IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
Winning the September 2011-election on a promise of higher taxes, the centreleft government made good on election promises in the 2012-budget by increasing taxes by half a percent of total tax revenue. In the spring of 2012 further tax increases followed on cars and energy consumption. Increasingly, however, the tax hikes (implemented and promised) became unpopular with large parts of the population as well as the governments supporters in labour unions; and in the summer of 2012 the government and the right wing opposition agreed on an income tax reform which for the first time in many years actually lowered the overall tax burden. In many ways, the tax reform marked a turning point in the tax debate, and the 2013-budget surprisingly included a cancellation of a number of unpopular taxes.
As described in last year’s report, the newly elected centre-left (minority) government made good on election promises by passing a 2012-budget which increased taxes by some DKK 6 bn. (€ 800 mill.) or equal to half a percent of total tax revenue. This was far less than the "promised" tax increases totalling some DKK 30 bn. (€ 4.0 bn.) describes in the common election manifesto of the Social Democrats and the Socialist People’s Party, who make up to thirds of the threeparty coalition government. The last coalition partner is the Social-Liberal Party who arguably is the reason why tax increases were so modest compared to the election promises made by leading figures of the then opposition, including now prime minister Ms Helle Thorning-Schmidt. Among taxes promised, but not implemented, were a 6 percent "millionaire tax", which would – again – bring the highest marginal tax on labour income above 60 percent.
Notwithstanding this, the 2012 budget – which was passed with the support of the Red-Green Alliance on the far left – contained a number of tax increases, many of which were afterwards rushed through parliament so that they could take effect from January 2012.
Effective from 2012, the value of private health insurance paid by the employer (and deductible as a business expense) is no longer tax-free for the employee. Thus the employee will face a tax of between 40 percent and 56 percent of the insurance premium. Also there are no longer any tax privileges if a company chooses to pay its employees in company shares. Hitherto, if all employees were access to the scheme, up to 10 percent of the salary could be paid in shares. The value of the shares would be fully deductable for the company (as would a normal salary), while the employee – upon selling the shares – would only be subject to the tax that applies to the profit from shares (at most 42 percent depending on the total income from shares that year). This compared with a top marginal tax on wage income of 56.1 percent. As of 2012, shares given to employees as part of their salary is taxed as regular labour income at the moment the employees acquire the shares (so if it is a right to buy shares, not until they exercise this right).
Also, the government and the Red-Green Alliance agreed on a tightening of the tax privileges related to private pension schemes. Firstly, the yearly tax on the return on private pension schemes was raised from 15 percent to 15.3 percent. Secondly, the maximum deductable amount which can be paid into a private pension plan with more than ten years but less than life-long return payments was reduced from DKK 100,000 to DKK 50,000 (€ 13,400 to € 6,700). The DKK 100,000 ceiling was introduced in 2010, before which there was no limit on the deductible amount. This is still the case for payments to life-long private pension schemes.
All in all, the abovementioned widening of the tax base for personal income taxes raised the tax revenue permanently by approximately DKK 1.2 bn. (€ 0.16 bn.) or some 0.1 percent of total tax revenues. This is excluding the temporary effect of the ceiling on deductions for private pension contributions, which will bring forward some tax revenue that would normally not materialize until the pensions were paid out.
It should be noted, that the increases to personal taxation in the 2012 budget came on top of increases already agreed upon in past tax reforms, most notably the 2010 tax reform (agreed upon in 2009) as well as the "Economic recovery package" (agreed upon in 2010).
The most subtle but also most significant of these tax increases was a four-year (2010-2013) nominally freeze of all tax thresholds, which are traditionally automatically indexed to reflect rising wages. Thus, the effect will be to keep all tax thresholds nominally unchanged from 2009 to 2013. The effect of the tax threshold freeze is best illustrated by looking at the effect on the number of taxpayers paying the top income tax rate.
In 2010 some 650,000 persons paid the top income tax, equal to 14 percent of all taxpayers. This was after the 2010 tax reform had brought the number down from 930,000 persons (20 percent) the year before. Normally, the automatic indexation of tax thresholds would keep the number of top income tax payers steady from one year to the next. But due to the tax bracket freeze, the number of persons affected by the highest marginal tax rate rose to 660,000 persons in 2011 and 710,000 persons in 2012.
Another aspect of earlier tax reforms affecting 2012 taxes was a gradual reduction of the standard deduction rate, which was part of the 2010 tax reform. The rate applies to e.g. labour union membership fee, unemployment insurance premium, but also net negative capital income (interest payments) above DKK 50,000 (€ 6,700). Hitherto such costs could be deducted against other taxes at a rate of 33.7 percent (average municipality), but beginning in 2012, the rate will be gradually reduced by one percentage point per year until reaching 25.7 percent in 2019.
Denmark already levies Europe’s highest consumption taxes, mainly due to a uniform VAT rate of 25 percent as well as high taxes on candy, alcohol, cigarettes and a variety of other products. In 2012 (and again in 2013) these were raised as a consequence of the new government’s 2012 budget agreement with the Red- Green Alliance.
In 2012, tax on soft drinks (with sugar), chocolate, candy, ice cream, beer, wine and tobacco was increased by some DKK 1.3 bn. (€ 170 mill.) in all. Interestingly, the increase in the tax on tobacco (which raises the price of a package of cigarettes from DKK 39 to DKK 42 or € 5.2 to € 5.6), was not expected to result in any extra revenue as the negative behavioural effects (less smoking and more cigarettes bought across the border in Germany) were expected to nullify the initial positive effects on tax revenues.
Also, a number of taxes or duties on as diverse products as light bulbs, coffee, tea and smokeless tobacco, along with the annual circulation tax on cars was increased in 2012 (and again in 2013) by a total of some 9 percent. These taxes had all been held constant in nominal terms since 2002 under the former government. Along with the abovementioned increases, this will bring the extra revenue on consumption taxes to some DKK 2 bn. (€ 270 mill.).
The 2012 budget agreement also contained a plan to raise a further tax revenue of DKK 1 bn. (€ 130 mill.) by introducing a tax on all food products with added sugar: Fruit yoghurt, marmalade / jam, ketchup, chocolate milk, etc. – but also relish or pickled products. The government had promised to present a detailed proposal for the tax later in 2012, but the tax became so unpopular, that the plans were scrapped in connection with the 2013 budget (see later).
Even before the proposed tax increases, official estimates put the total crossborder shopping out of Denmark at DKK 12 bn. (€ 1.6 bn.) or more than DKK 2000 (€ 270) per year per person.
Individuals were, however, not the only ones to feel the effect of the change of government. As indicated, some of the tax increases, which primarily affect consumers, also carry a burden for companies in terms of administrative costs and/or loss of business in their home market as shoppers head to Germany and Sweden. But Danish companies were also directly hit by a number of tax increases in the 2012 budget.
Most notably, the new government pushed through a quintupling of the tax on NOx-emissions from DKK 5 to DKK 25 per kg NOx (€ 0.67 to € 3.35). Effective from mid-2012 this drastic tax hike had grave effects on much of the Danish production industry already suffering under the increased energy taxes, which were parts of the 2010 tax reform. The environmental effects, however, are modest as less than five percent of the NOx-particles in Denmark are actually emitted in Denmark (the rest are carried into the country from abroad). Also, the largest emitter of NOx – transportation – will be exempt from the increase.
The government also tightened the rules concerning the tax-free transfer of family owned businesses from one generation to the next, and it tightened or introduced a number of rules in order to increase corporate taxes. These include higher fines for missing or incomplete transfer pricing documentation, limitations to the deduction of previous years’ loss in this year’s profits, as well as further limitations on the deduction of interest payments in company profits (mirroring German and French rules in this area). Also, beginning in the autumn of 2012, the corporate income tax payments of all companies have been made public.
Finally, the 2012 budget contained a number of business taxes that did not take effect until 2013 or later. In 2013 a work injury tax was introduced, which is supposed to reduce the number of work related injuries, but is arguably just another tax on having employees. The same year a tax on print ads distributed to private households were supposed to take effect; but it may not be compatible with EU-law and is still pending confirmation by the EU-Commission.
The only positive element in the 2012 budget was the amendment of one of the most criticised elements of the 2010 tax reform: A DKK 3,000/year (€ 400) add-on to taxable income for employees with (partly or fully) employer-paid telephone, PC or Internet available for private use outside the workplace. This corresponds to a tax of DKK 1,200-1,700/year (€ 160-230) depending on income (top income tax payer or not).
This "multi-media tax" was hotly criticised, and already in late 2010, the tax was amended to give married couples a 25 percent discount on the tax if they are both subject to it. Effective from 2012 the add-on to taxable income was lowered to DKK 2,500 (€ 340), and employer-paid PC and/or Internet were exempt, leaving only employer-paid telephone as the basis for the tax.
The government had originally estimated that this amendment would result in a loss of tax revenue to the tune of DKK ½ bn. (€ 70 mill.) or roughly one tenth of the total tax hike in the 2012 budget. But data has shown that the exemption of home computers and Internet had little effect on the number of people affected (mainly because of the spread of employer paid smart phones), and little if any tax revenue has actually been lost.
In the spring of 2012 two political agreements were reached which further increased the tax burden on households and companies.
In March 2012 a broad political agreement on energy policy 2012-2020 was reached, which aims to reduce overall energy consumption and increase the share of renewable energy. The total cost is estimated at some DKK 3½ bn. (€ 470 mill.), and will be mostly borne by private households. Among other things, the agreement calls for a "supply security tax", i.e. a tax on all energy consumption to ensure tax revenue as the reliance on conventional (and highly taxed) energy is reduced. This would among other things entail a tax on firewood, which has since been widely ridiculed, but which is currently being seriously contemplated in the relevant ministries.
Secondly, the government reached an agreement with a majority in parliament to tighten the rules regarding the taxation of leasing cars and "demonstration cars" (cars, registered by the car dealer as demonstration cars, and then later sold to consumers). Denmark is renowned for its high taxes on vehicles (registration fee is 180 percent of the value of the car, on top of 25 percent VAT) and naturally this has sparked ingenuity in order to reduce the tax payment. Not least so in the areas of leasing cars, and demonstration cars, because such cars hitherto paid registration fee on a "minimum price" based on the import price of the car, which was traditionally lower than the retail price (excluding taxes). Thus, at the time of the intervention, more than half of all new cars were registered either as leasing cars or demonstration cars. The intervention aimed to reduce the scope for using the minimum price, and will increase tax revenue by DKK 1 bn. (€ 130 mill.). In 2011 the total tax revenue on motor vehicles amounted to DKK 42 bn. or almost five percent of total tax revenue.
Even though the many tax hikes were arguably a natural consequence of the election promises of the new government, they nevertheless came under increasing attack – not just by corporations, but also by the government’s supporters in labour unions as well as the general public. Workers protested against the new business taxes which would accelerate the export of jobs to countries with lower taxes; and consumers reacted against the increase of excise duties at a time when wages stagnated. In 2012 the overall tax burden reached 48.5 percent of GDP.
To speak of a "tax revolt" of any kind is misleading, or at least premature; but it would be right to speak of a paradigm shift in the world’s most heavily taxed country. To paraphrase former US president Ronald Reagan, higher taxes are increasingly seen not as the solution to the problems facing Denmark, but rather as part of the problem themselves. This change of perspective manifested itself for the first time in the tax reform agreed upon in the summer of 2012.
The tax reform had been announces already in the government manifesto, which pledged to "markedly" lower the tax on labour income in order to boost labour supply by at least 7,000 persons (equal to some 0.025 percent). The cuts to income taxes were to be fully financed by other tax increases; in fact the manifesto spelled out that the positive supply side effects of the extra labour supply – estimated at some DKK 3 bn. (€ 0.4 bn.) – would finance an increase in public spending. Even so, the plans were vividly criticised by the Red-Green Alliance on the political far left for focusing solely on lowering the tax burden on labour income, thus widening the gap between those in work and those on government welfare. Ironically, this was exactly the same criticism that the members of the then opposition now government raised against the 2010 tax reform implemented under the then centre-right government.
Late in May 2012 the government presented its proposal for a tax reform and invited all political parties to negotiations. As the government does not command a majority in parliament, the support of either the left wing Red-Green Alliance (on whose support the government came to power) or at least one of the right wing opposition parties were needed in order to pass the reform.
What was surprising about the proposal was not so much the cuts themselves (more on that later) but the way in which the government proposed to finance them. Contrary to the words of the government manifesto, the cuts to income tax were not fully financed through other tax increases. In fact, approximately one quarter of the tax cuts (totalling more than DKK 14 bn. or € 1.9 bn.) were financed though lower spending on transfer incomes. A larger part of the state pension will now be means tested, but more importantly, the government proposed that for eight years the automatic adjustment of welfare benefits in line with rising wages will be suspended, and benefits will only be adjusted to reflect inflation.
Not surprisingly, this caused uproar in the Red-Green Alliance who had already been critical of the focus on cutting taxes for those in the work force. In short, the centre-left government who had for a decade in opposition attacked the previous government for "taking from the poor and giving to the rich" was now proposing a tax reform that would do just that.
Nevertheless, the government now began parallel negotiations with on the one hand, their natural ally on the left, the Red-Green Alliance, and on the other hand the two parties on the right who made up the former government: The Danish Liberal Party (Venstre) and The Conservative People’s Party. In the end, the government ended up sealing a deal with the two opposition parties of the former (centre-right) government; much to the dismay of the Red-Green Alliance.
From a pro-tax cut perspective, the final deal was even better than the original proposal. Essentially all the proposed tax cuts were kept in place, while some of the tax increases were scrapped. Instead, more than half the total loss of tax revenue would now be found by reducing public expenditure: Cuts on the military and a Danish EU-rebate would cover the difference.
As announced, the tax reform focused primarily on cutting the tax on labour income over a period of ten years. Most importantly, the threshold for the top income tax will be gradually increased from DKK 423,800 (€ 56,900) to DKK 507,600 (€ 68,100) with most of the increase in the years 2013 and 2014. This will reduce the share of taxpayers affected by the top income tax to less than 10 percent.
Also the "employment deduction", which today effectively reduces the marginal tax by 1.4 percent for those earning less than DKK 320,500 (€ 43,000), will be almost doubled, resulting in a marginal of less than 40 percent for the lowest incomes when fully implemented in 2021. In 2014 an additional employment deduction for low income single parents will be introduced, reducing the marginal tax by further 1.6 percentage points for this particular group of taxpayers.
For businesses, the reform abolished the tax on corporate capital gains from shares in unlisted companies even when the share held is less than 10 percent (corporate capital gains on shares above 10 percent is already tax free). Also a 2013-2014 tax break for certain investments in e.g. machines was introduced.
The final agreement still contained some tax increases, most notably the "regulation" of all duties (on light bulbs, vehicles, coffee & tea, alcoholic beverages of all kinds, soda water, chocolate and candy to name a few things) with 1.8 percent per year in the years 2013-2022. The increase will not be yearly, but in the years 2013, 2015 and 2018. Also there are increases to the yearly tax on diesel car and the payroll tax in the financial sector, as well as a cut in the maximum yearly tax deduction available for workers working away from home on a temporary basis.
In fact, the agreement also contained an end to the special tax break available to Danes stationed outside the country, but still liable for Danish income taxes (e.g. because they have not given up their home). Hitherto, such persons would be tax exempt on the income earned outside Denmark, but this exemption was lifted, sparking fierce criticism from corporations, NGO’s and others.
The criticism became so fierce that the exemption was reintroduced in the budget agreement for 2013 that was reached late in 2012 between the government and the Red-Green Alliance. The same budget also scrapped the fat tax that had been introduced in connection with the 2010 tax reform, and it shelved the plans for a tax on all food products with added sugar, which had been part of the 2012 budget and was supposed to take effect January 2013. Both the fat tax and the new sugar tax had been hotly criticised by corporations and were increasingly unpopular in the eyes of the general public.
Unfortunately, these much appreciated tax cuts were financed by increasing the state income tax by 0.19 percentage points. The lowest marginal tax rate will still be below 40 percent, but the top marginal tax rate will rise marginally to 56.2 percent as a result. Thus, despite all the positive changes in 2012, the problem with a high marginal tax on the most productive income earners remains.
M. Sc (Political science), senior adviser,
Confederation of Danish Industries
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