Welfare on the Cheap: Sweden Nibbles at Taxes

AUTHOR Astrid Lindgren is as well-known in her Swedish homeland for her caustic satire on high taxes, which helped bring down the Social Democratic government in 1976, as she is for her tales about the mischievous Pippi Longstocking.

Right before parliamentary elections that fall, Ms. Lindgren published a biting newspaper article criticizing the Swedish tax system. She wrote that she had earned so much money the previous year that she ended up owing 103 percent of her annual earnings in tax.

"The article was formally correct, although she could have had a partial refund the next year," says Danne Nordling, chief economist at the Taxpayers' Association, a group that lobbies for lower taxes. But her article so enraged readers "that the new bourgeois government came to power mainly due to her."

These days, while taxes are significantly lower than 20 years ago, Swedes still pay much higher taxes than their American counterparts pay. While the average income-tax rate is 30 percent, Swedes earning more than 220,000 krona (about $32,000) annually pay about 58 percent of their income in combined local and national tax.

No free smorgasbord

What do all these taxes help pay for? For decades, Swedes could rely on the state for free education, heavily subsidized medical care, and a relatively generous pension. Maternity and paternity leaves were paid for by the state, as well as virtually unlimited sick-day benefits and monthly child allowances, regardless of family income.

But this generosity clashes with the bottom line: Unemployment, for years about 1 percent, has climbed to 10 percent. The gross domestic product has dropped 6 percent in real terms, and the interest rate on the national debt threatens to take over other expenditures.

"We don't like the words 'welfare state' because to a US audience it has a bad connotation," says Knute Rexed, the Finance Ministry's chief economist. "But we don't want to retreat from welfare-state ambitions. We say if we want this system to be sustainable, we have to go back to Social Democratic tenets. That means a balanced budget."

Some see revising the tax system as a start to reaching that balanced budget by boosting private enterprise and the economy. In 1990, the Swedish tax system was reformed in an attempt to lower rates and broaden the base. The number of deductions was reduced, taxation of capital was made uniform to encourage savings, and net wealth tax on businesses was abolished.

Many wealthy Swedes who had chosen to live permanently abroad to escape the tax system are now returning home. Ms. Lindgren never left, but film director Ingmar Bergman, who resided in Germany for years after reportedly owing 110 percent of his income in taxes one year, has returned - along with many business people.

But now, with the country facing increased unemployment, a substantial budget deficit, and a rising national debt, taxes are set to rise again.

Entrepreneurs losing heart

For people like Ulrika Merkle, a young dentist who recently set up her own private practice, a tax hike could sting. "When you have an office like this, first you have to pay tax for each employee, and then your own tax. So it's very expensive to have employees, as you end up paying 36 percent on their paycheck," she says from her busy clinic in central Stockholm. "That's why people who have their own companies try to do most of the work themselves."

She adds that she doesn't try to work extra hours, because she feels that taxes eat up any additional money she would earn. "And I don't like the fact that I've studied so many years and don't get a higher salary than those who haven't," she says.

Critics of Sweden's welfare state say this problem is not just due to taxes, but to the extravagant benefits citizens receive. "Swedes can make more money by having kids than working, because they get child allowances for 18 years," adds an American journalist based in Stockholm. "The system here gives you every incentive to milk the system every way you can."

Some of the cuts over the last five years have had an undesirable effect, however. When the former center-right coalition government slashed compensation for illness, for example, unemployment shot up.

"Three years ago, there were always many people on sick leave, labor leave, student leave, baby leave, even hunting leave. Enterprises that needed 100 people had hired 125," says Martin Lindstahl, senior vice president of the Swedish Trade Council. "But when the crisis came, they all came back to work. So they had to fire one-fifth of the work force."

Mr. Nordling of the Taxpayers' Association says that at least cutting taxes can help shift some of the burden off entrepreneurs like Ms. Merkle, the dentist. The government, he says, receives funds not by strengthening the economy but by devising ingenious new ways to tax private citizens.

"They take taxes on everything now. For example, they now want to tax homeowners," he laments. "Politicians want to raise taxes on houses because, unlike capital, houses cannot travel abroad."