Nordic Countries: Rich AND Happy Despite High Taxes
Nordic countries take five of the top six places in the world happiness rankings. Only Costa Rica breaks their dominance of the top 6. But, They also have some of the highest tax rates on earth.
Whilst there is a theory, higher tax reduces growth and living standards, the paradox is that as tax rates rise, there’s actually a positive correlation with happiness. Also, if we compare tax rates to GDP per capita there is again a positive correlation. (although there are exceptions too)
So what can explain this paradox? Do countries get rich and then increase tax or can higher tax enable a stronger economy and better living standards?
Tax rose in 1960s and 70s.
It’s important to note, Nordic countries weren’t always high tax. In the 1960s, Denmark, Norway and Sweden had much lower rates of tax. But, generally speaking in the 1970s and 80s, there was a decision to increase taxes and fund a welfare state. It would be a mistake to label this as a move to a socialist economy. There is a thriving private sector, not controlled by government, but whilst the US has lower tax rates and has private health insurance, Nordic countries have a more comprehensive education and welfare state. So the key question is what do you get from higher tax rates? Universal healthcare and more or less universal education. The US spends nearly $15,000 per person on healthcare but does not have universal coverage. Life expectancy is also lower in the US than western Europe. Nordic countries do particularly well.
Another benefit of Nordic countries is that childcare has greater provision. The OECD noted that Swedish families paid around 4% of their income on childcare compared to average of 30% in other OECD countries. Not completely free, but it is a significant benefit, encouraging female participation in the labour market.
Trust
Of course, what works in Nordic countries may not be transferable to over countries. Firstly, there is widespread support for higher tax rates because there are clear benefits. Also, there is a stronger sense of social cohesion and trust. If you look at indexes of corruption, Nordic countries perform strongly, the UK and US have been falling down the league table. There is a single though interesting academic study which suggested that candidates and elected politicians in Finland have higher cognitive and non-cognitive skills than the general population. How much confidence would you have the US elected politicians are more capable than average voter? Stable geniuses aside.
A key aspect of economic growth is the skill levels of workforce and labour productivity. In Nordic countries tuition is generally free for domestic students. This compares to the UK where the state funds only around 30% and the US is much more expensive. Average tuition fees for Harvard can reach $90,000, with the average American student $40,000 in debt. The repayment burden is another hidden tax that affects living standards.
Unemployment benefits
Another interesting comparison is that in Scandinavian countries, unemployment benefit are not particularly more generous but coverage lasts for considerably longer and is combined with mandatory retraining. In fact almost all unemployed Nordics receive support, compared to typically fewer than half in the US. Yet, there is little sense that this leads to higher unemployment. And another comparison between the Nordic model and say the French UK model is that Nordic benefit protects workers rather than protecting jobs. Yet, if a firm does close down, workers have a safety net until they find new work. the point is there isn’t a rush to keep a declining firm in business with subsidies, but rather let firm fail and support the worker.
Hours worked – the key measure?
Also, if you are looking for an explanation for high levels of happiness, perhaps it’s not tax rates and GDP per capita, but hours worked. The Nordic model is based on relatively short working week.
Now an interesting comparison with the UK. Back in the mid 1990s, UK tax as a share of GDP was 29%. But, since then tax as a share of GDP have risen to 36% and is forecast to reach 38-39%, catching up with Nordic levels. But the rise has not been met with electorate approval — in fact UK voters have shifted more in favour of tax cuts.
The reason is it has occurred without any apparent improvement in the welfare state, waiting lists have got longer, tuition fees risen, and working-age benefits fallen behind wages. The UK rise was as much to do with an ageing population, slow growth and crises like Covid. The important thing is Nordic countries increased tax during a period of strong growth, and voters saw a clear return — often reducing household costs like childcare or university.
Low tax – But Rich
There are also examples showing low tax is compatible with good living standards. Switzerland taxes 27% of GDP, but is richer than most Nordics and ranks 10th for happiness. Though Switzerland with a historically large banking system, is rather unique. You could also use example of Ireland with low corporation tax attracting US inward investment. Also, I would be careful of a claim like high tax leads to high living standards because if you took an economy like say India or Mexico, you can’t just bolt a high tax regime onto the economy.
Key Lessons
A key feature of Nordic success is high levels of trust in society. But there are three important lessons. First, higher taxes can complement or even increase prosperity — especially if earmarked for spending which supports the economy and improves household welfare. Secondly, high tax doesn’t necessarily mean a socialist economy. You need private enterprise to generate economic growth, otherwise there is nothing to tax. Nordic countries have relatively low corporation tax, around 20-22%, which combined with strong property rights has encouraged firms that punch above their weight globally. Maersk, Lego, Volvo, Spotify — and recently Novo Nordisk, maker of Ozempic, a real boon to Danish GDP. Third high tax needs general support.
What Kind of Taxes?
When talking about the role of taxes, it is important to ask what kind of taxes do Scandinavian countries use? Apart from Norway, most Nordic countries have abolished wealth taxes. They typically have a VAT rate of 25%, and broad based income and payroll taxes. Also, because Nordic countries are more equitable, the tax revenue is not dependent on a small number of super rich taxpayers. However, another interesting observation is that in terms of countries with the highest marginal rate of income tax, again it is Nordic countries who are quite near the top. Note also, this isn’t a tax on top 1%, it is broad based on average households
In terms of raw materials, did Nordic countries get lucky. Certainly, Norway has built up an impressive Sovereign Wealth Fund, over 1 trillion and the biggest in the world. This came about through careful taxation and use of oil and gas revenues from the North Sea. Ironically, total production of oil and gas is similar between the UK and Norway. But, Norway had two big advantages. Firstly Norway produced more oil and gas when prices were higher. But, there was also a big difference in attitudes. When oil provided the UK with a tax windfall in the early 1980s, Mrs Thatcher’s government prioritised tax cuts and privatisation. Norway set up a sovereign wealth fund for when the fossil fuels run out.
The Nordic model’s weakness is that means taxing ordinary middle earners quite heavily — Denmark’s top rate bites at barely above the average wage, plus 25% VAT — and it needs very high employment to work at all, which ageing populations are steadily undermining. Add sluggish productivity, mobile high earners and capital, some of the developed world’s highest household debt, and immigration straining the political consensus behind universal benefits. None of that means high taxes made these countries poor or miserable — only that the model is more fragile than it looks.
But overall, there is much to like about the Nordic model. It combines the best of private enterprise with a strong welfare state. If you had to choose a country to be born in, it would be a very rational choice. Though the hardest part to copy isn’t the tax rate — it’s the trust.
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