Taxation and inequality: A revisionary study of changing income inequality in Finland, 1961–2005

ABSTRACT

Income inequality rose rapidly in Finland in the late 1990s and early 2000s. The prevailing discourse attributes this increase to a major tax reform in 1993. However, using time-series analysis and a novel profitability–pay-out metric, the present article argues that a correlation exists between profitability and the income share of the top 1 percent, the latter having been a driver of inequality. The article covers a 45-year period during which profitability and inequality first declined and then rose. The study demonstrates that while taxation has exerted an impact, profitability may also have been a fundamental factor behind changing inequality.

KEYWORDS:

• Income inequality
• profitability
• taxation
• Finland

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 According to Lambert and Thoresen (2012, p. 1), dual income tax has also been discussed in countries such as the UK, US and Canada.

2 Munro, 2012; Prasad, 2012; Slemrod, 1995; Steinmo, 2002; Wilkinson, 1993.

3 See Hietala et al., 2004. A similar reform was enacted in Norway in 2004–6 (see, e.g. Alstadsæter, Kopczuk, & Telle, 2014).

4 Before 1993, capital income was also subject to municipal taxation.

5 ‘Entropy’ refers to the erosion of the tax base via various exceptions granted through changes to the tax code. It dates back to the late nineteenth century and the first temporary tax laws passed in the Diet of the Grand Duchy of Finland. The first semi-permanent income and wealth tax law was passed in 1920. This law already contained a sizeable number of deductions on income-generating expenditure and debt (Statistical Office of Finland, 1926, pp. 2–3, 3–4).

6 See Appendix.

7 The term ‘business tax’ is used here for both non-incorporated businesses (e.g. sole traders and partnerships) and corporations. It should be noted that the tax treatment of these entities has differed throughout the period. In the 1990s and 2000s, sole-trader income, for example, was taxed solely at the owners' end. For partnerships, income was split between capital income and wages. The profits of listed corporations were treated solely as capital income and taxed accordingly (see Appendix).

8 Heino (2015) provides a detailed overview of the preparation and parliamentary discussions around this reform.

9 At the time, Finland purchased most of its crude oil from the USSR at prices which were less responsive to the shock caused by OPEC after the Jom Kippur war. Finnish GDP growth thus contracted not due to a direct price shock but due to a contraction in export demand.

10 The depression sparked a number or research projects on its causes and consequences. Kiander and Vartia (1998) provide a good summary of its ‘lessons’. The question of pre-crisis profitability does not, however, feature prominently in this research. Instead, much emphasis is placed on the role of 1980s fiscal and monetary policies.

11 Figure 4 shows pre-tax time-series from the national accounts. The figures are indices of cumulative year-on-year changes. See Appendix for the effects of tax exemptions on the firms' propensity to show their income in taxation.

12 PRR is described in greater detail in Section 2.

13 See Appendix for the households' capital income structure.

14 I thank Timo Matala of Statistics Finland for these data. Unfortunately, data are not available for the preceding years, nor was the exhaustive data set available for research.

15 For example, in 1968 the sample coverage was around 39 per cent, and the tabulations include all taxpayers in the p99.1–p100 bracket. Even sampling was for taxpayers below this bracket. From 1969, the tabulations have covered practically all individual taxpayers (Statistics Finland, 1972, 1974).

16 In this method, the unadjusted percentile shares are multiplied by $(1+c{)}^{1-1/\alpha }$, where c is the share of the population below the income threshold in the statistic and α is the Pareto alpha estimated using the Blanchet et al. (2017) method.

17 As such, this article does not attempt a Distributional National Accounts (DINA) style data integration (e.g. Garbinti, Goupille-Lebret, & Piketty, 2018). See Appendix for a more detailed description of methodology.

18 For the SNA68 based accounts, see Statistics Finland (1984). For capital stock accounts, see Statistics Finland (1985). The newer national accounts are available via Statistics Finland https://pxnet2.stat.fi/PXWeb/pxweb/en/StatFin/StatFin__kan__vtp/ (accessed on November 19, 2021).

19 The dashed lines give the most likely breaks and the horizontal lines with whiskers provide the 95 per cent confidence intervals.

20 The prominent peak in 1973–5 was ostensibly caused by rapid inflation which resulted in significant increases in the top 1 per cent's wealth tax as the taxable value of underlying property grew. As such, the early 1970s resemble the WWI and WWII years in a number of countries (e.g. Torregrosa-Hetland & Sabaté, 2022).

21 In other words, a VAR in levels was estimated up to the first five lags and the Akaike information criterion (AIC) was then used for choosing the appropriate number of lags, which in this case seems to be two. The ensuing MWald test could not establish the direction of Granger causality.

22 See Appendix on the households' capital income structure.