Wednesday, July 25, 2007

The Problem With Ad Hoc Tax Cuts

The Swedish centre-right government wants to increase employment. And it realizes that this is done most effectively by reducing taxes. So far, so good, in other words. The problem is that it remains unwilling to significantly reduce government spending. And to the extent the burden of spending for structural and cyclical reasons falls, it seems committed to using this to run large surpluses and pay off the government debt.

And so, it is not willing to commit to any significant across the board tax cuts. But how then will they be able to increase employment through tax cuts? Well, radical libertarian turned centrist technocrat finance minister Anders Borg probably thinks he is a real brilliant economist by coming up with the idea of targeted tax cuts to specific sectors. Labor cost sensitivity is higher in some sectors compared to others, mainly due to the fact that some are more labor intensive than others and the related fact that some products and services can more easily be done by consumers themselves or within the unofficial sectors. For example, you can cut your own hair or have a friend or relative do it, but you could hardly build your own car. And so, Borg probably thinks he is really smart by targeting the tax cuts to just specific sectors.

And well, targeted tax cuts to these sectors are indeed likely to generate more jobs than across the board tax cuts of a similar amount. The problem is that while it may "work" in that sense, this solution will have negative side effects that wouldn't have appeared with across the board tax cuts. First of all, it will lower productivity as it in effect means extra punitive taxation of more capital intensive sectors. And while consumers may not be able to build cars themselves, they can always substitute Swedish cars with foreign cars.

And secondly, this new special rules will create lots of extra bureaucracy, red tape and complications for small businesses. As is highlighted in this Dagens Industri-article, just about all organizations reject the proposal on precisely the massive amount of extra red tape for businesses. For example car mechanics will get tax relief when they fix cars-but not when they fix buses- Cafes will get tax relief except when they sell bread and so on.

It is time for the Swedish government to show that they really are different from the Social Democrats-and implement more broad based tax cuts financed by real spending cuts-something which would be unequivocally good and make the pick-up in Swedish growth more sustainable.


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