Per capita GDPalso is reasonably impressive, especially com-pared to most parts of the world, rangingfrom nearly $43,600 in oil-rich Norway toslightly more than $34,400 in Sweden.7

Before drawing conclusions about thedesirability of the Nordic model, however, itis important to answer three relevant ques-tions:

1. Why are Nordic nations relatively rich?2. Has the welfare state has helped or hin-

dered these countries’ economic perfor-mance?

3. Does the Nordic Model create moreprosperity than the (relatively speaking)limited-government model in the UnitedStates?

The answer to all of those questions is thatNordic nations are reasonably successful inspite of the welfare state. Nordic countries ben-efit from institutions—such as property rights,stable currencies, and the rule of law—thatfacilitate economic growth. And although theyhave large welfare states and concomitantlyhigh levels of taxation, their economic systemsin other respects are very market-oriented.Combined with the fact that before the mid-1960s the burden of government in Nordicnations was modest, these factors help explainwhy those countries today are relatively pros-perous.

But relative prosperity does not imply thatthe welfare state is good for growth, and itcertainly does not suggest that the NordicModel should be adopted by nations withsmaller governments. The United States canlearn something from the Nordic Model, butthe main lesson is that a large welfare statereduces economic performance.

The main difference between the Americansystem and the Nordic Model is that Americahas a medium-size welfare state and the Nordicnations have large welfare states. That explains,at least in part, why the U.S. economy general-ly outperforms the Nordic Model. Income is

2

America has amedium-size

welfare state andthe Nordic

nations have large welfare

states. Thatexplains, at leastin part, why the

U.S. economy generally

outperforms theNordic Model.

higher in America, unemployment is lower,and long-term growth is more impressive.High levels of government spending in Nordicnations have hindered economic performance.Excessive spending invariably creates a cultureof dependency and misallocates a nation’s eco-nomic resources. A heavy burden of govern-ment also requires an onerous tax burden, evenif a government seeks to raise revenue in a rela-tively nondestructive manner.

Comparing the United Statesand the Nordic Nations

The two main ways of comparing eco-nomic performance are rate of growth andlevel of output. One measures how fast grossdomestic product (or some similar measureof economic output) is expanding. The othercompares the absolute level of economic out-put (or some similar measure of prosperity).By both measures, the Nordic nations gener-ally do not fare well when compared to theUnited States.

The OECD and the International MonetaryFund publish comprehensive economic datathat can be used to compare growth rates inAmerica and the five Nordic countries.8 As seenin Figure 1, this data shows that the UnitedStates has enjoyed a faster rate of growth.According to the OECD, the U.S. grew by anaverage of 3 percent between 1981 and 1991and 3.3 percent between 1992 and 2006 (mean-ing average growth of 3.2 percent for 1981 to2006). The Nordic nations, by contrast, grewby an average of 2.2 percent between 1981 and1991 and 2.7 percent from 1992 to 2006(meaning average growth of 2.5 percent overthe entire period). The IMF, meanwhile,reports that U.S. growth averaged 3.1 percentfrom 1981–2006 compared to an average of 2.6percent for Nordic nations in the same period.9

Some might argue that the faster rate ofeconomic growth in the United States is theresult of more rapid population growth. Butthat explains only a fraction of the difference.Moreover, differences in population growthare irrelevant when examining per capita eco-nomic output, and America clearly enjoys a

3

Measures of percapita GDP fromthe World Bank,the OECD, theIMF, and the CIAall show thatAmericans haveabout $6,000 of additional economic outputper person.

United StatesUnited States

United States

Nordic Nations

Nordic Nations

Nordic Nations

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

OECD (1981–1991) OECD (1992–2006) IMF (1981–2006)

Figure 1Faster Growth in the United States

Sources: Organization for Economic Cooperation and Development, International Monetary Fund.

Ann

ual E

cono

mic

Gro

wth

4

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

World Bank 2006 OECD 2005 IMF 2006 CIA 2006

Nordic Average

United States

Figure 2Americans Enjoy More Output

Source: World Bank, Organization for Economic Cooperation and Development, International Monetary Fund, Central

Intelligence Agency.

Per

Cap

ita G

DP

0

5,000

10,000

15,000

20,000

25,000

30,000

Iceland Norway Denmark Sweden Finland United States

2003 Data, Alternative Measures of Well-Being

2003 Data, Basic Structural Indicators

Per

Cap

ita, U

S D

olla

rs

Figure 3Higher Levels of Disposable Income in the United States

Source: Organization for Economic Cooperation and Development.

large advantage using this comparison. Asseen in Figure 2, measures of per capita GDPfrom the World Bank, the OECD, the IMF,and the CIA all show that Americans haveabout $6,000 of additional economic outputper person, significantly more than $20,000for each family of four.

Although per capita GDP is an excellentmeasure of overall economic output relativeto population, it does not necessarily mea-sure living standards. Comparing U.S. andNordic living standards requires numbers fordisposable income or personal consumption.Fortunately, both types of numbers are avail-able. In both cases, the figures demonstratethat GDP statistics actually understate thedegree to which people in Nordic nationshave lower living standards compared totheir American counterparts.

The OECD, for instance, has two dataseries for disposable income, both included inFigure 3. According to a study using 2003data, the average person in the United Stateshad more than $27,000 of disposable income,

while the average person in Nordic nations(no data available for Iceland) had disposableincome of barely $14,300, less than 53 percentof the U.S. level.10 Even Norwegians, bolsteredby oil wealth, had per capita disposableincome of less than $16,800, barely 62 percentof the American level. Danes and Finns are atthe bottom, with less than 50 percent of thedisposable income of the average American. Aseparate data series, which includes numbersfor Iceland, is more flattering to Nordicnations. Per capita disposable income inAmerica barely changes, but the average dis-posable income for Nordic nations climbs bymore than $3,000.11 But even if this dataseries is more accurate, the average resident ofa Nordic nation has only 65 percent of thedisposable income of the average American.

Personal consumption numbers tell a simi-lar story. In 2005, the Danish Finance Ministryproduced numbers comparing per capita pri-vate consumption in OECD nations.12 As seenin Figure 4, the average person in Nordicnations has barely 51 percent as much private

5

The average person in Nordicnations has barely 51 percentas much privateconsumption asan averageAmerican.

0

50,000

100,000

150,000

200,000

250,000

Norway Denmark Iceland Sweden Finland United States

Private Consumption per Capita

Individual Consumption per Capita

Figure 4Higher Living Standards in America

Source: Danish Finance Ministry.

Dan

ish

Kro

ne

consumption as an average American. TheNorwegians are the most prosperous, but eventheir private consumption is just 56 percent ofU.S. levels. Both the Swedes and the Finns haveless than 50 percent of the private consump-tion of average Americans.

Defenders of the welfare state could re-spond by arguing that people in Nordic nationsdo not need to worry about financing their ownconsumption because the government takescare of so many expenses. The Danish FinanceMinistry study includes figures on individualconsumption per capita, which includes items“paid for by the public sector.” This shrinks thegap, but Figure 4 shows that the U.S. retains alarge advantage. Norwegians are the bestregional performers and Finns are the worst,but gaps between individual Nordic nations aretrivial compared to the gap between all theNordic nations and the United States.

Even those numbers may overstate theprosperity of Nordic nations. According to aKPMG study, which attracted some attentionin the Norwegian press, Scandinavians are thepoorest people in Western Europe onceincome is adjusted for taxes and the cost of liv-ing. Danes had the lowest adjusted income, fol-lowed by the Norwegians and the Swedes.Finland managed to edge out Belgium, so thefour Nordic countries in the survey occupiedfour of the bottom five slots.13

Where’s the Convergence?

Whether measured by annual growthrates or levels of output, income, or con-sumption, Nordic nations have inferior eco-nomic performance when compared to theUnited States. This does not mean Nordicnations are economically unsuccessful. Nordoes it mean that the United States economyis without flaws. But it does mean that it israther absurd to claim that, as Jeffrey Sachsdoes, that “the Nordic countries outperformthe Anglo-Saxon ones on most measures ofeconomic performance.”

The performance gap between Americaand the Nordic nations is particularly note-

worthy since economic theory generallyassumes that a nation with less incomeshould grow faster than a nation with moreincome. This phenomenon, known as conver-gence, is based in part on the relatively non-controversial proposition that more invest-ment will flow to a poorer nation to takeadvantage of lower production costs andmore profit-making opportunities.

There was substantial convergence for sev-eral decades after World War II, largelybecause European nations suffered so muchdamage during the conflict and started withlow levels of income. But after several decadesof strong growth, economic performance inEuropean nations—including Nordic coun-tries began to wane. And beginning in the1980s, following Reagan-era reforms toreduce the burden of government, the UnitedStates has widened its lead. As Figure 5 illus-trates, the United States has maintained asteady advantage over Nordic nations in com-parisons of per capita GDP.14

Not all Nordic nations are the same, ofcourse, so “average” calculations often dis-guise important differences. Figure 6, forinstance, shows per capita GDP figures for theindividual Nordic nations measured as a shareof U.S. output based on OECD and IMF data.Oil-rich Norway stands out as the strongesteconomy of the Nordic nations, surpassingeven the United States according to IMF fig-ures. Sweden and Finland, by contrast, are theleast impressive nations in the region.

Other Measures ofProsperity

Unemployment is often one of the mainindicators of economic vitality. Nordicnations generally have low levels of unemploy-ment. Indeed, the average unemployment rateis not significantly higher than the Americanlevel. Iceland, Denmark, and Norway haveespecially strong job markets, while Finlandand Sweden lag.

Youth unemployment figures show a simi-lar pattern. The United States has a slightly

6

According to aKPMG study,

Scandinavians are the poorest

people in WesternEurope once

income is adjust-ed for taxes and

the cost of living.

7

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

United States

Nordic Average

Figure 5Nordic Nations Consistently Lag U.S. Economic Output

Per

Cap

ita G

DP

Source: International Monetary Fund World Economic Database.

40%

60%

80%

100%

120%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Denmark IMF Finland IMF Iceland IMFNorway IMF Sweden IMF United StatesDenmark OECD Finland OECD Norway OECDSweden OECD

Figure 6Where’s the Convergence? Per Capita Output as Share of U.S. Level

Sources: Organization for Economic Cooperation and Development, International Monetary Fund.

lower rate of unemployment for ages 16-24,but the difference is not large and Denmarkand Iceland actually have better numbers thanAmerica. Statistics for long-term unemploy-ment, however, are not flattering for Nordicnations. More than 18 percent of the unem-ployed in Nordic nations have been out ofwork for more than 12 months. In the UnitedStates, by contrast, fewer than 12 percent ofthe unemployed have been jobless that long.15

Another noteworthy feature of labor mar-kets in Nordic nations is the role of govern-ment as a major employer. As noted by aGerman think tank, “On average, the share ofstate employment in total dependent employ-ment across Scandinavia is 32.7%, comparedto only 18.5% in the non-Scandinavian coun-tries of the EU-15.”16 In the United States, gov-ernment workers account for slightly morethan 15 percent of the workforce.17 Moreover,the same researchers say that some Nordicnations are prone to re-characterize welfarebeneficiaries as government employees, a prac-tice that artificially overstates economic out-put (since government salaries are added to

GDP) and artificially understates unemploy-ment.18

Proponents of the Nordic model argue thatthe United States does not have an advantagein every measure of prosperity and the qualityof life, and they often cite leisure time as animportant variable. It is certainly true thatAmericans spend more time on the job. Asseen in Figure 7, Americans spend more timeeach year working than the residents of everyNordic nation. According to OECD data, onlypeople in Finland and Iceland work similarhours to Americans, while Norwegians work400 fewer hours each year.19 The NordicStatistical Yearbook has weekly labor supplyestimates that show a similar pattern, withAmericans working 41 hours per week whileresidents of Nordic nations work between 35and 38 hours each week.20

It is unclear, though, whether working fewerhours than Americans translates into moreleisure time for people in Nordic nations. Theworkweek is composed not only of hours inpaid employment, but also of time spent inhousehold production (cooking, cleaning,

8

A German thinktank estimates

that nearly one-third of

Scandinavianworkers are

employed by thestate. In the

United States by contrast, government

workers accountfor slightly more

than 15 percent ofthe workforce.

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

Denmark Finland Iceland Norway Sweden United States

Figure 7Average Annual Hours Worked

Source: Organization for Economic Cooperation and Development Country Statistical Profiles.

Ann

ual L

abor

Sup

ply

household repairs and maintenance, etc). Thereare not many cross-country studies of house-hold work, so comparing America and theNordic nations is rather difficult. But a Swedishstudy found that 90 percent of the gap betweenthe hours worked by Swedes and Americans dis-appeared once household production wasadded to the equation. Inferences can also bedrawn by comparing the United States andGermany. A German study explains: “On aver-age Americans and Germans spend roughly thesame hours working, but Americans spendmore time in market work while Germansspend more hours in household production.Americans do not work longer hours thanGermans overall, but they allocate a larger shareof working time to gainful employment andinvest less in self-provision.”21 The studyexplains that tax policy is a key factor.

Moreover, even if people in Nordic nationstruly have more leisure time, it is not necessar-ily what they prefer. As the president of theEuropean Central Bank recently remarked:

Lower participation rates are not neces-sarily solely associated with personalpreferences, but are also triggered bythe legal and regulatory environment,tax systems and social institutions.Benefit systems that are too generousdiscourage job search, early retirementschemes encourage early withdrawalfrom the labour market—employmentrates for older workers aged 55–64stood at just 40.2% in the euro area in2005 and, according to the OECD, ataround 60% in the U.S.—and marginaltax rates that are too high discouragelabour market entry and have a down-ward effect on average hours worked.22

A study from the Bank confirms thisanalysis. It explains that “while the overall taxwedge in the euro area currently amounts toroughly 64 percent of the earnings of an aver-age production worker, that of the UnitedStates is limited to about 37 percent.” It thenreports: “Our analysis using the [New Area-Wide Model] confirms the widely-held view

that reductions in tax distortions have bene-ficial effects on labour-market outcomes andgeneral economic performance. In fact, low-ering euro area tax wedges to levels prevailingin the United States is found to result in a risein hours worked and output by more than 10percent in the long run.”23

An OECD study also threw cold water onthe assertion that Europeans have freely cho-sen to work less:

The leisure time enjoyed by individualsis obviously important for any evalua-tion of well-being, and workers’ choiceson how to allocate their time have adirect bearing on cross-country com-parisons of economic aggregates. . . . AsEuropean workers worked more thantheir US counterparts up to the late1960s, it is difficult to invoke long-standing cultural differences to explaincurrent labour-utilisation patterns. Adifferent explanation focuses on therole of policies and institutions, whichmay both depress and boost workinghours. . . . [R]elatively low hours workedper person in Europe can be fullyexplained by policy distortions arisingfrom high marginal taxes on labour.24

Shifting to another measure of prosperity,cross-country wealth data is relatively scarceand presumably less precise than income data,but the figures that are available show that theUnited States has a large advantage in per capi-ta wealth.25 Indeed, as shown in Figure 8,Americans have twice the household wealth ofSwedes, Finns, and Norwegians (no data avail-able for Iceland and Denmark). Americans alsoown more consumer products, particularlydurable equipment such as automobiles andhousehold appliances.26 Americans also enjoymore housing. Indeed, poor people in theUnited States have as much housing space asthe average European.27 As stated above, noneof these comparisons suggest that Nordicnations are economic failures. Indeed, they areamong the world’s wealthiest economies, buthigh taxes and excessive government spending

9

Americans have twice thehousehold wealthof Swedes, Finns,and Norwegians.

mean that they are not as wealthy as they couldbe. It also means they trail the United States inalmost all measures of economic success.

Last but not least, defenders of the NordicModel argue that the United States suffersfrom greater levels of income inequality.Various measures of inequality, such as Ginicoefficients, confirm that “wealthy” Americansearn a bigger share of the pie than upper-income citizens in Nordic nations. But thisdata is incomplete without also looking at thesize of the pie.

As illustrated in Figure 9, the poorest 10percent of Americans have about the samelevel of income as the poorest 10 percent ofFinns, Swedes, and Danes. Only in oil-richNorway is there a noticeable gap (data forIceland not available). What differentiatesAmerica from the Nordic nations is theincome of everyone else. The rich, the middleclass, and the working class in the UnitedStates enjoy higher levels of income than theirNordic counterparts.28

If nations are being judged on the pros-perity of their poorest citizens, then Nordicnations certainly are equal to the UnitedStates. Indeed, they even have a slight advan-tage (though even that advantage might dis-appear if Nordic nations had US levels ofimmigration). But if nations are beingjudged on factors beyond just the well-beingon the poorest segment of the population,then the United States holds a clear edge.

There is also some evidence that Nordicnations are moving in the wrong direction,particularly when compared with otherEuropean nations with smaller burdens ofgovernment. As one researcher explained,“Over the last decade, the incomes of thepoorest 10% of the population have growneight times faster in Ireland than in Sweden,and six times faster in Britain. As a result, so-called Anglo-Saxon economies like Irelandand the UK now for the first time have asmaller proportion of their population belowthe poverty line than does Sweden.”29 This

10

If nations arebeing judged on

factors beyondjust the well-being

on the poorestsegment of the

population, thenthe United States

holds a clear edge.

0

20,000

40,000

60,000

80,000

100,000

120,000

Finland Norway Sweden United States(Panel Study of

IncomeDynamics)

United States(Survey ofConsumerFinance)

Figure 8Per Capita Net Wealth

Source: Luxembourg Wealth Survey Project.

Eur

os

may be more a reflection of positive reformsin nations such as Ireland rather than anindicator of problems in countries likeSweden, but it does suggest that strong eco-nomic growth is better than income redistri-bution if the goal is to help the least fortu-nate in society.

The United States has enjoyed faster eco-nomic growth than Nordic nations. Moreover,per capita GDP is higher in the United States,as are levels of disposable income and privateconsumption. Unemployment is modestlylower in America, and per capita wealth is sig-nificantly higher. The Nordic Model may beinstructive, but not in the way advocates claim.

The Costly Nordic Welfare State

Why are people in the United States moreprosperous than their Nordic counterparts?Is it by chance, the result of different endow-ments, or the consequence of policy choices?Regarding the latter possibility, policymakersin America and the Nordic nations have

made divergent choices about the burden ofgovernment.

Government SpendingAs seen in Figure 10, government spend-

ing consumes a larger share of GDP in allNordic nations than it does in the UnitedStates. Sweden has the biggest burden of gov-ernment, followed by Denmark and Finland,with Iceland and Norway closer to theAmerican level. The larger burden of govern-ment presumably does not bode well forNordic competitiveness since this meanspoliticians and bureaucrats have more powerover how resources are allocated. And sincepolicymakers are more likely to be influencedby political considerations rather than eco-nomic factors, that undermines economicperformance.30

But not all government spending is creat-ed equal. Economists generally find thatsome forms of government spending causeless damage (or even generate some benefits),particularly outlays for physical infrastruc-ture and education. That does not necessari-ly mean that spending in those areas leads to

11

In every Nordic nation,the top tax rate is imposed on taxpayers withmiddle-classincomes. Taxpayers in the United Statesdo not get hitwith the highesttax rate untilincome climbs tomore than$336,000.

39%

43%

38%

50%

38%

0% 10% 20% 30% 40% 50% 60%

United States

Denmark

Finland

Norway

Sweden

Figure 9Share of U.S. Median Income Received by Low-Income OECD Households, 2000

Source: Economic Policy Institute.

faster growth, but it does mean that there aresome benefits to offset at least some of thecosts associated with shifting resources fromthe productive sector of the economy to gov-ernment.

Other types of spending, by contrast, aremore likely to weaken economic perfor-mance, particularly consumption spendingand transfer outlays.31 Figure 11 shows thatgovernments in Nordic nations are muchmore likely to spend money in these areas.

Aggregate Tax BurdenHigh levels of government spending, not

surprisingly, are associated with higher levelsof taxation. Figure 12 shows total receipts(including non-tax revenues) and tax rev-enues for the United States and the Nordicnations. Total receipts is an important mea-sure since it is a rough approximation of theamount of money being transferred from theproductive sector to government, whereas taxrevenue is an important measure since it is arough approximation of the extent to whichthe fiscal system discourages work, saving,investment, and entrepreneurship.

Marginal Tax RatesBut just as all types of spending are not

equal, neither are all forms of taxation.Revenues raised by a low-rate consumptiontax impose only a modest burden on eco-nomic performance. Revenues collected asthe result of high tax rates on productivebehavior, by contrast, are likely to be associ-ated with lower levels of work, saving, invest-ment, and entrepreneurship.

Key factors to examine include the top taxrates on individual income and corporateincome, but double taxation of dividendsand capital gains is also an important gaugeof the tax code’s bias against saving andinvestment, as are direct taxes on capital,such as death taxes and wealth taxes. Theexistence of such taxes, particularly if taxrates are non-trivial, reduces incentives toengage in wealth-creating activities.

Looking at taxes on personal income, theUnited States has a significant advantage overmost Nordic nations. As seen in Figure 13,Denmark, Sweden, and Finland all imposemuch higher tax rates on personal income.Norway’s top tax rate is significantly higher if

12

A Swedish studyfound that

90 percent of thegap between the

hours worked bySwedes and

Americans disap-peared once

household production was

added to theequation.

20%

25%

30%

35%

40%

45%

50%

55%

60%


Figure 10Burden of Government Spending

Shar

e of

GD

P

Source: Organization for Economic Cooperation and Development Fiscal Indicators, 2006.

13

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%


Transfer Spending

Consumption Outlays

Figure 11Spending on Transfers and Consumption


20%

25%

30%

35%

40%

45%

50%

55%

60%

65%


Total Receipts (2006)

Tax Revenues (2003)

Figure 12Government Revenue


Shar

e of

GD

PSh

are

of G

DP

the payroll tax rate is included. Iceland, how-ever, has a less punitive system for highly suc-cessful taxpayers, and Norway actually has aslight advantage over the United States if mea-suring only the personal income tax.

Another key difference between Americaand the Nordic nations is that top tax ratespenalize a much larger share of the popula-tion in Nordic nations. In every Nordicnation, the top tax rate is imposed on tax-payers with middle-class incomes. Norway isthe most lenient of the Nordic nations,allowing taxpayers to earn the equivalent ofabout $75,000 before the top tax rate takeseffect. Taxpayers in the United States, by con-trast, do not get hit with the highest tax rateuntil income climbs to more than $336,000.

On the other hand, every Nordic nationenjoys a lower corporate tax rate than theUnited States. Corporate income in theUnited States is taxed at 39.3 percent, whilethe tax rate in Nordic nations is no higherthan 28 percent.32 As seen in Figure 14,Americans firms face a competitive disadvan-tage in this key measure.

Many other tax measures also play a role.Payroll taxes reduce incentives to work, andthese levies tend to be more onerous in Nordicnations. Taxes on saving and investment areespecially important, with the United Statesalso having a modest advantage in this area.America’s biggest advantage, though, is thetax burden on consumption. Value-addedtaxes (VATs) tend to be less destructive thanincome taxes, but they still undermine growthby driving a wedge between earnings and con-sumption. Simply stated, people sacrificeleisure and earn income because of the thingsmoney can buy. But if taxes reduce theamount of possible consumption—eitherbecause the money is taxed when earned orspent, then there is less incentive to be pro-ductive. The United States does not have aVAT, but all Nordic nations have high-rateVATs, with Sweden and Denmark imposingthe maximum rate of 25 percent.33

The absence of a VAT does not mean thereis no tax burden on consumption in theUnited States. Sales taxes are imposed by 45states, and the federal government imposes

14

Every Nordicnation enjoys a

lower corporatetax rate than the

United States.

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%


With Employee Share of Payroll Tax

Personal Income Tax

Figure 13Top Tax Rate on Personal Income, Including Sub-National Income Taxes


numerous excise duties. Moreover, the taxburden on consumption in Nordic nations isnot as onerous as the rates suggest sincesome goods and services benefit from prefer-ential rates. Yet, as illustrated in Figure 15,even with these caveats, the tax burden onconsumption is about three times higher inNordic nations than it is in the United States.

Does Big GovernmentExplain the Gap between

the United States andNordic Nations?

Although rich by world standards, Nordicnations are not as prosperous as the UnitedStates. Nordic nations also have bigger gov-ernments than the United States. The obviousquestion to ask is whether these facts are relat-ed. Is excessive government the reason Nordicnations are not as wealthy as America?

While this paper does not seek to answerwhether this correlation necessarily means thatbig government is causing the economy inNordic nations to lag America’s economic per-

formance, there is ample evidence that exces-sive government spending34 and high taxrates35 hinder economic growth. Moreover,there do not appear to be other factors thatwould be causing economic growth in Americaand the Nordic nations to follow divergentpaths.

Nordic Nations:A Laissez-Faire Past and

a Hopeful FutureAs shown in Figure 16, the tax burden in

Nordic nations and America was remarkablysimilar until 1960. Not coincidentally, it wasduring this pre-1960 era that Nordic nationsgrew rapidly and became rich.

Beginning in the mid-1960s, and accelerat-ing through the 1970s and into the 1980s,however, the Nordic nations created large wel-fare states. Indeed, this is the key differencebetween America and the Nordic nations. TheUnited States has a medium-sized welfarestate and the Nordic nations have large welfarestates. Otherwise, America and the Nordicnations have many features in common. Both

15

If the “size of government”factor is removed from the EconomicFreedom of theWorld indicators,Nordic nationsscore an averageof 8.35, rankingabove the 8.25score for theUnited States.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%


Figure 14Nordic Nations Have Lower Corporate Tax Rates


16

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%


0

10

20

30

40

50

60

1925 1933 1950 1960 1965 1970 1975 1980 1985 1990 1995 1998 1999

DenmarkFinlandNorwaySwedenUSA

Figure 15Higher Tax Burden on Goods and Services in Nordic Nations

Figure 16Nordic Nations Used to Have Competitive Tax Systems

Source: Organization of Economic Cooperation and Development.

Source: Ratio Institute, Sweden.

Shar

e of

GD

PTa

x as

Sha

re o

f G

DP

the Nordic nations and America have soundinstitutions, including stable currencies, ruleof law, and property rights. Both the Nordicnations and America have relatively open mar-kets. Indeed, if the “size of government” factoris removed from the Economic Freedom of theWorld indicators, Nordic nations score an aver-age of 8.35, ranking above the 8.25 score forthe United States.36

Other measures indicate the Nordicnations have sound institutions and pro-growth policies in areas other than fiscal poli-cy. The World Bank publishes comprehensiverankings of national business environments.The United States is near the top of the list,ranked third, but all the Nordic nations rankamong the world’s most open economies forbusiness activity. Finland has the lowest rank-ing, but is still 14th out of 175 nations.37

The World Bank rankings are not an out-lier. Reviewing 11 different competitivenessscorecards, the United States has an averageranking of 6.6, compared to 10.6 for Nordicnations.38 America scores slightly better, butthe United States and the Nordic nations areall considered among the world’s most com-petitive nations. There are even some areaswhere Nordic nations score above the UnitedStates. In the first international ranking ofproperty rights, for instance, the United Statestrails the four Nordic nations in the survey.39

Norway is number one, Sweden and Denmarkare tied for third, and Finland ranks number11—all above the number 14 ranking for theUnited States.

The Nordic nations also have excellent rep-utations for honest government. According toTransparency International, the five Nordicnations rank among the eight least corruptnations in the world, with Finland and Icelandtied for first place.40 The United States alsodoes well, with a ranking of 20 out of 163nations, but the higher scores for the squeaky-clean Nordic nations presumably help offsetthe larger burden of government.

The Nordic nations also deserve attentionfor important reforms. Iceland, for instance,has a flat tax (albeit with a 36 percent rate),personal retirement accounts, and quasi-pri-

vatized fisheries. Sweden, meanwhile, has anextensive school choice system and personalretirement accounts.

Prosperity and the Welfare State:

Understanding CausalityMany prosperous nations in Western

Europe have large welfare states. This leadsunsophisticated observers to sometimes assumethat high tax rates and high levels of govern-ment spending do not hinder growth. Indeed,they sometimes even conclude that bigger gov-ernment somehow facilitates growth. After all,government in Sweden is larger than it is inmany nations that have lower living standards.

This analysis puts the cart before the horse.It is possible for a nation to become rich andthen adopt a welfare state. There is even a rela-tionship studied in academic literature, knownas Wagner’s Law, which revolves around thetendency for policy makers to expand the sizeof government once nations obtain a certaindegree of prosperity.41 A poor nation thatadopts the welfare state, however, is unlikely toever become rich.

Before the 1960s, Nordic nations had mod-est levels of taxation and spending. They alsoenjoyed—and still enjoy—laissez-faire policiesand open markets in other areas. These are thepolicies that enabled Nordic nations to pros-per for much of the 20th century. Once theircountries became rich, politicians in Nordicnations focused on how to redistribute thewealth that was generated by private-sectoractivity. This sequence is important. Nordicnations became rich, and then governmentexpanded. This expansion of government hasslowed growth, but slow growth for a richnation is much less of a burden than slowgrowth in a poor nation.

Conclusion

Residents of Nordic nations sometimesexpress public pride in their model, but their

17

Before the 1960s,Nordic nationshad modest levelsof taxation andspending. Oncetheir countriesbecame rich,politicians inNordic nationsfocused on howto redistributethe wealth thatwas generated byprivate-sectoractivity.

private behavior presents a more complicatedpicture. Many productive people have depart-ed for lower-tax jurisdictions. Others remain,but they move their assets so they are hiddenfrom tax authorities.

Sometimes this hidden discontent becomesvisible. Four of the five Nordic nations nowhave right-leaning governments. The Swedeselected a conservative coalition governmentlate last year and the Finns made a similarchoice earlier this year.42

It is unclear whether electoral changes willlead to government reform. But if residents ofNordic nations want faster growth, more pros-perity, and improved competitiveness, theyneed to reduce the size of the public sector.Excessive government diminishes growth.And although the Nordic countries’ relativelyfree markets mitigate the damage caused byhigh taxes and high spending, the burden ofgovernment is hindering economic perfor-mance. The Nordic Model is preferable to theContinental or Corporatist Model of nationssuch as France and Germany, which combineswelfare state policies and interventionism. Butthe Nordic Model does not look very impres-sive when compared to the United States.

Notes1. Andre Sapir, “Globalisation and the Reform ofEuropean Social Models,” Bruegel Policy Brief,Issue 2005/01, November 2005, http://www.bruegel.org/Public/fileDownload.php?target=/Files/media/PDF/Publications/Policy%20Briefs/PB200501_SocialModels.pdf.

2. Jeffrey D. Sachs, “The Social Welfare State,Beyond Ideology: Are Higher Taxes and StrongSocial ‘Safety Nets’ Antagonistic to a ProsperousMarket Economy? The Evidence Is Now In,”Scientific American, November 2006, http://www.sciam.com/article.cfm?articleID=000AF3D5-6DC9-152E-A9F183414B7F0000.

3. Thomas Fuller and Ivar Ekman, “The Envy ofEurope,” International Herald Tribune, September17, 2005, http://www.iht.com/articles/2005/09/16/business/wbmodel.php.

4. Jeffrey Owens (presentation to the UnitedStates Council for International Business confer-ence, “New OECD International Tax Initiatives:

Looking Ahead,” Washington, DC, June 4, 2007).

5. Organization for Economic Cooperation andDevelopment (OECD), “OECD in Figures,” Paris,2006, http://www.oecdobserver.org/news/printpage.php/aid/1988/OECD_in_Figures_2006-2007.html

6. Ibid.

7. International Monetary Fund, “World EconomicDatabase” (2006 data), www.imf.org/external/pubs/ft/weo/2007/01/data/index.aspx.

8. All data adjusted for inflation to measure realchanges rather than nominal changes.

9. International Monetary Fund, “World EconomicDatabase” (1981–2006 data), www.imf.org/external/pubs/ft/weo/2007/01/data/index.aspx.

10. Romina Boarini, Asa Johansson, and MarcoMira d’Ercole, “Alternative Measures of Well-Being,” Social, Employment and Migration Work-ing Paper no. 33, OECD, February 17, 2006, www.oecd.org/dataoecd/13/38/36165332.pdf.

11. OECD, “Basic Structural Statistics,” Main Eco-nomic Indicators, September 2006, www.oecd.org/dataoecd/8/4/1874420.pdf.

12. Finance Ministry of Denmark, “Svar pa sporgs-mal nr. S 332 til finansministerer af 16. marts 2005stillet af Peter Christensen (V),” April 4, 2005, www.folketinget.dk/samling/20042/spoergsmaal/S332/svar/endeligt/20050407/156410.PDF.

13. Lars Henrik Bjørgum, “Minst I Lomme-boken,” Dagens Naeringliv, March 23, 2005.

14. The U.S. population has grown more rapidlythan the population in Nordic nations, so the sig-nificant gap in growth comparisons translates intoa smaller advantage when examining per capitaGDP.

15. OECD, “OECD in Figures, 2006–07,” Paris,2007, www.oecdobserver.org/news/printpage.php/aid/1988/OECD_in_Figures_2006-2007.html.

16. Hans Werner-Sinn, “Scandinavia’s AccountingTrick,” IFO Viewpoints no. 80, Institute for Eco-nomic Research, November 10, 2006, http://www.cesifo-group.de/portal/page/portal/ifoHome/B-politik/05stp/_stp?item_link=stp080.htm.

17. Department of Labor, “Employment SituationSummary: July 2007,” Bureau of Labor Statistics,August 3, 2007, www.bls.gov/news.release/empsit.nr0.htm.

18

18. Werner-Sinn.

19. OECD Statistics, “Dataset: Country StatisticalProfiles, 2006,” http://stats.oecd.org/WBOS/default.aspx?DatasetCode=CSP6.

20. Frank Dahlgaard, ed., Nordic Statistical Yearbook,2006 (Copenhagen, Denmark: Council of Mini-sters, 2006), www.norden.org/pub/ovrigt/statistik/sk/N2006001.pdf.

21. Conny Olovsson, “Why Do Europeans Work SoLittle?” Seminar Paper no. 727, Institute for Inter-national Economic Studies, Stockholm University,February 2004; Ronald Schettkat, “Differences inUS–German Time-Allocation: Why Do AmericansWork Longer Hours Than Germans?” Institute forthe Study of Labor Discussion Paper no. 697, January2003, pp. 2–3 and 15, ftp://repec.iza.org/RePEc/Discussionpaper/dp697.pdf.

22. Jean-Claude Trichet, “Structural Reforms inEurope,” Speech given at the OECD Forum, Paris,May 22, 2006, www.ecb.int/press/key/date/2006/html/sp060522_1.en.html.

23. Gunter Coenen, Peter McAdam, and RolandStraub, “Tax Reform and Labour-Market Perfor-mance in the Euro Area: A Simulation-BasedAnalysis Using the New Area-Wide Model,” Euro-pean Central Bank Working Paper no. 747, April2007, http://www.ecb.int/pub/pdf/scpwps/ecbwp747.pdf.

24. Boarini, Johansson, and D’Ercole.

25. Eva Sierminska, Andrea Brandolini andTimothy M. Smeeding, “Comparing Wealth Distri-bution across Rich Countries: First Results fromthe Luxembourg Wealth Study,” LuxembourgWealth Study Series Working Paper no. 1, August 9,2006, http://www.lisproject.org/publications/lwswps/lws1.pdf.

26. Fredrick Bergström and Robert Gidehag, “EUvs. USA,” Timbro, June 2004, www.timbro.com/euvsusa/pdf/EU_vs_USA_English.pdf.

27. Robert E. Rector and Kirk A. Johnson, “Under-standing Poverty in America,” Heritage Foun-dation Backgrounder no. 1713, January 5, 2004,www.heritage.org/Research/Welfare/bg1713.cfm.

28. Lawrence Mishel, Jared Bernstein, and SylviaAllegretto, The State of Working America, 2006/2007(Washington: Economic Policy Institute, 2007),http://www.stateofworkingamerica.org/swa06_ch08_international.pdf.

29. Lorraine Mullally, “Warning to Brussels—Don’t Be Seduced by the Nordic Model,” Europe’s

World, Spring, 2007, http://www.europesworld.org/EWSettings/Article/tabid/78/Default.aspx?Id=4169306f-b19d-438e-a0e4-a84906b2e09f.

30. Daniel J. Mitchell, “The Impact of GovernmentSpending on Economic Growth,” Heritage Foun-dation Backgrounder no. 1381, March 15, 2005,http://www.heritage.org/Research/Budget/bg1831.cfm.

31. See “Supplemental Appendix” to Daniel J.Mitchell, “The Impact of Government Spending,”http://www.heritage.org/Research/Budget/bg1831_suppl.cfm.

32. Chris Atkins and Scott Hodge, “U.S. StillLagging Behind OECD Corporate Tax Trends,”Tax Foundation Fiscal Facts no. 96, July 24, 2007,http://www.taxfoundation.org/publications/show/22501.html.

33. European Commission, Taxation Trends in theEuropean Union: Data for the EU Member States andNorway (European Communities, Brussels: 2007),http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_structures/Structures2007.pdf.

34. Daniel J. Mitchell, “The Impact of GovernmentSpending.”

35. Christina Romer and David Romer, “TheMacroeconomic Effects of Tax Changes: EstimatesBased on a New Measure of Fiscal Shocks,” NBERWorking Paper no. 13264, July 2007, http://www.nber.org/papers/w13264.

36. James Gwartney and Robert Lawson, EconomicFreedom of the World: 2007 Annual Report (Vancouver,Canada: Fraser Institute, 2007), http://www.freetheworld.com/2007/EFW_Complete_Publication_2007.pdf.

37. World Bank, Doing Business 2007: How to Reform(Washington: World Bank, 2006), http://www.doingbusiness.org/documents/DoingBusiness2007_FullReport.pdf.

38. Author calculations based on competitivenessindices found in Daniel Mitchell, “CompetitivenessMeans Less Government, Not More,” HeritageFoundation Backgrounder no. 1929, April 20, 2006,http://www.heritage.org/Research/Budget/bg1929.cfm.

39. Alexandra Horst, “International Property RightsIndex, 2007 Report,” Property Rights Alliance,2007, http://internationalpropertyrightsindex.org/UserFiles/File/PRA_Interior_LowRes.pdf.

40. Transparency International, “Corruption Percep-

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tions Index 2006,” Berlin, Germany, November 2006,www.transparency.org/content/download/10825/92857/version/1/file/CPI_2006_presskit_eng.pdf.

41. Bharat R. Kollut, Michael J. Panik, andMahmoud S. Wahab, “Government Expendituresand Economic Growth: Evidence from G& Coun-

tries,” Applied Economics 32, no. 8 (June 2000):1059–1068.

42. Daniel J. Mitchell, “Hoping to RestoreGrowth, Voters Rebel against Sweden’s High-TaxWelfare State,” Heritage Foundation Webmemono. 1219, September 21, 2006, http://www.heritage.org/Research/Taxes/wm1219.cfm.

OTHER STUDIES IN THE POLICY ANALYSIS SERIES

602. Do You Know the Way to L.A.? San Jose Shows How to Turn an UrbanArea into Los Angeles in Three Stressful Decades by Randal O’Toole (October 17, 2007)

601. The Freedom to Spend Your Own Money on Medical Care: A Common Casualty of Universal Coverage by Kent Masterson Brown (October 15, 2007)

600. Taiwan’s Defense Budget: How Taipei’s Free Riding Risks War by Justin Logan and Ted Galen Carpenter (September 13, 2007)

599. End It, Don’t Mend It: What to Do with No Child Left Behind by Neal McCluskey and Andrew J. Coulson (September 5, 2007)

598. Don’t Increase Federal Gasoline Taxes—Abolish Them by Jerry Taylor and Peter Van Doren (August 7, 2007)

597. Medicaid’s Soaring Cost: Time to Step on the Brakes by Jagadeesh Gokhale (July 19, 2007)

596. Debunking Portland: The City That Doesn’t Work by Randal O’Toole (July 9, 2007)

595. The Massachusetts Health Plan: The Good, the Bad, and the Ugly by David A. Hyman (June 28, 2007)

594. The Myth of the Rational Voter: Why Democracies Choose Bad Policiesby Bryan Caplan (May 29, 2007)

593. Federal Aid to the States: Historical Cause of Government Growth and Bureaucracy by Chris Edwards (May 22, 2007)

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