The Power of Economists within the State 9781503601857

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The Power of Economists within the State

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The Power of Economists within the State

Johan Christensen

Stanford University Press Stanford, California

Stanford University Press Stanford, California © 2017 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, or in any information storage or retrieval system without the prior written permission of Stanford University Press. Printed in the United States of America on acid-free, archival-quality paper Library of Congress Cataloging-in-Publication Data Names: Christensen, Johan, author. Title: The power of economists within the state / Johan Christensen. Description: Stanford, California : Stanford University Press, 2017. | Includes bibliographical references and index. Identifiers: LCCN 2016029014 (print) | LCCN 2016030429 (ebook) | ISBN 9781503600492 (cloth : alk. paper) | ISBN 9781503601857 (ebook) Subjects: LCSH: Economic policy—Case studies. | Fiscal policy—Case studies. | Economists— Political activity. | New Zealand—Economic policy. | Ireland—Economic policy. | Norway— Economic policy. | Denmark—Economic policy. Classification: LCC HD87 .C479 2017 (print) | LCC HD87 (ebook) | DDC 330.9—dc23 LC record available at https://lccn.loc.gov/2016029014 Typeset by Thompson Type in 10.25/15 Brill

Contents

List of Tables and Figures

vii

Acknowledgments ix

1 Economists and Market-Conforming Reform 2 The New Economics and Politics of Taxation 3 New Zealand: Plotting a Market-Oriented Revolution 4 Ireland: Populist Politics in a Generalist System

1 29 55 81

5 Norway: Economic Experts in the Social-Democratic State 6 Denmark: Equality before Efficiency, Politicians before Experts

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Appendix: List of Interviews

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181

Notes 185 Bibliography 193 Index 209

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List of Tables and Figures

Tables 1.1 Expectations about causal processes 2.1 Top statutory personal income tax rates, 1981–2010: Selected countries 2.2 Total tax revenues as a percentage of GDP, 1980–2010: Selected countries 2.3 Deductions, allowance, and credits in the personal income tax base, 2007 A.1 List of interviews

26 41 42 47 181

Figures 1.1 Theoretical model 22 2.1 Composition of tax revenues in the OECD countries (average), 2009 32 2.2 Top statutory tax rates on labor income, 1980–2010 44 2.3 Top statutory tax rates on labor and thresholds for top rates, 2009 45 2.4 Average tax wedge on labor for single workers without children at average earnings, 1980–2010 46 2.5 Revenues from value-added taxes as a percentage of total tax revenues, 1980–2010 48 2.6 Value-added tax rates and bases, 2008 49 2.7 Top statutory tax rates on corporate income, dividend income, interest income, and wage income, 2005 51 2.8 Total tax revenues as a percentage of GDP, 1980–2010 53

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Acknowledgments

I

WOULD like to thank all the people who contributed to this book. At the ­European University Institute, Sven Steinmo provided me with great ideas and advice at crucial stages in this project and stimulated me to develop what turned into the core argument of this book. I am also grateful to my colleagues in Florence for the many discussions about the project, in particular Emre Bayram, Pelle Moos, Anna auf dem Brinke, Michael Grätz, Charlotte Haberstroh, Tamara Popic, Raphael Reinke, and Julian Schwartzkopff. Pepper Culpepper, R. Kent Weaver, and Niamh Hardiman also gave me excellent comments and ideas about how to take the project further. At Stanford University, Mark Granovetter provided me with encouraging feedback and invaluable advice about how to turn this into a book. I am also grateful to Woody Powell, Mitchell Stevens, and everyone else at SCANCOR for offering a stimulating academic environment and giving me the time to complete the book. I also benefited from discussions with Paolo Parigi and the graduate students in the Sociology Department. Furthermore, special thanks go to the three reviewers—John L. Campbell, Monica Prasad, and Elizabeth Popp Berman—whose critical engagement and extensive comments greatly improved the book. This study could not have been carried out without the kind cooperation of my interviewees. In all the four countries examined in this book, policy makers were more than willing to share their experiences and insights into the processes behind tax policy change. I am equally grateful to the institutions that hosted me while I was carrying out interviews. At the University College Dublin, Niamh Hardiman, Muiris MacCarthaigh, and Brian Nolan provided valuable contacts and comments as I was carrying out my inquiries. In Copenhagen, the Department of Political Science at the University of Copenhagen offered me an office, and Lotte Jensen at the Copenhagen Business School helped me with contacts. In Oslo, Fafo Institute for Labour and Social Research and director ix

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Acknowledgments

Jon M. Hippe provided support throughout the project. In Wellington, the Centre for Accounting, Governance and Taxation Research at the Victoria University became a home away from home, thanks to David White and Vanessa Borg, whose generosity made my stay in New Zealand a very happy one. I am also grateful to Margo Beth Fleming at Stanford University Press for believing in this project and for helping me navigate the publishing process, to James Holt for his assistance with the manuscript, and to Margaret Pinette for excellent editing. Finally, I thank my parents and my sister for their support. And most of all, I would like to thank my wife Elisa for her constant support and encouragement, but most important, for all the good times we have had while this book was in the making.

The Power of Economists within the State

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Chapter 1

Economists and Market-Conforming Reform

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RELAND had already undone itself before the global recession did. In 2007—a year before the onset of the international financial crisis—the Irish property bubble burst, and real estate prices that had been growing rapidly for two decades started to plummet. So did the tax receipts from property transactions, which suffered a drop of 36 percent in 2008. The loss of tax revenue marked the beginning of the Irish fiscal and economic crisis. The meltdown that followed was of historical proportions. Between 2007 and 2010, GDP (gross domestic product) fell by 12 percent, unemployment tripled—from less than 5 percent to almost 14 percent—and a generous bank bailout produced a sovereign debt crisis that forced the Irish government to accept a rescue package from the European Union (EU) and the International Monetary Fund (IMF). The country once known as the “Celtic Tiger”—renowned for its remarkable economic growth from the mid-1990s onwards—was reduced to one of the “P.I.I.G.S.,” (Portugal, Ireland, Italy, Greece, and Spain), figuring alongside the debt-ridden economies of Southern Europe. Ireland’s spectacular boom and bust were intimately linked to the tax policies pursued by Irish governments. Usually the story is cast in market-oriented terms: Irish policy makers used a very low corporate tax rate to attract foreign direct investments and cut taxes on labor to create incentives for enterprise and growth. Yet, a closer look at the Irish case shows that this narrative is misleading. The tax policies pursued by Irish governments from 1980 onwards were not attuned for the most part to market principles; they ran directly counter to them. Whereas conformity to markets implied level playing fields and taxation that was neutral with respect to economic behavior, Irish tax policy was geared toward directing and influencing—economists would say “distorting”—the economic choices of households, businesses, and investors. The most striking evidence of this was the Irish property boom, which was driven partly by a wide 1

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array of specific tax breaks for investments in the construction of everything from hotels and seaside resorts to multistory car parks and sports clinics. In fact, the tax policies of Irish governments bore a strong resemblance to the interventionist tax schemes that were popular around the world in the 1960s and 1970s. The Irish tax regime was profoundly different from the policies of another small Anglo-Saxon country on the other side of the globe. New Zealand, to many observers, was the textbook case for the use of market principles in public policies. In the 1980s, it went further than any other advanced economy in lowering tax rates and eliminating exemptions, deductions, and loopholes from the tax code. In stark contrast to Ireland, the governing principle in New Zealand was that the tax system should influence economic choices as little as possible. This principle was applied with remarkable rigor. For instance, New Zealand was the only developed country without tax incentives for private retirement savings and without any exemptions from its value-added tax. The differences in tax policy among the Scandinavian countries were equally puzzling. Despite its social democratic credentials, Norway adopted a major market-oriented reform of taxation in 1992. Though more moderate in scope than in New Zealand, the reform lowered the top statutory tax rate on labor considerably and introduced a system that was neutral with respect to a number of economic decisions. At the same time, the Norwegian tax system retained features that ran counter to market principles, in particular a very favorable tax regime for housing. Denmark, on the other hand, resisted market-conforming tax policies for a very long time. Despite a series of policy revisions in the 1980s and 1990s, Denmark maintained remarkably high marginal tax rates on labor and high and uneven rates on different types of capital income. As recently as in 2009, a Danish worker on just above average wages paid 63 percent of the last krone she earned in total taxes on labor—that is, 12 percentage points more than in Norway and almost twice as much as in New Zealand. These brief presentations raise a general question of interest to students of political economy, public policy, and economic sociology alike: Why do some advanced capitalist countries go further than others in adopting market-­ conforming policies? Why do some states seek to achieve economic growth through policies that emphasize economic efficiency and level playing fields while others pursue prosperity by stimulating specific economic sectors and activities? The book addresses this broad query by looking at one of the main areas of market-oriented reform from 1980 onwards. Taxation was at the center of ef-

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forts to restructure the economic systems of advanced economies in this period due to its critical role in financing the activities of the state and its impact on the workings of the economy. The tax reforms enacted by Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States were powerful symbols of the broader movement toward a greater role for markets in public policy. Market-conforming tax policies, as I conceptualize them, entailed the reduction of marginal tax rates, the removal of tax breaks and more uniform taxation of different types of income and assets—all changes that were meant to stimulate the free operation of markets and an efficient allocation of resources. (See the following pages for a more extended discussion of the concept.) Both technical and highly politicized, the field of taxation provides fertile terrain for exploring the politics behind the turn to the market in public policy. This book offers an in-depth account of the driving forces behind market-conforming policies based on a comparative analysis of the actors and institutions that formed tax policy across a carefully selected set of small, developed countries—New Zealand, Ireland, Norway, and Denmark—over the period from 1980 to 2010. Whereas previous scholarship has pointed to political parties, production regimes, and political institutions as determinants of the adoption of marketconforming policies, this book highlights the role of economic experts within the state. The core argument of the book is that the varying degree of marketoriented reform to an important extent reflected the historical institutionalization of economic expertise in state bureaucracies. Market-oriented policies were adopted in some places and not in others not only because of differences in governing parties, economic structures, or legislative institutions but also because the institutional entrenchment of the experts that advocated neoclassical economic ideas varied dramatically across countries. Economic knowledge had a potentially profound impact on the adoption of market-conforming policies, I argue, yet this impact depended crucially on the position established by economic experts inside the state. This argument points to the interaction between professional groups and administrative institutions as determinant of public policies. Highly trained experts often occupy strategic positions within government bureaucracies from which they may pursue professionally defined policy agendas, and they possess knowledge resources that they can leverage vis-à-vis elected politicians. At the same time, professional groups penetrate state bureaucracies to different degrees. The position of experts varies across both countries and organizations,

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depending not only on functional tasks but also on political-administrative struggles over the proper role of different forms of knowledge in managing the affairs of the state. This book thus puts forward a contingent argument about the institutional role and policy impact of a specific form of professional knowledge, namely economic expertise. This argument joins a growing literature about the role of the economics profession in the diffusion of market-oriented policies.

Economists and the Turn toward the Market in Public Policies The worldwide liberalization of economic policies has been one of the defining political-economic trends of the late twentieth and early twenty-first centuries (see, for example, Simmons, Dobbin, and Garrett 2006). Governments around the globe have adopted a wide array of reforms aimed at achieving economic gains by allowing markets to operate more freely. These policies include the deregulation of product markets, labor markets, and financial markets; the liberalization of trade; the corporatization and privatization of state entities; and low-rate, broad-base tax reform. A growing body of literature sees the “ubiquitous rise of economists” as one of the principal drivers behind these reforms (Markoff and Montecinos 1993; Bockman and Eyal 2002; Fourcade Gourinchas and Babb 2002; Babb 2004; Fourcade 2006, 2009; Chwieroth 2009; Reay 2012). This mostly sociological literature highlights that economics has become a “global profession” within which ideas and practices spread rapidly across national borders (Fourcade 2006). The transnational economics discipline has been characterized by an “overwhelming domination of U.S.-based scholars, scholarship, and institutions” (Fourcade 2009: 256). The field has been led by a small group of top American economics departments including MIT, Chicago, Harvard, Yale, Berkeley, Stanford, and Princeton (Chwieroth 2007: 11–12). From the 1950s onwards, these institutions led the way in what is often described as a “paradigm shift” from Keynesian to neoclassical economics. This included the emergence of monetarism, “rational expectations” and microfoundations in macroeconomic theory, as well as new economic theory in fields such as taxation, labor, and finance. With the advent of neoclassical economics, the substantive focus of the discipline shifted from the demand side toward the supply side of the economy and from macroeconomic issues toward microeconomic questions. Moreover, formal modeling based on sophisticated mathematics emerged as the domi-

Economists and Market-Conforming Reform

5

nant and unifying methodological approach (Colander 2000; Fourcade 2009: ch. 2). To be sure, this paradigm shift was neither sudden nor complete, and substantive differences over policy remained (cf. Campbell and Pedersen 2014). Yet, modern neoclassical economics is widely regarded as “the most coherent and well-bounded scholarly enterprise in the social scientific field” (Fourcade 2009: 3), with broad consensus around basic assumptions and methodological techniques (see, for example, Reay 2012 on the “flexible unity of economics”). An important channel for the diffusion of market-oriented policies has been the growing role of economists trained in U.S.-style neoclassical theory both in international organizations like the IMF (Evans and Finnemore 2001; Chwieroth 2009) and in national governments—especially in developing countries such as Chile (Montecinos 1998), Mexico (Centeno 1997; Babb 2004), and the Eastern European states (Bockman and Eyal 2002) but also in developed economies like Australia (Pusey 1991) and Italy (Quaglia 2005). Yet, as Marion Fourcade has pointed out, the ascent of the economics profession has varied greatly across states: “Economic knowledge gets entrenched with different force across countries, in different places and institutions, and for different purposes, and its very substance can also differ in subtle ways” (Fourcade 2009: 261). Moreover, she links the varying role of economists to national differences in the political-administrative order, that is, in the “organization and exercise of ‘government’” (247). My argument builds on this literature by stressing the role of economists in bringing about market-oriented reform and the importance of administrative institutions in shaping the role of economic experts. But it also makes two novel contributions. First, it makes the link between the role of neoclassical economists as agents of market-oriented reform at the end of the twentieth century and the buildup of economic expertise in government bureaucracies during the Keynesian era. As I will show, the institutional position and authority granted to Keynesian economists in the postwar decades was crucial for the later adoption of neoclassical economic perspectives within the state. Ironically, the ties established between government ministries and the economics discipline during the Keynesian era later served as channels for the diffusion of new economic ideas that prescribed market-oriented reform. Second, I extend the discussion about the influence of economists into the realm of public administration. For all its emphasis on the power of economic “technocrats,” the sociological literature has paid surprisingly little attention to

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the issue of how economists influence policy through public bureaucracies. Although this literature suggests several sources of policy power for economic experts, it says little about how economists act in the policy process and about the ideas and norms that underpin their administrative behavior. I address these issues by drawing on insights from the state and bureaucracy literatures. As laid out in detail later in the chapter, I argue that the particular expertise, ideology, and norms of neoclassical economists shaped their administrative behavior in ways that were conducive to greater influence in policy making. This argument sheds new light on the question, raised by academics and casual observers alike, of why economists have become so influential in the formulation of contemporary public policies.

Market-Conforming Tax Policies The broad shift from state interventionism toward social and economic policies that emphasize the role of markets has been given many labels, including “neoliberal,” “Washington consensus,” “free-market,” “market friendly,” and “market conforming.” Although there is clearly much overlap among these concepts, I prefer to use the more specific term market conforming to describe the policies investigated in this book. By market-conforming policies I mean policies that conform to the free operation of markets and that aim to ensure an efficient allocation of resources.1 Conformity to markets in public policy implies that governments, instead of intervening directly in the economic choices of businesses and individuals, rely on market mechanisms to achieve economic goals. Significantly, this does not mean that states retreat from economic management but rather that they “enlist” the market in governing the economy (Krippner 2007; Schmidt and Woll 2013). Indeed, it is often shown that the deregulation of markets is accompanied by the introduction of new sets of rules to ensure that the freer markets operate properly (for example, Vogel 1996). In the field of taxation, market-conforming or market-based policies are usually identified with the lowering of tax rates, the broadening of tax bases, and the removal of tax distortions to economic behavior (Steinmo 1993, 2003; Swank 1998, 2006; Boix 1998). In line with this understanding, I operationalize market-conforming tax policies as consisting of three elements: the reduction of marginal tax rates, the broadening of tax bases through the removal of deductions and exemptions, and more uniform taxation of different types of income and assets. One could object that market-conforming policies also involve lower-

Economists and Market-Conforming Reform

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ing the overall level of taxation to reduce the role of the state in the economy. However, I maintain that limiting the size of government is a separate issue that should not be conflated with the orientation toward the market in public policy. Market-conforming taxation is not about reducing the level of revenue but rather about collecting a given amount of revenue in a way that entails the fewest possible distortions to the allocation of resources. An advantage of this more restricted definition of market-conforming tax policies is that it distinguishes between tax reforms that combined reduced rates with the removal of tax deductions and the closing of loopholes—such as the 1986 U.S. Tax Reform Act—and reforms that cut rates at the same time as expanding tax breaks—such as the 1981 U.S. Economic Recovery Tax Act. As tax experts Joel Slemrod and Jon Bakija point out, the “underlying philosophies [of these reforms] were vastly different and in some ways contradictory” (Slemrod and Bakija 2004: 24). Whereas the former type of reforms was aimed at generating efficiency, the latter type was at odds with notions about an efficient allocation of resources. This distinction is obscured in some important studies of tax reform, such as Monica Prasad’s comparative analysis of free-market reforms in the United States, the UK, France, and Germany (Prasad 2006). The definition employed in the present study allows us to separate the two, with only the first type of reforms being classified as market conforming. Yet, why do these reforms warrant our attention? Some would claim that low-rate, broad-base tax reforms were narrow, technical policy changes, which favored a role for economic experts and never generated much political opposition. Because these reforms were often broadly revenue neutral, they did not fundamentally change the parameters of the state. This view is inaccurate for several reasons. First, low-rate, broad-base reforms were often major policy events: In many places they constituted the most fundamental changes to tax systems in a generation or more. The 1986 U.S. tax reform and the Swedish “tax reform of the century” in 1991 are good examples of this (Steinmo 1993). Second, even if some aspects of these reforms were highly technical, the main lines were not. Reductions in tax rates and the removal of deductions were things most taxpayers could relate to. Tax policy is arguably more visible and politicized than other areas of economic policy, such as monetary policy or financial market regulation. For instance, Hirschman and Berman characterize tax policy as a “well-defined, highly public and partisan [issue]” where “economists should have less direct influence” (Hirschman and Berman 2014: 784). Third,

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a­ lthough this type of reform left room for political agreement, it also encountered staunch opposition in many quarters. The removal of tax breaks was opposed by businesses that benefited from special incentives; the lowering of top tax rates met resistance from low income earners and leftist parties; and the curtailment of deductions for home ownership, pension savings, and the like was often wildly unpopular. Finally, even if the reforms did not dramatically alter the size of the state, they did entail a new role for the state in the economy. With the reforms, the state abandoned its role in actively directing the flow of investment to priority industries and socially desirable ends, and it lowered its ambitions for redistribution and social policy provision through the tax system. In other words, market-conforming tax reforms constituted politically contested and economically consequential changes to a core area of social and economic policy.

Conventional Accounts: Ideas, Interests, and Institutions The existing literature offers a series of explanations for the adoption of marketconforming policies. I here review three types of conventional accounts, which emphasize, respectively, ideas, political parties and interest groups, and political institutions. In the standard ideational account, market-oriented reforms of taxation represented a “shift in policy paradigm” (Swank and Steinmo 2002: 643), that is, a fundamental change in the ideas of policy makers about the goals and instruments of policy (cf. Hall 1993: 279). The belief that tax policy could be used to achieve industrial and redistributive policy goals by influencing economic behavior was abandoned in favor of the idea that the tax system should be neutral with respect to economic choices to generate an efficient allocation of resources (Steinmo 2003: 213–226). The key policy prescriptions were to lower tax rates at the same time as broadening the base on which taxes were levied. The basic ideational argument is that market-oriented tax reforms around the world were the result of policy learning and the spread of new economic ideas about tax policy from the United States (Steinmo 2003: 209). Yet, although this account is persuasive as an explanation for the common trend toward marketconforming policies, it offers little help in understanding why these policy prescriptions were much more influential in some places than in others. A potential explanation for the uneven spread of ideas can be found in the literature on policy diffusion. In one prominent model, the diffusion of a given

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policy through learning or imitation depends on geographical or sociocultural proximity (for example, Weyland 2005; see Simmons, Dobbin, and Garrett 2006 for a review). Diffusion “happens among groups of peers who share information and whose experiences are more relevant to each other—among neighbors, cultural groups, or states at the same level of development” (Simmons, Dobbin, and Garrett 2006: 798). Countries are more likely to adopt policy ideas from countries that are close to them in terms of geography, language, history, or religion, which would lead us to expect market-oriented policies to spread more easily from the United States to Anglo-Saxon countries than to Scandinavian or Continental European states. However, a problem with this model is that it puts little emphasis on the necessary role of actors in carrying ideas and turning them into policy. Diffusion is supposed to occur between “countries” that learn from or mimic their “peers.” But the concrete lines of transmission are missing. Another problem is that the model disregards national institutional contexts. By treating the adopting states as black boxes, the model glosses over the fact that states are complex decision-making systems that vary in their institutional makeup. An ideational approach that does take the issues of agency and institutional context seriously is John Campbell and Ove Kai Pedersen’s argument about “knowledge regimes” (Campbell and Pedersen 2011, 2014). They contend that the diffusion of neoliberalism is meditated by “the organizational and institutional machinery that generates data, research, policy recommendations and other ideas that influence public debate and policymaking,” what they refer to as a knowledge regime (Campbell and Pedersen 2014: 3). This includes “policy research organizations like think tanks, government research units, political party foundations, and others that produce and disseminate policy ideas” (3). Campbell and Pedersen’s claim that the organization of knowledge matters for the adoption of economic policy ideas is important and very much in line with the argument of this book. However, their emphasis on the whole range of policy research organizations draws the attention away from the primary importance of ministerial bureaucracies (beyond their research units) for the adoption of new policy ideas. Which knowledge structures and actors are most significant is of course an empirical question. But a priori there are good reasons to believe that location matters: Experts in top bureaucratic positions are likely to have a more direct influence on policy making than experts in independent policy research organizations (Halligan 1995). Not only do bureaucrats

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have privileged access to politicians, they are also intimately involved in the actual drafting of policy. A second set of explanations for variation in the adoption of market-­ conforming policies emphasizes political parties and interest groups. A prominent exponent for the partisan account is Carles Boix, who argues that the “ideological preferences of the party in power” are the key determinants of “which ‘competitive strategy’ countries embrace to affect the supply conditions of the economy” (Boix 1998: 3). The different objectives of parties lead them to choose widely different economic policies. Right parties want to maximize economic growth and protect economic liberties and therefore pursue market-­conforming tax policies, whereas left parties seeking to modify market outcomes and redistribute wealth prefer more interventionist policies (Boix 1998: 3–4). In the same vein, Duane Swank argues that right governments are more likely than left governments to adopt market-conforming tax policies because they see greater economic and electoral benefits from this kind of reform (Swank 2006: 856–857). These partisan accounts have two important flaws. First, they build on a simplistic conception of policy making. In the party narrative, tax policy decisions directly reflect the policy preferences and strategic calculations of politicians. Yet, real-world policy making is far more complex, as politicians interact with bureaucrats, outside experts, and other stakeholders who bring their own knowledge and policy ideas to the table. Second, the stylized tax policy preferences of the left and the right bear little resemblance to the actual positions of political parties. In many places, the issue of market-conforming tax reform cut across the left–right cleavage (for example, Steinmo 1993; Patashnik 2008). On the left, some saw lower rates and broader bases as a means to improve the functioning of the economy and increase fairness, whereas others held on to high tax rates on top incomes and capital as a tool for ensuring redistribution and social solidarity. On the right, politicians embraced the prospect of lower rates but were reluctant to give up the benefits for individuals and businesses related to deductions and specific tax incentives. Tax policy preferences were thus far more complex than portrayed by the partisan accounts, and so were the politics of taxation. Other accounts see business groups as the protagonists of market-oriented reform. One version of this argument is the varieties of capitalism (VoC) perspective, which affirms that there are two distinct and stable forms of capital-

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ism: liberal market economies (LMEs), where businesses coordinate through markets and the public sector plays a limited role, and coordinated market economies (CMEs), where businesses coordinate at the sectoral or national level and the state intervenes actively in industrial and social policy (Hall and Soskice 2001). In VoC accounts, firms are the crucial actors in producing lasting differences between countries belonging to the two varieties of capitalism. The policy preferences of firms are conditioned by the production regime and therefore vary systematically between CMEs and LMEs. Whereas businesses in liberal economies support liberalization, businesses in coordinated economies see liberalization as detrimental to the political-economic institutions on which they depend (for example, Hall and Thelen 2009: 21). In the area of taxation, Duane Swank argues that CMEs are less likely to adopt market-conforming tax reforms than LMEs because in CMEs interventionist tax policies are integral to state promotion of long-term growth and high marginal tax rates on capital and employers are necessary to maintain social solidarity (Swank 2006: 858). The VoC framework is useful for understanding some of the persistent differences between LMEs and CMEs, such as the higher total tax level in the social-­democratic countries than in the liberal economies. However, it has trouble explaining change that is incoherent with the existing regime. The emphasis on the complementarities between the institutions of the political economy seems to preclude the enactment of liberal policies in a coordinated economy and vice versa (see, for example, Streeck 2005). This weakness can be related to the primary role attributed to firms in the VoC framework. For reasons well specified in this literature, firms are unlikely to push for path-breaking changes in political-economic institutions. At the same time, the VoC literature downplays the role of other actors who arguably are more capable of enacting fundamental change, such as state actors. Yet, it does not put forward a convincing argument for why the adaptations of firms excludes a potent role for the state (see, for example, Hall and Thelen 2009: 16–17). This exclusion deprives the VoC perspective of an important source of change and incoherence. Finally, the degree of market-oriented reform has been attributed to political institutions. The thin version of the argument is that political institutions with fewer “veto players” permit a greater extent of reform (Tsebelis 1995; for an application to tax policy, see Ganghof 2006). Veto players are actors whose agreement is necessary to change the status quo, and they can be either institutional (for example, chambers in parliament) or partisan (such as political

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parties needed for a majority). In systems with only one veto player, a governing majority can enact its policy proposals without facing institutional barriers or resistance from coalition partners. The veto player framework is undoubtedly useful for understanding differences in the prospects for policy change. At the same time, it can tell us very little about the initial motivation for change or the direction of reform, that is, why reform took a market-conforming or interventionist course. Another version of the institutional argument is more relevant for our purposes. Relying on a thicker notion of institutions, Sven Steinmo contends that political institutions shape the roles, strategies, and preferences of actors in policy making. “Different decision-making systems,” argues Steinmo, “have profoundly shaped the formulation of tax policy [by influencing] who dominates the tax policy-making process, the strategic choices and ultimately the policy preferences of these same actors” (Steinmo 1993: 10). Yet, the major shortcoming of this argument is that it does not specify which institutions matter and exactly how they shape preferences, strategies, and roles in policy making. The theoretical framework presented in the following pages seeks to provide a more elaborate response to these questions.

Economists and the State The argument of the book diverges from these conventional accounts by emphasizing the role of economists within the state as drivers of market-oriented reform. It starts from the basic premise that economists can be important policy actors. Economists produce and carry knowledge and ideas about economic policy that help political leaders address societal challenges and possess professional authority that confers legitimacy on their proposals. From the 1970s onwards, neoclassical economic experts were important providers of ideas about market-conforming policies. Yet, the argument highlights that the policy influence of economists depends crucially on their position within state bureaucracies. Due to historical differences in the institutionalization of economic knowledge, economists in some places occupied strategic positions at the center of the state, whereas in other places they remained at the margins of the administrative system. These differences, I contend, contributed to the cross-national variation in the adoption of market-conforming policies. This account of market-oriented reform differs in significant ways from the ones discussed earlier: Although it shares the ideational literature’s attention to economic ideas, it is more focused on the actors that carry and advocate these

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ideas. And although it follows the “knowledge regime” literature in the emphasis on the organization of knowledge, it concentrates on economists inside rather than outside the state. The argument also echoes institutionalist insights about the impact of political-administrative structures, but it goes beyond this in its focus on the agency of professional groups operating within institutions. At the same time, this argument joins a growing body of scholarship about the impact of economic experts and the organizations they inhabit on the spread of ideas and policies (Babb 2004; Fourcade 2006, 2009; Chwieroth 2009; Hirschman and Berman 2014). Following this literature, my argument builds on theory from the sociology of professions and organizations. But it also draws on the original insights of the state-centered literature of the 1980s (Skocpol 1985; Weir and Skocpol 1985) as well as related work within public administration (Carpenter 2001). As such, the argument combines what Peter Hall has called “economist-centered” and “state-centered” approaches (Hall 1989a). In the theoretical framework presented over the following pages, I first discuss how professions like economics emerge, reproduce, and transform within the state, and then go on to discuss the power of economists in policy making within public bureaucracies.

The Rise of the Economics Profession within the State

Professions, according to Andrew Abbott, are “exclusive occupational groups applying somewhat abstract knowledge to particular cases” (Abbott 1988: 8). What distinguishes professions from other social groups is that they possess some special skill acquired through extensive training and rooted in an abstract system of knowledge. This special expertise is the basis for the position of professions in society. Whereas earlier theories said that professions have power and prestige because their knowledge corresponds to central needs of society, scholars like Eliot Freidson and Magali Larson have argued that professional power is based on “gain[ing] support from strategic social or political groups” (Larson 1979: xiii; see also Freidson 1970). In other words, professions seek to persuade groups in power that their special competences are instrumental to achieving salient political goals. The emergence of professions within the state therefore depends on the sponsorship of political or administrative elites. Professions “originally emerge by the grace of powerful protectors” (Larson 1979: xii), and their privileged role is “secured by the political and economic influence of the elite which sponsors

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[them]” (Freidson 1970: 73). This does not mean that professions are forever dependent on their original sponsors. Once a professional group has obtained a stable position in the state apparatus, it can use this position to pursue its own goals. As Larson puts it, “Professions gain autonomy: in this protected position, they can develop with increasing independence from the ideology of the dominant social elites” (Larson 1979: xii). The reproduction of professions within the organizations of the state depends in large part on the “filtering of personnel” on professional criteria (DiMaggio and Powell 1983: 152). This entails that staff is recruited and promoted mainly on the basis of academic qualifications rather than on attributes such as seniority or administrative experience. Recruitment based on a common professional training ensures that new organization members share the basic skills, way of thinking, and behavioral norms of their colleagues: To the extent managers and key staff are drawn from the same universities and filtered on a common set of attributes, they will tend to view problems in a similar fashion, see the same policies, procedures and structures as normatively sanctioned and legitimated, and approach decisions in much the same way. (DiMaggio and Powell 1983: 153)

But at the same time as being a mechanism of reproduction, recruitment of newly educated professionals is a source of innovation and change. The transformation of a profession is usually triggered by ideational changes at its core. The central tenets and beliefs of an academic profession are not set in stone; they change over time through what has been described as a process of “scientific revolutions” or “paradigm shifts” (Kuhn 1962).2 When basic assumptions and principles change at the center of a profession, this can be expected to stimulate ideational change among its broader membership. New ways of thinking spread from the academic core to the periphery of professionals working in a wide array of organizations, including state bureaucracies. The channels of diffusion are much the same as the ones that generate reproduction, namely academic training and professional networks (cf. DiMaggio and Powell 1983: 152). New approaches taught in academic courses are picked up by graduate students who subsequently get jobs in the outside world. And novel ideas spread within networks of professionals that cut across organizational boundaries, through journals, conferences, and other forms of knowledge exchange. To be sure, the diffusion of a new paradigm in the social sciences is neither sudden nor complete. It is a gradual process that often unfolds over decades

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and that rarely affects every part of the profession. Existing ideas often persevere in parts of the discipline and blend with approaches within the new paradigm. Campbell and Pedersen emphasize the lengthy coexistence of paradigms during periods of ideational change: “One [paradigm] can exist alongside another in competition for long periods of time . . . the shift from one paradigm to another does not involve an abrupt break but rather is an incremental and evolutionary process” (Campbell and Pedersen 2014: 11). The point is rather that the spread of new ideas is a contingent process that depends on the ties between the academic core and the organizations where professionals work. The most important ties in this regard are recruitment ties. Organizations that hire staff based on advanced academic qualifications in a particular field—such as a PhD in economics from a top university— establish a direct link for the transmission of new approaches from the center of the discipline. “Recruitment procedures matter [because] they establish a pathway through which new beliefs can be transmitted,” observes Chwieroth. “Organizations that recruit almost exclusively among individuals with a particular type of training or degree are highly susceptible to developments within that profession” (Chwie­roth 2009: 51). Organizations that practice this type of “intellectual monocropping” (Evans and Finnemore 2001) are exposed to the changing paradigms within a discipline, whereas organizations that recruit more broadly are less sensitive to these changes. Moreover, the speed at which ideas spread through the inflow of new recruits will depend on the rate of generational change. New paradigms take root “as cohorts with older-style training are replaced with cohorts with newer-style training” (Colander 2007: 19; see also Chwieroth 2007: 18). In periods with extensive retirement and replacement of staff, ideational change within an organization can be swift. In periods with little staff turnover, the process will be slower. State bureaucracies can also be connected to the academic discipline in a number of other ways, including through professional associations and journals, conferences and seminars, advisory commissions and other kinds of advisory work, as well as more informal contacts. By stimulating interaction and knowledge transfer, links of this kind facilitate the diffusion of new paradigms from the academic core to the broader field of professionals. The upshot is that the closer the relationship between the organization and the profession, the more sensitive the organization will be to ideational changes in the discipline. It is important to note that this argument constitutes

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an alternative to the country-to-country diffusion model discussed earlier. This ­alternative model emphasizes the links among professionals at the microlevel rather than the links among countries at the macrolevel. Diffusion flows “along the lines of relations linking theorists, rather than along the lines of relations linking adopters” (Strang and Meyer 1993: 498; see also DiMaggio and Powell 1983 on normative isomorphism). In other words, the crucial variable in accounting for the spread of new ideas is not geographical or cultural proximity but the organizational embeddedness of the profession. Whereas the discussion so far has applied to professions in general, the economics discipline also has certain special attributes that distinguish it from other professional groups. The sociologist Marion Fourcade emphasizes two such features: the intimate links between economics and the exercise of state power and the transnational nature of the economics profession (Fourcade 2006, 2009). Historically, the rise of the economics profession was closely tied to the expansion of state capabilities after World War II. As nation-states assumed increasingly complex tasks of economic management, economics emerged as a “technique of government” (Fourcade 2009: 2). Economists gained legitimacy by linking their specific expertise to goals seen as essential for the prosperity of the nation. Based on this, modern polities “increasingly acknowledged the special place of economic information and expertise within government structures and administrations” (Fourcade 2009: 24). But the close relationship between economic expertise and state power also meant that the role of economists was profoundly shaped by what Fourcade calls the “administrative order.” In her comparative analysis of economic knowledge in the United States, the UK, and France, Fourcade stresses “the importance of the organization and exercise of ‘government’ in shaping the economists’ professional and intellectual enterprises” (Fourcade 2009: 247). Political and administrative institutions not only filter the access of academic knowledge to the policy process (cf. Weir and Skocpol 1985). They also confer authority on the professional projects of economists: “By defining the terms under which economic knowledge is incorporated into public policy, public administrations have implicitly contributed to construct the professional role of the economist” (Fourcade 2009: 25; emphasis in the original). Different institutional constellations thus gave rise to different roles for the economics profession: In the porous, specialist American bureaucracy, academic economists played a key role as top bureaucrats and advisors; in the British generalist civil service, economists were marginal; and in the stat-

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ist system in France, technocrats with broad training in economics, law, and political science dominated. The implication is that the role of the economics profession within government will depend on the nature of the state itself. At the same time as the practice of economists is intimately linked to national political-administrative institutions, the economics profession is distinguished by its transnational character. Economics has become a global discipline where ideas, practices, and authority flow from the “core” of top U.S. economics departments to the “periphery” of professionals working in universities, governments, and businesses all over the world (Fourcade 2006). The channels of diffusion are manifold. Beyond the advocacy of international organizations such as the IMF, the World Bank or the Organisation for Economic Co-Operation and Development (OECD) and the “missionary” work of American economists, an important channel has been the training of foreign students. Returning graduates with doctorates from American universities have played key roles in economic policy making in a number of countries—in particular developing ones (Fourcade 2006: 172–173; see, for example, Babb 2004). This is highly relevant for the discussion about how new economic ideas spread to government bureaucracies. In a transnational field like economics, it is not only the ties between an organization and the national profession that count but also the links that connect the organization to the international discipline. In the words of Fourcade: “Relations in the international field of economics (and particularly vis-à-vis the United States) can thus be just as important as relations within national fields in driving institutional or intellectual reproduction and change” (Fourcade 2009: 243). To summarize, the theoretical arguments presented so far imply, first of all, that the formation of economic expertise within the state depended not only on political and economic factors but also on features of the administrative system. Second, they imply that the spread of ideational changes from the core of the economics discipline to government bureaucracies was contingent on the ties between bureaucratic organizations and the academic discipline and that both national and international linkages were significant in this regard.

The Power of Economists in Policy Making

The previous section addressed the mechanisms underlying the emergence and transformation of economists within the state. But how do economists influence policies once inside the bureaucracy? The sociological literature on the

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economics profession has not dealt explicitly with this issue. Although the literature generally portrays economists as powerful technocrats, it does not offer a genuine theory of policy making to account for their influence. The problem is that one cannot infer from the mere presence of economists in the bureaucracy that economists actually influence policy. As we know from the state and bureaucracy literatures, the ability of bureaucratic organizations to shape public policies varies enormously (Skocpol 1985; Carpenter 2001). The question is therefore if and why economists inside the state were able to exert effective influence over public policies. I propose to address this question by drawing on the concept of “bureaucratic autonomy.” The argument I put forward is that economists were able to exert a major influence on policy because their particular expertise, ideas, and behavioral norms were conducive to bureaucratic autonomy, that is, the ability to independently formulate, pursue, and attain their policy preferences. The notion of state or bureaucratic autonomy is useful in this context because it provides a theoretical foundation for making sense of the policy role of state actors. In the 1980s, state theorists such as Theda Skocpol argued that the state is not just an arena for struggles between interests in society; it is an actor in its own right, able to “formulate and pursue goals that are not simply reflective of the demands or interests of social groups, classes, or society” (Skocpol 1985: 9). This kind of autonomous state action is driven by bureaucratic organizations, or what Skocpol characterized as “organizationally coherent collectivities of state officials” (Skocpol 1985: 9). Bureaucratic autonomy can be identified with three essential features. The first is that bureaucrats independently formulate preferences about policy goals and solutions. Bureaucracies can be regarded as autonomous when they develop preferences, interests, and ideologies that are distinct from those of politicians and interests groups (Carpenter 2001: 14). The second feature is that bureaucrats actively pursue their preferences (Skocpol 1985: 9). In the policy process, we can identify this with an activist approach to policy advice. That is, bureaucrats push their own policy views vis-à-vis political leaders to influence their policy preferences. Third, bureaucratic autonomy implies that bureaucrats attain their preferences. This means that officials succeed in imposing their preferences on politicians, who are formally in charge of making policy decisions.3 As Carpenter points out, Bureaucratic autonomy lies less in fiat than in leverage . . . the dominant form of bureaucratic autonomy exists not when agencies can take any action at will but when they can

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change the agendas and preferences of politicians and the organized public. (Carpenter 2001: 4, 15; emphasis in the original)

It is important to note that the ability of bureaucracies to impose their own goals and solutions on those of politicians and interest groups is not constant. Bureaucratic autonomy varies across countries, policy areas, periods, and organizations (Carpenter 2001: 4; Skocpol 1985: 14, 17). The role of the official in policy making ranges from the subordinate, who is exclusively concerned with carrying out the will of politicians, to the powerful, who is heavily involved in the formulation of goals and solutions (Aberbach, Putnam, and Rockman 1981; Campbell 1988). The degree of bureaucratic autonomy is partly determined by the legal mandates and governance structures of an organization, what is often referred to as formal autonomy. But effective autonomy also depends on other features of the organization and its staff (Carpenter 2001). In line with this, I argue that the professional background of officials may be seen as an important determinant of bureaucratic autonomy, given that professionals possess particular expertise, ideas, and norms. Professionals’ primary source of bureaucratic autonomy is their expertise, that is, particular skills rooted in an abstract system of knowledge. Professional expertise is forged through formal training and refined through interaction with other members of the profession. The cultivation of this kind of knowledge will thus be most intense in organizations where the profession holds a dominant position. On the most basic level, expertise confers legitimacy on a profession when it is socially recognized (Larson 1979; see also Babb 2004: 15–16; Chwieroth 2009: 11–12). The acknowledgment of a profession’s expertise in understanding and solving a policy issue grants authority to its members in the policy-making process. That authority will be even greater if the profession has an effective monopoly of knowledge, that is, if it is the only group with recognized knowledge about the issue at hand. This idea of expert power dovetails with the Weberian argument about bureaucracy as domination through knowledge. For Max Weber, the power of bureaucracy derived in large part from its specialized expertise, as the expert training of officials puts them in a strong position vis-à-vis politicians: “The power position of a fully developed bureaucracy is always overtowering. The ‘political master’ finds himself in the position of a ‘dilettante’ who stands opposite the ‘expert’ facing the trained official who stands within the ­management

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of administration” (Weber 1946: 232). This argument has been echoed in a number of key studies of bureaucracy. Hugh Heclo, for instance, argued that administrators shape policy by means of “administrative resources of information, analysis, and expertise” (Heclo 1974: 303–306; see also Peters 2010: 198–199). In practical terms, professional expertise may strengthen the ability of officials to set the policy agenda, to evaluate and counter policy proposals, and to warn politicians about deficiencies of existing policies. Yet, while expertise is conducive to authority at a general level, the power deriving from particular types of expertise depends on the political and economic context. The influence of professions in the bureaucracy hinges on their special knowledge being regarded as useful for achieving salient political goals. Just as professional groups can gain leverage when their knowledge is seen as indispensable for achieving core political objectives, they can be marginalized when their specific expertise is no longer perceived as relevant, such as after major social or political change (Larson 1979: xii). For instance, in the wake of the Great Depression and World War II, the macroeconomic expertise of Keynesian economists came to be seen as crucial for achieving the new political goals of active economic management, whereas the expertise of lawyers came to be regarded as irrelevant for addressing these goals. Likewise, in the 1970s and 1980s, economic crises and policy failures brought issues relating to the supply side of the economy to the fore. Whereas the macroeconomic expertise of Keynesian economists was seen as ill suited to handle these problems, the expertise of neoclassical economists in the analysis of markets and micro­ economic questions corresponded more closely to the economic problems of the day. This, I argue, strengthened the policy leverage of neoclassical experts in this specific political-economic context. (By contrast, the microeconomic expertise of neoclassical economists would likely have procured them little influence in the context of planning in the 1940s and 1950s.) A second source of professional power in policy making is ideology. Given that professions rely on abstract systems of knowledge, the potential for producing ideology is inherent to a profession (Freidson 1970). Professional status “allows a group of experts to define and construct particular areas of social reality, under the guise of universal validity conferred on them by their expertise” (Larson 1979: xiii). Professional ideologies can provide a powerful motivation for change. As Theda Skocpol points out, ideologies may “encourage leading state officials to pursue transformative strategies”—that is, to actively pursue

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an agenda of policy change (Skocpol 1985: 9). This kind of policy advocacy is often based on a perceived discrepancy between theory and reality—between such perfect notions as “full employment” or “efficient markets” and the imperfect status quo. For instance, in the context of laissez-faire in the 1930s, Keynesian ideology constituted a radical agenda that motivated economists to work for fundamental policy changes. Similarly, in the 1970s and 1980s, at a time of extensive state intervention, neoclassical ideas provided a radically different vision of the economic order, which motivated economically trained officials to pursue reform. In other words, the transformative nature of neoclassical ideology spawned autonomous action on the part of bureaucrats. Finally, professionally defined norms about administrative behavior may constitute a source of bureaucratic autonomy. One of the main tenets of the sociology of professions is that professionals act according to norms and standards defined within the profession (Wilensky 1964). In an organizational context, professional background can be a stronger determinant of behavior than functional role or features of the organization (DiMaggio and Powell 1983: 152–153). An official’s professional training can thus have major implications for what he or she perceives as appropriate behavior in the policy process (Wilson 1989: 59–60, 70; see March and Olsen 1989). Officials who lack professional ties and identify primarily as public servants will be sensitive to norms that define clear boundaries between the roles of bureaucrats and ministers, leading them to take a restrained approach to policy advice. Officials with a strong professional identification will be less attentive to such norms and more concerned about “doing what is right” according to the principles of their profession, inducing them to take a more activist approach to policy advice. This may particularly be the case for neoclassical economists. Sociologists John Markoff and Verónica Montecinos argue that identification as economists implies adherence to a set of values and principles that are distinct from those of civil servants or politicians: The honor of professionals, then, is likely to involve a devotion to the intellectual standards of the body of knowledge to which they adhere . . . this is distinct both from the pride in skilled service of Weber’s bureaucrats and from the pride in defense of group interests of responsible politicians . . . Economists accordingly often see themselves as in the service of “rationality” or “efficiency” rather than in the service of the goals of their superiors . . . economists may therefore be seen not merely as possessors of technical skills in the service of particular policies, but as representatives of an intellectual

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Economists and Market-Conforming Reform Economic Political Administrative Character of national context context context economic profession

Institutionalization of economic knowledge in the state (1945–1975) Paradigm shift in economics discipline Position of neoclassical economists in the state (1975–) Expertise

Ideology

Administrative norms

Policy-making power of officials (bureaucratic autonomy)

Market-conforming policies (1980–2010)

Figure 1.1. Theoretical model. community devoted to the development and interpretation of a body of ideas not wholly manipulable by power-holders. (Markoff and Montecinos 1993: 51–52)

The attachment to professional norms can thus lead economists to actively pursue their policy agenda vis-à-vis politicians, with little regard for the prerogatives of elected leaders. Based on these theoretical mechanisms, we would expect bureaucratic autonomy to be greater in organizations dominated by neoclassical economists than in departments where other groups prevail. The theoretical framework thus combines an argument about large historical processes with a microlevel account of individual behavior within organizations. The historical-institutional element centers on how political projects and administrative institutions shape the bureaucratic role of particular professional groups and how the administrative entrenchment of professions conditions the diffusion of new ideas within the discipline. The microorganizational element stresses how professional background not only determines expertise but also shapes the identities and role perceptions that determine administrative behavior. The resulting theoretical model is illustrated in Figure 1.1. The figure summarizes the main theoretical expectations. First, I expect the postwar institutionalization of economic knowledge within the state to reflect

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a broad set of economic, political, administrative, and professional factors. Second, I expect the institutional entrenchment of economic expertise in this period to condition the later adoption of neoclassical economic thinking. Third, I expect that the stronger the position of neoclassical economists within the state in the period from 1975 onwards, the greater leverage will officials have in the formulation of policy—due to differences in expertise, ideational motivation, and administrative behavior. Finally, I expect a greater policy role for bureaucrats to contribute to a greater extent of market-oriented reform.

Cases and Methods The book explores these theoretical propositions across a set of small, developed countries: New Zealand, Ireland, Norway, and Denmark. These states have small culturally and ethnically homogenous populations and highly advanced economies. These cases are selected because they allow us to isolate some of the key relationships outlined earlier, thereby providing a laboratory for exploring the theoretical argument. First, as small and homogenous polities, these countries have simple legislative institutions compared to larger and/or more culturally diverse states. None of the four countries has a second parliamentary chamber with effective veto power, meaning that the power to pass legislation is concentrated in a single assembly. This distinguishes them from the federal bicameral systems in states such as the United States, Germany, and Switzerland. The four countries studied here also have small and tightly knit policy elites. Politicians, bureaucrats, businesspeople, and interest group leaders know each other well and interact frequently. Moreover, the cultural homogeneity of these states means that divisive issues of race, ethnicity, and religion are less salient politically than in more diverse countries. Taken together, it can be argued that these features lower the barriers to reaching consensus and producing political decisions. This does not necessarily mean that policy making is a simple affair. The prevalence of minority or coalition governments in these states (apart from New Zealand) makes political negotiations necessary. And, in the Nordic countries, the presence of corporatist bodies and institutional mechanisms for investigating policy implies that policy formulation can be a long and deliberative process (Arter 2008; Campbell and Pedersen 2014). Yet, the well-bounded and concentrated policy-making systems of these small states offer a favorable setting for zooming in on the linkages between the professional makeup of bureaucracies and the adoption of market-conforming policies.

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The disadvantage with this strategy is that it makes it more difficult to generalize the findings to larger, messier policy-making contexts. In the tightly knit policy-maker communities of small states it may be easier for economic experts to “capture” politicians, and there are fewer institutional barriers to the policy influence of experts. Yet, although this may magnify the effects of the role of economists within the state, it should not bias the study in favor of our hypothesis relative to rival hypotheses. Small states arguably provide a favorable setting for the influence of other policy actors too: Close relationships between policy elites can make it easier for political parties to colonize the state and set policy on their own, just as it can give interest groups privileged access to decision makers. And the economic vulnerability of small states may favor the involvement of interest groups in policy making through corporatist bargaining (Katzenstein 1985). In other words, the small state setting does not privilege the role of economic experts over other actors. The fact that these countries are advanced economies should also make them less likely cases for the influence of U.S.-style economics. The literature about the globalization of economic knowledge argues that developing countries were most susceptible to the diffusion of American-style economics because of the stronger need for legitimacy vis-à-vis international financial institutions and other parts of the international community (Babb 2004: 215). Developed countries did not incorporate U.S.-trained economists in top policy-­making positions to the same extent, due to factors such as “a closed civil service, strong autochthonous intellectual traditions, and less exposure to international policy pressures” (Fourcade 2006: 174). From this perspective, the developed countries examined here constitute hard cases for the adoption of neoclassical economic thinking. But why these particular countries? The four cases are selected with a view to evaluating our explanation for the adoption of market-conforming policies at the same time as controlling for rival explanations. Similar cases are therefore matched in pairs on key political-economic and sociocultural dimensions. In terms of production and welfare regimes, New Zealand and Ireland are liberal market economies with residual welfare states, whereas Norway and Denmark are coordinated market economies of the social democratic kind with generous universal welfare states. In terms of history, language, and culture, the first two countries belong to the Anglo-Saxon sphere and the last two to the Scandinavian area. Of course, this does not mean that the paired countries are perfect

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mirror images of each other. For instance, Denmark used to be a medium-sized empire, which Norway was not. (Indeed, Norway was ruled from Copenhagen for nearly four centuries.) But considering that we are dealing with real-world cases, the paired countries do exhibit a number of similar features that provide a basis for comparison. The matching allows us to hold alternative explanatory variables constant across pairs of cases, meaning that any variation in outcomes within these pairs must be attributed to other factors. In addition, the cases include countries that are different in significant respects but exhibit similar policy outcomes. For instance, New Zealand and Norway both introduced market-­conforming tax reforms even though they have different production and welfare regimes, cultural legacies, and political institutions. This comparison of “most different systems” complements the matching of similar systems by allowing us to pinpoint those factors that are common to otherwise different systems and that therefore may account for the similar outcomes (for a discussion of this kind of “mixed systems design,” see Frendreis 1983). To demonstrate that the proposed causes actually produced the observed outcomes, the comparative analysis is combined with the tracing of causal processes within each case (see George and Bennett 2005: ch. 10; Gerring 2006: ch. 7). This entails confronting our theoretical expectations about the links in the causal chain—that is, from the institutional position of economists to the adoption of market-conforming policies—with empirical evidence. Demonstrating the influence of economists and their ideas poses challenges in this respect (see Chwieroth 2007; Béland and Cox 2010). First, given that ideas in themselves cannot be observed, how do we show that an actor holds a particular idea? Chwieroth discusses three approaches to measuring ideas: examining behavior, relying on written and oral records, or using educational background as a proxy (Chwieroth 2007: 8–9). As he points out, the first option is problematic because conflating ideas and actual behavior means that ideas cannot be used to explain action. Chwieroth favors the third option based on its potential for quantification. Yet, arguably, this alternative suffers from the same problem as the first: If we equate ideas with educational background, we cannot use someone’s education to explain his or her beliefs. It also excludes anyone who comes to believe in a certain idea without having studied at the right university. The second option does not go free of this problem either: Policy documents, for instance, constitute both expressions of ideas and actions in themselves. Interviews are arguably less prone to this problem but pose challenges in terms

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of truthfulness and memory. Yet, provided that we rely on a range of written and oral records, I would argue that the second option is the best we have. This is the approach taken in this book, which uses a combination of policy documents, interviews with the actors themselves, and interviews with other actors to ascertain the existence of particular policy ideas. Second, how do we demonstrate that these ideas actually influence policy outcomes? Demonstrating influence is a challenge in any study of decision making: Apart from the difficulties associated with identifying ideas, this problem is not particular to studies involving ideas. Influence is usually understood as an actor’s ability to shape a decision in accordance with his or her own preferences (Dür 2008: 561). If we accept that preferences can be idea based (rather than derived solely from material interests) (for example, Mehta 2010), this understanding applies to the influence of ideas, too. According to Andreas Dür, tracing of influence usually involves gathering evidence on the following steps in the causal chain: initial preferences, influence attempts, access to decision makers, decision makers’ response to influence attempts, and degree of correspondence between preferences and outcomes (Dür 2008: 562). The book applies a version of this model to trace the policy influence of economists and their ideas. If the core argument of the book—that the postwar institutionalization of economic expertise conditioned the role of neoclassical economists in state bureaucracies in the 1970s and 1980s, which in turn influenced policy outcomes through the intervening variable of bureaucratic autonomy—is correct, we should observe the causal processes shown in Table 1.1. Table 1.1 Expectations about causal processes. In bureaucracies where economic expertise was strongly institutionalized in the postwar period:

In bureaucracies where economic expertise was weakly institutionalized in the postwar period:

1. Dominance of neoclassical ideas in economic bureaucracy 1980s–

1. Marginal role of neoclassical ideas in economic bureaucracy 1980s–

2. Bureaucrats formulate tax policy preferences independently of politicians and interest groups

2. Bureaucrats lack unique and well-formed agenda in tax policy

3. Bureaucrats actively advocate policy preferences vis-à-vis politicians

3. Bureaucrats do not actively advocate policy preferences vis-à-vis politicians

4. Politicians change their policy preferences through interaction with bureaucrats

4. Politicians do not change their policy preferences through interaction with bureaucrats

5. The policies adopted correspond to the policy preferences of bureaucrats

5. The policies adopted do not correspond to the policy preferences of bureaucrats

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To draw causal inferences, we need to show empirically that these intervening variables were present and connected in the particular, specified ways. The empirical analysis is based on a unique combination of historical evidence and interviews with present-day policy makers. The book draws on nearly eighty original interviews with policy-making elites, including several ministers of finance, top-level bureaucrats, academic economists, and business and union representatives, conducted by the author between 2009 and 2011 in Dublin, Wellington, Copenhagen, and Oslo (see the Appendix for a full list of interviews). The interviews provide evidence on the preferences, motivations, and behavior of key policy actors, thereby offering a glimpse into the often opaque internal politics of treasuries and ministries of finance. The data from the interviews are triangulated with evidence from policy documents and other written sources. The book follows a rather simple plan. Chapter 2 discusses the politicaleconomic and intellectual background for the turn toward market-conforming tax policies and traces common trends and diverging paths in the changes to tax systems from 1980 to 2010. The following four chapters constitute the empirical core of the book. Chapter 3 investigates the role of state economists in New Zealand’s radical shift to market-oriented policies in the 1980s. Chapter 4 examines why Ireland pursued a wholly different set of tax policies and discusses the impact of its generalist civil service on the position of economists in the bureaucracy. Chapter 5 documents the central role of economic expertise in the Norwegian social-democratic state and traces its long-term implications for economic policy making, and Chapter 6 investigates why the same pattern did not manifest itself in neighboring Denmark. The final chapter revisits the theoretical argument and considers what general lessons can be drawn from the analysis.

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Chapter 2

The New Economics and Politics of Taxation

I

N 1979 and 1980, Irish cities and towns were the scene of massive tax protests. Altogether 750,000 people—that is, nearly one-quarter of the Irish ­population—took to the streets to express their discontent with a tax system that imposed high rates on some while letting others get away with paying very little taxes. The Irish case was not unique. Across the developed world, publics and policy makers had become increasingly disaffected with the existing approach to taxation. Relying on a combination of high statutory tax rates and generous tax incentives, governments at the time used the tax system not only to raise revenue and redistribute income but also to direct investments in socially and economically desirable directions. This policy of taking with one hand and giving with the other was “a centrepiece of the post-war compromise between capital and labour in all western industrial democracies” (Steinmo 2003: 215). But going into the 1980s there were growing concerns that these policies were doing more harm than good. Despite steeply progressive rate schedules there was little effective redistribution through the tax system. And even if tax rates were high on paper, many tax systems were unable to generate sufficient revenues. But even more important to economists, existing tax policies grossly distorted economic choices, leading to a misallocation of resources and welfare losses for society. The systematic analysis of the economic efficiency of tax policies was part of the broader shift from Keynesian to neoclassical economics. Based on notions such as “tax wedges,” “efficiency costs,” and “neutrality,” economists in the 1970s started to bring attention to the “adverse incentive effects of high marginal tax rates” and the “distortions caused by differential tax treatment of economically similar activities” (Boskin 1990: 3). Sure, taxes were necessary to raise revenue. But the way tax systems were set up impeded the effective functioning of markets and economic growth. The solution, they argued, was to lower rates and 29

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broaden bases. This agenda spurred a veritable “tax reform movement” in the 1980s, centered on Ronald Reagan’s 1986 Tax Reform Act. The passage of a fundamental overhaul of the tax code in the United States signaled to policy makers across the world that major changes to tax policy were possible. Yet change did not proceed tidily and uniformly in one direction. Countries responded to the challenges facing tax systems in different ways: Some moved decisively toward a market-conform tax system, others introduced certain market-­oriented elements, and others again pursued a different set of policies altogether. These choices were not merely technical, relevant only to a narrow circle of tax experts. What was at stake was the very future of the state: How would its activities be financed, by whom, and at what cost to society? To illustrate the different choices made, this chapter traces the diverging tax policy trajectories of four countries that serve as examples of the broader variation in reform: New Zealand, Ireland, Norway, and Denmark. But first it provides a brief introduction to the basic concepts of taxation and to the intellectual background for the tax reforms from 1980 onwards.

The Nuts and Bolts of Taxation Taxes exist first and foremost to finance the activities of the state. They raise revenues that pay for such things as health care, education, pensions, defense, and public administration. Indeed, state capacity is intimately related to the ability to collect revenue from citizens. States without effective systems for imposing and collecting taxes have little hope of pursuing ambitious social or industrial policies. Related to this, taxes also have an important redistributive function. Not only do states redistribute income through the tax system by putting greater tax burdens on some groups than others, for instance through progressive taxation; they also use the revenues generated from taxation to finance welfare transfers that benefit people on lower incomes (such as social assistance, basic old-age pensions, or disability pensions) and services that contribute to equal opportunities (such as universal health care or education). In fact, tax-financed transfers play a much greater role in reducing income inequality than progressive taxes in most OECD countries (see, for example, Kenworthy 2009). But tax policies are used to achieve a number of other policy objectives, too. States manage the macroeconomy by increasing or reducing the tax level; they stimulate specific economic activities such as petroleum extraction or film production by providing targeted tax incentives; and they encourage socially desir-

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able activities such as home ownership or donations to charity by offering tax deductions. Needless to say, these goals often come into conflict. A tax break for one activity reduces the revenue available for financing other activities. Indeed, special tax breaks can be seen as just another form of public spending, which is why many scholars refer to them as “tax expenditures” (Howard 1997). Although taxation is often perceived as a highly complex and technical matter, it is essentially a question of rates and bases. States levy taxes on different aspects of economic activity, that is, on different tax bases. The main tax bases are income (such as the salary or the interest that you earn), spending (the goods and services that you buy), and capital stock (for example, the value of the houses or yachts that you own). When we talk about how broad a tax base is, we mean how much of the tax base is liable to taxation. A broad tax base is one that includes all or most income (or spending), whereas a narrow tax base means that significant parts of income are excluded from the base through deductions or exemptions. The tax rate is the percentage of what you earn, buy, or own that is owed to the government. The statutory tax rate is the rate that appears in the tax code, that is, the tax rate “on paper.” (Unless otherwise noted, this is the rate I refer to as the “tax rate.”) The effective tax rate, on the other hand, is the actual percentage of your income that is taxed, after deductions, allowances, and so on, are taken into account. For example, if a tax is levied at a rate of 30 percent but exempts the first $50,000 earned, someone with an income of $100,000 faces a statutory tax rate of 30 percent but an effective tax rate of only 15 percent ($50,000 ( 0.3 = $15,000). Economists also distinguish between marginal and average tax rates. The marginal tax rate is the tax rate on the last dollar you earn, whereas the average tax rate takes into account the tax rate across all your earnings. Say that a tax is levied at a rate of 10 percent on the first $50,000 earned and 30 percent on the rest. In this case, someone with an income of $100,000 faces a marginal tax rate of 30 percent and an average tax rate of 20 percent ($50,000 ( 0.1 + $50,000 ( 0.3 = $20,000). Tax schedules like this one, where rates increase with income, are referred to as progressive. By contrast, tax rates are proportional (or flat) when they are the same at all income levels and regressive when they decrease with income. Taxes fall under three main headings: taxes on labor, consumption, and capital (including corporate taxes). In revenue terms, taxes on labor are the most important. Labor is subject to several taxes—personal income tax, social

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The New Economics and Politics of Taxation

Property: 6%

Other: 1%

Corporate income: 8%

Goods and services: 33%

Personal income: 25%

Social security and payroll: 28%

Figure 2.1. Composition of tax revenues in the OECD countries (average), 2009. source: OECD Revenue Statistics 2011 (OECD 2011e).

security contributions levied both on employees and employers, and payroll taxes—which together account for more than half of total tax receipts in the OECD countries (see Figure 2.1). The total tax burden on a wage earner is the sum of these taxes. Although social security contributions may be earmarked for specific purposes or administered in particular ways, they are equivalent to personal income taxes in terms of their economic incidence: They add to the cost of labor. These taxes do, however, have different profiles. Personal income taxes are often progressive, with rates that increase with income and standard allowances for earnings up to a certain threshold. Social security contributions and payroll taxes, on the other hand, tend to be proportional or even regressive (see Prasad and Deng 2009). They are usually levied at a flat rate, but only up to a certain income ceiling, above which additional earnings are exempt. Consumption taxes, that is, taxes on goods and services, account for onethird of tax revenues in the OECD area. The most important tax on consumption is the value-added tax (VAT), which is levied at every stage of the supply chain on the value added, that is, on sales minus purchases. Some countries, such as the United States, instead have retail sales taxes that apply only to the sale of a good to its end user and thus are less comprehensive than a VAT. In addition to general consumption taxes, there are excise taxes on specific goods

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33

and services, such as motor vehicles, gasoline, tobacco, alcohol, and soft drinks. Excises may be imposed to raise revenue or to protect public health or the environment. In economic terms, many excises are justified by the negative externalities related to the production or consumption of a product, which implies that the product carries a cost for society that is not reflected in its price. As opposed to personal income taxes, consumption taxes nearly always have a regressive profile (Prasad and Deng 2009). Taxes on general consumption like the VAT hit low-income earners hardest because they are the ones who spend the greatest portion of their income. (People with higher earnings put more of their income aside as savings.) This is also true for excises, which usually target goods that make up a larger portion of spending at lower income levels. At the same time, consumption taxes are effective revenue generators for the state. As a number of scholars have pointed out, the countries with the largest and most redistributive welfare states rely heavily on regressive consumption taxes rather than on progressive taxes to finance their social spending (Steinmo 1993; Lindert 2004; Prasad and Deng 2009). Not coincidentally, the highest VAT rates in the world are found in the Nordic countries, whereas the United States lacks a comprehensive tax on consumption. The final category of taxes, taxes on capital, accounts for a smaller share of tax revenues in the OECD countries. Capital taxes are taxes on different types of savings and investments, such as bank deposits, shares, houses, pension savings, or corporate investments. Capital taxes are levied either on the income from capital (for example, personal income taxes on interest, dividends, and capital gains, as well as corporate income taxes), on the stock of capital (such as property taxes or wealth taxes) or on the transfer of capital (including stamp duties or gift and inheritance taxes). The total tax rate on a capital asset is the sum of these taxes. Given that capital ownership is much more concentrated than income, taxes on capital can have a strong redistributive effect (Piketty 2014). But capital is also the base that is most difficult to tax, given not only the mobile character of some types of capital but also the administrative difficulties involved in valuing certain assets.

The Postwar Tax Regime Across the Western world, taxes on individuals and businesses alike were raised dramatically during World War II to pay for the war efforts. After the war, governments saw little reason to bring tax rates back down. Revenues were instead

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The New Economics and Politics of Taxation

diverted to political projects such as economic reconstruction and the expansion of the welfare state. And in line with the Keynesian belief that the state ought to play an active role in the economy, the tax system came to be seen as a key instrument of economic management. “With these beliefs,” observes Steinmo, “a new policy idea emerged: instead of reducing rates across the board, the government could direct investment in socially and economically desirable ways by offering tax incentives to corporations and wealthy investors” (Steinmo 2003: 213). That is, policy makers could use the tax code to manipulate microeconomic decisions about what activities to invest in. The result was a tax regime characterized by high rates and a wide array of specific tax incentives. In the 1970s, top statutory tax rates on personal income stood at more than 60 percent nearly everywhere in the OECD and exceeded 75 percent in a number of countries. For instance, the UK in 1976 had a top rate of 83 percent, and the highest rate of the U.S. federal income tax was 70 percent—that is, before adding state income taxes (Sandford 1993: 12). These high rates were, however, alleviated by a number of deductions, exemptions, and specific incentives that narrowed the tax base. Many of the Anglo-Saxon countries offered large deductions for private social benefits such as pension savings and health insurance, whereas the Scandinavian countries provided generous deductions related to home ownership. Likewise, in the taxation of consumption, many goods and services were exempt or subject to reduced rates. And nearly everywhere incentives such as investment tax credits and accelerated depreciation allowances reduced the effective tax burden on capital (see King and Fullerton 1984). By the late 1970s, publics and policy makers alike were questioning whether the compromise of high rates for generous incentives was such a bargain after all. There was a “widespread belief that taxes were failing to achieve the social and economic objectives they had been designed to meet” (Sandford 1993: 17). Many policy makers were concerned that the existing tax regime was failing to fulfill its most fundamental goal, namely to raise revenue. Despite high statutory rates, many tax systems had been so hollowed out by tax breaks that they failed to generate enough revenue to cover government expenditures. Some parts of the tax system had turned into net benefit systems. For instance, in the Nordic countries the effective taxation of personal capital incomes and debtfinanced investments was often negative, meaning that the state was giving out money rather than taking it in (Sørensen 1998: 16; Andersson et al. 1998: 122).

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The erosion of the tax base contributed to large deficits in some countries and more generally raised concerns about the financial basis for the welfare state. In public debate, the unfairness of the tax system loomed even larger. On paper, income taxes were steeply progressive. But, in practice, the many tax deductions reduced or erased altogether the progressivity of the system. One reason was that the well-off more easily could exploit loopholes in the system and often had income from capital rather than labor. Another reason was that many tax deductions could be applied up to the top rate faced by the taxpayer, which was higher for people with larger incomes. This had the perverse effect that the value of the deductions increased steeply with income. The unequal tax treatment of people at the same income level also raised protests. Under the existing regime, different types of income faced different tax rates and were liable to different types of deductions. This meant that people at the same income level could face very different tax burdens, all depending on the source of their income. For instance, the Irish tax demonstrations in 1979–1980 were sparked by the fact that regular salaries were subject to much higher effective tax rates than were the incomes of farmers and the self-employed (Hardiman 2000: 827). What raised the greatest concern among economists, however, was the effect of the tax system on economic behavior. Whereas Keynesian economists had seen taxation as a tool to influence economic decisions in desired directions, a new generation of economists emphasized the distorting effects of taxes on economic choices.

Taxation and Efficiency The new economic theory about taxation that emerged at the beginning of the 1970s centered on the notion of “optimal taxation.” In a series of articles, the British economist James Mirrlees and his American colleague Peter Diamond— who would both go on to win the Nobel Memorial Prize in Economics— discussed how to design a tax system that would maximize social welfare and raise a given amount of revenue (Mirrlees 1971; Diamond and Mirrlees 1971a, 1971b). The “optimal tax model” was an attempt to explicitly address the tradeoff between equality and efficiency in taxation. Although progressive taxation increased total welfare by redistributing income to people who had more use for an extra dollar, it also reduced the incentives of high income earners to work and therefore constituted a cost for society. Now, this was hardly a new insight. The novelty rather lay in Mirrlees and Diamond’s formal and mathematical

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The New Economics and Politics of Taxation

treatment of the issue, which provided a theoretical basis for thinking more systematically about the economic effects of taxation: Although economists, and some policy-makers, were quite cognizant prior to 1971 of the trade-off between redistribution through the tax system and work incentives, the formulation proposed by Mirrlees and later extended by many others provides a formal means by which that trade-off can be assessed. More important, it is capable of quantification, thereby providing a basis for substantive policy recommendations by economists based on the numerical specification of the trade-offs involved. (Moffitt 2010: 192)

The highly formalized treatment of the equity-efficiency trade-off reflected Mirrlees’s background in mathematics. As one economist commented, “The level of formalization he used was completely uncommon in 1971. Only perhaps in finance would you find mathematics that was as sophisticated. [Mirrlees] just raised the mathematical level for everyone” (quoted in Fourcade 2009: 152). It was also emblematic of the broader methodological turn toward formalization within the economics discipline at the time, in which formal modeling of theoretical arguments based on advanced mathematics became the predominant (and only fully legitimate) approach to examining economic questions (Fourcade 2009: ch. 2). Even though Mirrlees’s aim was to reconcile redistribution and efficiency (see Fourcade 2009: 158), it was the latter—the negative incentive effects of taxation—that received most attention among economists (Saez 2001). The basic efficiency argument was the following: Taxes create tax wedges, that is, differences between the before- and after-tax prices of goods or economic activities, such as between the take-home pay of an employee and the labor costs of the company. When the tax wedges on different goods or activities are of the same size, the tax system is neutral with respect to economic decisions. But when tax wedges are of different size, relative prices change. For instance, if work is taxed and leisure is not, working becomes relatively less profitable relative to staying at home. These changes in relative prices influence economic choices, leading actors to substitute one good or economic activity for another. For example, a high marginal tax rate on wage income induces people to work less or do untaxed work at home instead. These substitution effects are referred to as distortions. By distorting the economic choices of individuals and businesses, differential tax wedges give rise to an inefficient allocation of resources. This means that scarce resources are diverted from their most productive use

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37

into less productive enterprises. Inefficiencies of this kind impede productivity and growth, thereby reducing the economic well-being of society. This argument was based on general neoclassical assumptions about how individuals seek to maximize utility and firms seek to maximize profits. (In the following, I therefore refer to this as the “neoclassical,” “tax economic,” or “efficiency-based” view on taxation.) Although Mirrlees and Diamond addressed this issue at a highly theoretical level, the efficiency-based view was also expressed in more concrete economic discussions about tax policy design. The most significant contribution in this regard was the Meade Report, published in 1978 by a UK commission that was chaired by James Meade—recipient of the Nobel Memorial Prize in Economics in 1977—and included several other prominent economists (Meade 1978). The report established “incentives and economic efficiency” as a primary consideration in tax policy design and analyzed the distortions of economic choices caused by the British tax system. It also offered recommendations about how to address the efficiency problem when designing tax policy. Although the report avoided the optimal taxation framework of Mirrlees and Diamond (Kay 2010), its reasoning pointed in the same direction, that is, toward tax policies that reduced costly distortions of economic behavior. The efficiency-based analysis of taxation in particular pointed to three features of postwar tax systems as sources of major inefficiencies. First of all, high marginal tax rates on high labor incomes discouraged labor supply. In his original discussion of the optimal tax schedule on labor, Mirrlees had come to the surprising results that for the highest income earner the optimal tax rate was zero and that in general the optimal tax schedule was close to flat with marginal rates in the range of 20 to 30 percent (Mirrlees 1971). The results were driven by the large efficiency costs related to taxing high incomes. It is worth emphasizing that these were theoretical results. The finding that the optimal top rate was zero had limited relevance in practice because it applied only to the very highest earner and did not rule out high marginal rates on the second-highest earner (Mankiw, Weinzierl, and Yagan 2009). And the shape of the optimal tax schedule depended on the specific assumptions made. An early follow-up study found declining (though somewhat higher) optimal marginal tax rates at high incomes (Tuomala 1990). But later work relying on different assumptions found optimal marginal tax rates on labor to be high and rising with income—up to between 50 and 80 percent for top earners (Saez 2001). Yet, the lesson that most

38

The New Economics and Politics of Taxation

economists drew from Mirrlees’s results was that taxing income had significant negative incentive effects, especially at higher income levels (see the contributions in Adam et al. 2010). For economists concerned about efficiency, reducing the highest marginal tax rates on labor and flattening steeply progressive rate schedules thus became a top priority. Furthermore, the Meade Report argued that the distortions caused by taxes on labor could be reduced by shifting the tax burden from income toward consumption (Meade 1978). The report pointed to the fact that income taxes provide disincentives for savings relative to consumption because they tax income used for consumption only once (when it is earned) while taxing income set aside as savings twice (when it is earned and when it yields a return). Consumption taxes, by contrast, treat savings and consumption equally because they affect savings only once (when they are spent) and therefore reduce the distortion of economic behavior. Of course, the potential efficiency gains from taxing consumption depended on the design of the tax on expenditures. As Diamond and Mirrlees (1971a) showed, an optimal indirect tax should avoid intermediate goods so as not to distort production decisions. And Atkinson and Stiglitz (1976) found that consumption taxes that applied equally to all final goods minimized tax distortions. In other words, economic theory indicated that a shift from income taxes toward a broad-based consumption tax—along the lines of a valueadded tax—would increase economic efficiency. The second major source of inefficiency in the existing tax regime was the plethora of tax deductions and incentive schemes, which distorted economic choices about investments, saving, borrowing, and so on. Mortgage interest deductions, for instance, made it cheaper to borrow money and more profitable to invest in housing than other assets. There was also a direct link between deep deductions and the problem of high tax rates because deductions made it necessary to charge higher rates to raise a given level of revenue. As the Meade committee argued, One corollary of this need to keep marginal tax rates down is a general presumption in favour of tax systems which provide a broad basis for revenue-raising purposes. To raise a given revenue by means of low rates of tax spread over a large tax base may be assumed to cause less marked “substitution” distortions than to raise the same revenue by concentrating high rates of tax on a few activities . . . For this reason it is of great importance to resist erosion of the tax base through a multiplication of exemptions and reliefs. (Meade 1978: 9–10)

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The policy prescription was thus to broaden the tax base through the elimination of as many deductions and loopholes as possible. Finally, high and uneven effective tax rates on capital discouraged savings and gave rise to misallocation of investments. One of the main results from the optimal tax literature was that taxes on capital should be avoided because they distort production (Diamond and Mirrlees 1971a) and discourage savings (Atkinson and Stiglitz 1976). To be sure, this conclusion was controversial. Later work pointed out that because capital income can be seen as a proxy for a person’s ability to pay and is an important source of economic inequality, taxing capital income can be a good way to redistribute income (Saez 2002; Piketty 2014). Yet, for many economists, “The logic for low capital taxes [was] powerful: the supply of capital is highly elastic, capital taxes yield large distortions to intertemporal consumption plans and discourage saving, and capital accumulation is central to the aggregate output of the economy” (Mankiw, Weinzierl, and Yagan 2009: 21). Economists were, moreover, concerned about the variation in the taxation of capital and its distorting effects on the allocation of investments. Empirical work showed how differences in the effective tax rates on capital—depending on the type of asset, industry, financing, and ownership—influenced the incentives to save and invest (King and Fullerton 1984). To reduce these distortions, economists argued, it was necessary both to lower marginal tax rates on capital and to introduce more uniform taxation of different types of capital income. The efficiency-based economic analysis of taxation discussed so far should not be confused with the “supply-side economics” associated with economists such as Arthur Laffer and Robert Mundell. The ideas of supply-side economists about taxation centered on the “Laffer curve,” which illustrated that beyond a certain tax level raising the tax rate would lead to a drop in tax revenues due to reduced labor supply. Based on this model, Laffer argued that many taxes were so high that a reduction in the marginal tax rate would actually lead to an increase in tax revenues, as people got incentives to work and earn more. To be sure, the argument that lower marginal taxes would increase labor supply was central to optimal taxation theory and the conception of the “efficiency costs” of high marginal tax rates on labor. However, only the supply-siders believed that the effect on labor supply was of such a magnitude that the revenue gain from the increase in taxable income would offset the revenue loss from a lower tax rate. And as many mainstream economists took pains to point out, this position was held only by a tiny minority within the economics profession—usually

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The New Economics and Politics of Taxation

dismissed as “cranks” (Krugman 1994). In other words, supply-side economists promoted a distinct and rather extreme set of ideas about tax policy, which only to a limited degree overlapped with the mainstream efficiency-centered economic analysis. Certainly, not all economists subscribed to the efficiency-based view of tax policy described over the previous pages. There were still economists who held on to the Keynesian view that taxes were powerful instruments for directing investments and managing the macroeconomy and who were skeptical about the magnitude of the negative incentive effects of taxation. Yet, within the neoclassical camp there was a high degree of consensus on the low-rate, broadbase doctrine. Almost without exception, the tax economists interviewed for this book highlighted the distortions associated with high marginal tax rates and tax breaks and the benefits of low neutral taxation. To be sure, the initial theoretical findings of the optimal tax literature were discussed and refined in subsequent research. But there was no sustained alternative to the view that taxes were causing major economic inefficiencies and that reducing rates and broadening bases was the appropriate remedy.

The Tax Reform Movement The agenda of lower rates and broader bases formed the basis for what has often been called the “tax reform movement” of the 1980s. The first to move was Margaret Thatcher, who in 1979 and again in 1984 drastically reduced top statutory tax rates and broadened the tax base in the UK. Yet, the movement was epitomized by the 1986 U.S. Tax Reform Act, a fundamental overhaul of the tax code adopted under the Reagan administration with the support of a Democratic Congress. Arguably one of the most remarkable pieces of legislation in recent American history, the reform cut the top federal tax rate on personal income from 50 to 28 percent and reduced the corporate rate from 46 to 34 percent, at the same time as eliminating a wide range of tax expenditures for both individuals and corporations (see, for example, Slemrod and Bakija 2004: 25). The bargain of lower rates in exchange for the removal of special tax incentives constituted a powerful example for policy makers elsewhere. Over the next decade, a number of countries around the world adopted major changes to their tax systems. The common threads that ran through these reforms were reductions in statutory tax rates on personal and corporate income, broadening of the tax base through the removal of tax breaks, and greater

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Table 2.1 Top statutory personal income tax rates, 1981–2010. Selected countries. Country

1981

1990

2000

2010

France Germany Italy Japan United Kingdom United States OECD average

60 56 72 93 60 77 65.7

56 53 50 65 40 36 50.7

58 54 46 50 40 47 48.9

46 47 45 50 50 42 45.8

note: The rate does not include additional taxes on labor such as social security contributions on employees and employers. The OECD average is unweighted and covers the twenty-four countries for which data are available for the whole period. source: Torres, Mellbye, and Brys 2012.

emphasis on broad consumption taxes (Sandford 1993: 9–20). As shown in Table 2.1, top statutory tax rates on personal income dropped dramatically during the 1980s in several major economies and among the OECD countries in general. The average top personal income tax rate in the OECD fell from more than 65 percent in 1980 to little more than 50 percent in 1990. This downward trend continued through the 1990s and 2000s, albeit at a slower pace (Torres, Mellbye, and Brys 2012; see also Brys, Matthews, and Owens 2011). The same trend was evident in corporate taxation. The statutory corporate income tax rate fell markedly in nearly all the developed economies from the mid-1980s onwards. Within the OECD, the average statutory tax rate on corporate income decreased from 51 percent in 1982 to 42 percent in 1990 and dropped further to 31 percent in 2006 (OECD 2007a). These cuts in personal and corporate income tax rates were, however, accompanied by measures that broadened the tax base (Swank and Steinmo 2002). Many countries eliminated or scaled back generous deductions and allowances offered to individual taxpayers for things such as mortgage interest payments or pension savings. And governments removed or curtailed favorable tax schemes for companies such as investment credits and accelerated depreciation allowances (Swank 1998). In other words, personal and corporate taxes were levied at lower rates than before but also on a wider income base. This meant that the cuts in statutory tax rates did not lead to similar drops in effective tax rates. In fact, effective tax rates on individuals and corporations remained remarkably stable throughout the 1980s and 90s (Swank and Steinmo 2002: 644–645; Swank 2002, 2006).

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Table 2.2 Total tax revenues as a percentage of GDP, 1980–2010. Selected countries. Country

1980

1990

2000

2010

France

39

41

43

42

Germany

36

35

36

35

Italy

29

36

41

42

Japan

25

29

27

28

United Kingdom

34

34

35

33

United States

26

26

28

24

OECD average

30.1

32.8

34.9

33.3

note: The OECD average is unweighted and covers the twenty-six countries for which data are available for the whole period. The average is calculated by the author. source: OECD Revenue Statistics (OECD 2015).

In addition to reforms of income taxation, several countries overhauled their consumption tax regimes in this period. In particular, a number of states adopted general value-added taxes in the 1980s and 1990s, which were broader than earlier sales taxes (Brys, Matthews, and Owens 2011: 11; Owens 2006). In fact, by 2000, all OECD countries bar the United States had introduced a VAT. The share of value-added taxes in total tax revenues in the OECD increased from 11 percent in 1980 to 19 percent in 2010 (OECD 2015). But even if consumption taxation became more broad based, there was no shift in the overall tax burden toward consumption taxes (Campbell 2004; OECD 2015). Contrary to what many believe, this set of tax policy changes did not lead to a general reduction in tax revenues. Often reforms were broadly revenue neutral due to the joint effect of lower rates and broader bases. Within the OECD, total tax revenues as a percentage of GDP actually increased slightly from 1980 to the late 1990s (Campbell 2004; Brys, Matthews, and Owens 2011). This is illustrated in Table 2.2, which reports the aggregate tax level in a set of major economies and the OECD average. From 2000 to 2010, the overall tax level in the OECD countries decreased slightly, but this drop was largely due to the effect of the Great Recession on tax revenues. By 2012, total tax revenues were again close to the 2000 level. In other words, these tax reforms were less about how much the government should raise in taxes than about how these revenues should be raised. The reforms reflected a shift in the notion of what role the tax system should play in socioeconomic management. Although revenues remained more or less constant, this shift had major consequences for economic behavior and inequality,

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changing the incentives to work, save, and invest and redistributing costs and benefits between income groups and industries. Many supporters of reform saw these policy changes as a universal and inevitable motion toward the “perfect” tax system of low rates and broad bases. In books such as World Tax Reform: A Progress Report (Pechman 1988) and Successful Tax Reform (Sandford 1993), authors sympathetic to the cause surveyed the progress of different countries toward an ideal tax structure and discussed the preconditions for successful reform. But, much to their dismay, policy change did not advance neatly and uniformly in this direction. As in other areas of market-oriented reform, there were significant variations within the general trend. Countries responded to the challenges facing tax systems in different ways, adopting the “low rate, broad base” doctrine to varying degrees, pursuing alternative agendas and—as was often the case—combining contradictory tax policy measures. Moreover, major reform was often followed by setbacks, reversals, and erosion. The 1986 U.S. tax reform, the symbol of the tax reform movement, quickly unraveled as its supporting coalition withered and special interests started pecking away at the system (Patashnik 2008). Thatcher’s reform in the UK also faded over time, as top tax rates on labor were raised again to 50 percent in the 2000s. To illustrate the uneven movement toward market-conforming policies, the rest of this chapter traces the diverging tax policy trajectories of four cases that stand as examples of the broader variation in reform: New Zealand, Ireland, Norway, and Denmark. With high-rate, narrow-base tax systems, these small states faced a similar set of tax policy challenges going into the 1980s related to the revenue-raising capacity, equity, and efficiency of the system. Yet, over the next decades, they followed remarkably different paths, ranging from radical market-oriented reform to interventionist policies.

Diverging Tax Policy Trajectories Taxing Labor

The postwar tax systems of New Zealand, Ireland, Norway, and Denmark all shared the main characteristics of the Keynesian tax regime described earlier. At the beginning of the 1980s, they all had steeply progressive tax schedules for labor income, with top statutory rates of between 65 and 75 percent. In line with the general trend, all these countries reduced the top statutory tax rate on labor over the course of the next decades. But, as shown in Figure 2.2, the m ­ agnitude

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The New Economics and Politics of Taxation

Tax rate 80% 70% 60% 50% 40% 30% 20% 1980

1985 Denmark

1990 1995 2000 Norway Ireland

2005 New Zealand

2010

Figure 2.2. Top statutory tax rates on labor income, 1980–2010. note: The rate includes personal income tax on labor and social security contributions on employees and employers. sources: New Zealand: White 2009, Gemmell 2010; Ireland: author’s own calculations based on Department of Finance 2010b; Norway: author’s own calculations based on Van den Noord 2000, NOU 2003, Finansdepartementet 2008, 2010b; Denmark: Finansministeriet 1999, OECD 2011f.

of the rate cuts varied dramatically. The country that stood out among the others—and indeed, among the developed economies in general—was New Zealand. Between 1984 and 1990, New Zealand cut the top tax rate on labor in half, from 66 to 33 percent. The new rate, significantly, was even lower than the top rates introduced by Thatcher in Britain and Reagan in the United States. And, unlike the UK and the United States, New Zealand kept the top rate at a very low level over the following decades. In the other countries, cuts in the highest statutory rate on labor were more limited in scope. Norway took the most significant step toward lower rates early on, reducing the top rate on labor from more than 70 percent in the mid-1980s to 55 percent in 1992. The top rate later increased with the introduction of an additional bracket in the surtax and extra employers’ social security contributions on very high incomes, but it was brought down again in 2006. In Ireland, the top statutory rate on labor was reduced very gradually, from 75 percent in the mid-1980s to 53 percent in 2008. Irish governments did make substantial tax cuts during this period, but these cuts mainly reduced average tax rates (see the following discussion) and had little effect on the highest marginal rates facing taxpayers. Top statutory rates were also raised to over 60 percent again by 2010

The New Economics and Politics of Taxation

Top tax rate on labor 70% 60%

145%

55%

157% 54%

Threshold for top rate as percentage of average wage 180% 63% 160% 140%

50% 40%

45

120% 38%

100%

90%

100% 80%

30%

60%

20%

40% 10% 0

20% New Zealand

Ireland

Norway

Denmark

0

Figure 2.3. Top statutory tax rates on labor and thresholds for top rates, 2009. The bars represent the top rate on labor (left axis), and the markers represent the threshold for the top rate (right axis). source: OECD 2010: 77–109.

in response to the fiscal crisis. Most reluctant in terms of reducing tax rates was Denmark, which maintained very high top statutory rates on labor throughout the 1990s and 2000s. The top tax rate in Denmark stood at 63 percent until 2010, when it was reduced to 56 percent. Top statutory rates, however, only tell part of the story because they kick in at different points in the income distribution. In some countries large swaths of taxpayers faced the highest rate, whereas in other countries it only applied to people with very high incomes. This is illustrated in Figure 2.3, which shows the top statutory tax rates on labor (the bars plotted on the left axis) and the income levels at which these rates kick in (the triangles plotted on the right axis) in 2009. The figure reinforces the image of divergence in the tax level on high labor incomes. In New Zealand, the very low top tax rate of 38 percent kicked in at relatively high income levels—at about 1.5 times the average wage. By contrast, the threshold for the Irish top rate was below the average wage, meaning that even people with ordinary wages faced the highest tax rate of 55 percent. Surprisingly, the figure indicates that high marginal taxes on labor were more

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The New Economics and Politics of Taxation

Tax wedge 60% 50% 40% 30% 20% 10% 0 1980 Denmark

1985

1990 Norway

1995 Ireland

2000

2005

New Zealand

2010 OECD average

Figure 2.4. Average tax wedge on labor for single workers without children at average earnings, 1980–2010. note: The tax wedge equals total taxes paid on labor (including social security contributions) divided by the total labor cost of the employer. For 1980–2004, the definition of average worker is restricted to workers in manufacturing. For 2005–2010, it covers all private sector workers. source: OECD Taxing Wages (OECD 2012a).

widespread in Ireland than in Norway: Although the two countries had similar top rates, fewer Norwegians actually faced this rate as it applied only to people earning more than 1.6 times the average wage. The figure also highlights the much broader scope of high marginal taxes on labor in Denmark than in Norway. Not only did the Danish top rate stand at 63 percent; the rate also kicked in already at average wage levels. This meant that more than half of all taxpayers would have to pay almost two-thirds of the last krone earned in taxes if they decided to work extra hours (Skattekommissionen 2009: 248). Interestingly, additional data show that, at lower income levels, marginal taxes were no higher in Denmark than in Norway (OECD 2012a). The Danish anomaly thus consisted mainly in the persistence of very high marginal rates on average incomes and above. To what extent did cuts in statutory tax rates translate into reductions in the average tax burden on labor? Figure 2.4 shows the average tax wedge on labor—that is, taxes paid on labor as a percentage of the total labor cost of the employer—for workers with average earnings from 1980 to 2010. (The gap in the figure indicates a change in the definition of the measure; see note.)

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Table 2.3 Deductions, allowance, and credits in the personal income tax base, 2007. Standard deductions/ credits

Private health care

New Zealand Ireland

Pension savings

Mortgage interest

Investments in specific economic activities

(✓) ✓

✓

✓

Family/ children ✓

✓

Norway

✓

✓

✓

Denmark

✓

✓

✓

✓

✓

sources: White 2009; Commission on Taxation 2009; NOU 2003; OECD 2011f; Skattekommissionen 2009.

In New Zealand, the average tax wedge declined from 1985 onwards, though much less sharply than the top statutory rate—suggesting that the rate reductions mainly benefited people on higher incomes. In Ireland, it was the other way around: The decrease in the average tax wedge surpassed the reductions in the top statutory rate. Between 1987 and 2004, the average tax burden dropped from 43 to 24 percent, which illustrates that the large tax cuts in Ireland in this period were distributed across the income spectrum. In Norway, the average tax burden on labor dropped markedly as a result of the rate reductions in the early 1990s, falling below the OECD average. The average tax wedge on labor in Denmark remained at a higher level throughout the period but did decrease slowly from the mid-1990s onwards. What the measures of tax rates and wedges do not take into account is the role of deductions and relief schemes in the tax system. The four countries surveyed here differed not only in the magnitude of rate cuts but also in the extent to which they eliminated tax breaks and loopholes. In the early 1980s, all of these countries offered a wide array of tax deductions, reliefs, and exemptions. A quarter-century later, the picture had changed dramatically. Table 2.3 gives an overview of the major types of deductions in the four countries in 2007. Most noteworthy is the absence of personal income tax deductions in New Zealand. In the late 1980s, New Zealand went further than any other OECD country in eliminating deductions and reliefs. The indiscriminate abolition of tax breaks, including for pension savings and life insurance, left New Zealand with a personal income tax base that was broader than that of any other country in the world. This radical base-broadening stood in stark contrast to the policies in Ireland. Rather than eliminating deductions, Ireland extended existing

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tax breaks and introduced new incentive schemes in the 1980s and 1990s (NESC 1990; Commission on Taxation 2009: pt. 8). Not only did Ireland maintain generous tax deductions for private health care and private pension savings, it also introduced a series of highly distorting tax incentives for various types of property investments. And it expanded standard allowances to the extent that by 2007 half of all income earners did not pay any income taxes (Commission on Taxation 2009: 54). Like New Zealand, Norway and Denmark took steps toward broader tax bases from the mid-1980s onwards. Most important in this regard was the curtailment of the interest deduction, which in the early 1980s allowed taxpayers to deduct interest payments on their mortgages up to the top marginal tax rate of more than 70 percent. Norway reduced the interest deduction to 28 percent in 1992, whereas Denmark moved more slowly in the same direction, limiting the deduction to 46 percent from 1994 and to 33.5 percent from 2002. However, in both countries the interest deduction continued to represent a significant departure from a broad income tax base. In other words, base broadening in the Scandinavian countries was significant but far less radical than in New Zealand.

Taxing Consumption

To what extent was the reduction of top tax rates on labor combined with a shift toward broad-based consumption taxes? Figure 2.5 shows the changes Percent of total tax revenues 35 30 25 20 15 10 5 0 1980 Denmark

1985

1990 Norway

1995 Ireland

2000

2005

New Zealand

2010 OECD average

Figure 2.5. Revenues from value-added taxes as a percentage of total tax revenues, 1980–2010. source: OECD Revenue Statistics (OECD 2012b).

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49

over time in the share of total tax revenues coming from value-added tax (VAT), the most important general consumption tax in most OECD countries. We should first note the different starting points: Whereas value-added taxes in 1980 accounted for about one-fifth of revenues in the Scandinavian countries, New Zealand did not have a VAT at all—only a sales tax that raised little revenue. However, the tax burden in New Zealand shifted dramatically toward broad-based consumption taxes with the introduction of a Goods and Services Tax (GST—equivalent to a VAT) in the late 1980s. The GST was levied at a low standard rate of 12.5 percent on a very broad base and has been described as “an almost perfectly neutral value-added tax system, owing to the single uniform . . . rate of 12.5% and the virtually complete absence of exemptions” (OECD 2007b: 110). In Ireland there also was a moderate shift toward general consumption taxes, as a result of the widening of a very narrow tax base and improvements in tax administration in the 1980s. Yet, the Irish VAT was levied at a higher rate and on a significantly narrower tax base than the New Zealand GST. As shown in Figure 2.6, the standard Irish VAT rate of 21 percent applied to little more than half of all consumption (55 percent), as compared to 98 percent in New Zealand. Standard VAT rate 25%

25%

25%

Breadth of base 100%

98% 21%

20%

15%

17.7% 62% 12.5%

55%

57%

58%

80%

60%

10%

40%

5%

20%

0

New Zealand

Ireland

Standard VAT rate

Norway

Denmark Breadth of base

OECD average

0

Figure 2.6. Value-added tax rates and bases, 2008. The bars represent the rate (left axis), and the markers represent the breadth of the base (right axis). source: OECD Consumption tax trends (OECD 2011a: 73, 109).

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In Norway and Denmark, there was no notable shift toward broad-based consumption taxes, but the VAT share of tax revenues remained stable at a relatively high level throughout the period. Although VAT rates in both countries were raised slightly over the period to 25 percent, the VAT base was not broadened in any significant way. The standard rate consistently applied to around 60 percent of consumption, as certain goods and services were exempt or subject to lower rates. In other words, New Zealand was the only country that moved decisively in a market-conforming direction by switching the tax burden from labor to comprehensive consumption taxes.

Taxing Capital

Concerns about efficiency and neutrality also pointed in the direction of taxes on capital that were lower and uniform across different types of investments, such as in business activity, stocks, bank savings, pensions, or housing. To what extent were such policies adopted in practice? Figure 2.7 shows the top statutory rates on different types of capital income (plus wage income for comparison) in 2005. As we see, New Zealand and Norway went furthest in introducing low, uniform rates on capital income. New Zealand leveled out the previously highly uneven taxation of capital with the introduction of a flat 33 percent rate on corporate income and most types of capital income in 1989. The rates on personal capital income were increased to 39 percent in 1999 but were brought back down again in 2010. Norway took equally large steps in a market-­conforming direction, reducing the tax rates on corporate profits, interest income, and dividends to 28 percent flat in 1992. In fact, the low, single taxation of dividends left Norway with the lowest statutory tax rate on distributed profits in the OECD (van den Noord 2000: 15), until double taxation of dividends was reintroduced in 2006. The low tax rates on capital in Norway were, however, to some extent undermined by the maintenance of a net wealth tax, which increased the effective marginal tax rates on capital significantly for people with wealth above a minimum threshold (OECD 2012c). Denmark and Ireland, on the other hand, did not pursue market-conform taxation of capital. Ireland, to be sure, had a corporate tax rate that at 12.5 percent was the lowest in the OECD. Low corporate taxation was a legacy from the late 1950s, when Ireland had introduced a zero tax rate on export production. Yet, Irish policy makers did not move toward more uniform taxation of differ-

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Tax rate 70% 60% 50% 40% 30% 20% 10% 0

New Zealand Corporate

Ireland Dividends

Norway Interest

Denmark

OECD average

Wages

Figure 2.7 Top statutory tax rates on corporate income, dividend income, interest income, and wage income, 2005. note: Tax rates for wage income are adjusted to include social security contributions. source: OECD 2006a: 83.

ent forms of capital, and tax rates on dividend and interest income remained relatively high. In Denmark, the tax rates on capital remained even higher. Even as the corporate tax rate was gradually lowered from 50 percent in the 1980s to 25 percent in 2010, Denmark maintained progressive taxation with top rates of more than 60 percent on income from interest and shares—in stark contrast to the idea of low, uniform capital taxation. These statutory rates do not, however, give us a complete picture of capital taxation. Most tax systems offer deductions or other provisions that favor certain kinds of investments, such as retirement savings or owner-occupied housing. From an efficiency point of view, this type of privileged tax treatment distorts investment decisions. New Zealand was the only country that moved decisively away from tax advantages of this kind. The removal of the tax breaks for retirement savings in the late 1980s made the taxation of pensions in New Zealand more neutral relative to other types of savings than in any other OECD country (Yoo and de Serres 2005: 92; Marriott 2008). And even though investments in housing were somewhat advantaged in New Zealand due to the

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a­ bsence of income taxes or capital gains taxes on houses, the tax privilege for housing was modest by international standards (OECD 2007b: 126–127). By contrast, the other three countries maintained sizeable tax advantages for housing and pensions. Norway continued to offer a substantial tax advantage for investments in owner-occupied housing due to a large interest deduction and little or no taxation of the benefits from owning a house (Finansdepartementet 2007). In Denmark, the tax advantage for owner-occupied housing was smaller than in Norway due to more realistic taxation of both land and imputed income from housing. Yet investments in housing still faced markedly lower effective tax rates than bank deposits or stocks, and pension savings faced an even lower rate (Skattekommissionen 2009: 263). In Ireland, a rather lenient regular tax regime for housing was combined with a wide array of tax breaks for specific types of property investments. This led the OECD to conclude that the “Irish housing tax system is among the most favourable in the OECD” and that “no other OECD country has kept such a range of favourable tax treatments of housing as Ireland” (OECD 2008a: 12, 48). Ireland also offered tax incentives for private pension savings that constituted a tax expenditure of nearly 2 percent of GDP in 2003 (Yoo and de Serres 2005).

Total Tax Revenues

What impact did these changes in the taxation of labor, consumption, and capital have on the overall tax level? Figure 2.8 shows the development over time in total tax revenues as a percentage of GDP. The figure suggests that the development in these four countries conformed to the general trend noted earlier, namely that the aggregate tax level remained more or less stable from 1980 to 2010. Even if the tax level fluctuated over time, it did so within relatively narrow bounds. Throughout the period, the overall level of taxation was higher in the two Scandinavian states than in the two Anglo-Saxon countries. In Norway, total tax revenues fluctuated between 40 and 45 percent, reaching their lowest level right after the 1992 tax reform but inching up again thereafter.1 In Denmark, the total tax level climbed steeply in the 1980s and then stabilized at between 45 and 50 percent of GDP. The tax share in New Zealand and Ireland started off at a lower level, equal to 30 percent of GDP in 1980. Interestingly, the tax burden in New Zealand actually increased to 37 percent during the “low rate, broad base” reforms in the second half of the 1980s, which can be ascribed to the introduction of a broad-based value-added tax

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Percent of GDP 55% 50% 45% 40% 35% 30% 25% 20% 1980 Denmark

1985

1990 Norway

1995 Ireland

2000

2005

New Zealand

2010 OECD average

Figure 2.8. Total tax revenues as a percentage of GDP, 1980–2010. note: The OECD average is unweighted and covers the twenty-six countries for which data are available for the whole period. The average is calculated by the author. source: OECD Revenue Statistics (OECD 2015).

and the elimination of tax expenditures. The tax level did, however, decrease somewhat again from 1990 onwards. One possible exception from the general stability in the tax share is Ireland, where total tax revenues slipped from 34 percent of GDP in 1994 to 27 percent in 2010. In part, this can be seen as the result of the large cuts in the tax burden on labor and the general narrowing of the tax base during this period. However, it must be noted that the Irish numbers are sensitive to the exceptionally high levels of economic growth in this period (more than 8 percent annually from 1994 to 2007) and to the large portion of foreign direct investment (FDI) in the Irish economy. By some accounts, the tax level in Ireland was both considerably higher and more stable over time when calculated as a percentage of gross national product (that is, excluding FDI) (Madden 2008). To summarize, there was no uniform movement toward market-­conforming tax policy across the four countries surveyed here. At one extreme, New Zealand went further than any other developed economy in market-oriented reform, radically lowering rates, broadening bases, and increasing neutrality in all areas of taxation. Norway took important steps in the same direction, reducing the highest tax rates on labor and pursuing low neutral taxation of capital. Yet, the embrace of market principles did not extend to all areas of taxation,

54

The New Economics and Politics of Taxation

as Norway retained, among other things, a very favorable tax regime for housing. At the other end of the spectrum, neither Ireland nor Denmark pursued major efficiency-oriented reforms. Ireland maintained a very narrow tax base and expanded the use of specific tax incentives that distorted the allocation of capital. And, although Irish governments did introduce tax cuts from the mid1990s onwards, these cuts brought down average tax rates on labor but did little to reduce top marginal rates. Denmark also resisted the introduction of marketconforming policies, maintaining very high marginal tax rates on above-average labor incomes as well as high, uneven, and in some cases progressive rates on capital income.

Conclusion The unraveling of the postwar tax regime coincided with the general breakdown of Keynesian economic management in the 1970s and 1980s. Whereas economic experts in the decades after the war had regarded tax policy as a lever for steering the economy, a new generation of economists came to see the system of high rates and targeted incentives as detrimental to economic efficiency. Reducing the distortions of taxation became part and parcel of the broader agenda for market-oriented economic reform. Spearheaded by large-scale tax reforms in the United States and the UK, a number of countries across the world moved toward lower tax rates and broader bases. Yet, this general trend concealed great variation in the adoption of market principles in taxation. As we have seen, countries responded to the problems facing tax systems in a variety of ways, ranging from the close embrace of efficiency-oriented policies to the pursuit of alternative tax policy agendas. The political answer to the question of how the state should be financed was less a uniform march toward marketconformity than an incoherent set of movements in different directions. The next chapters seek to account for these diverging paths.

Chapter 3

New Zealand Plotting a Market-Oriented Revolution During the reform years, the conventional relationship between elected governments and bureaucratic advisers in a Westminster system was to a great extent reversed. The Treasury became the principal initiator; to know what governments would do, one had to read the Treasury’s briefing papers, not party programmes. —Jack Nagel, “Social Choice in a Pluralitarian Democracy: The Politics of Market Liberalization in New Zealand,” 1998: 243

F

OR all the talk about the free-market policies of Margaret Thatcher and Ronald Reagan, their economic reforms pale in comparison to those introduced in New Zealand. From 1984 onwards, a Labour government rapidly ­adopted a series of policies that transformed a heavily state-controlled economy into a textbook case of liberal economic governance. These reforms not only included a radical deregulation of product and financial markets, the removal of protective trade barriers, the lifting of capital controls, and the corporatization and privatization of large parts of the state (see Bollard 1994); they also featured a set of tax policies that have been described as “the most radical tax reform programme ever implemented by a Western government” (Kay and King 1990: 219). Between 1984 and 1990, New Zealand slashed the top statutory tax rate on labor from 66 to 33 percent, eliminated virtually all tax breaks for individuals and businesses, and put into place the broadest value-added tax in the world. And, unlike the 1986 U.S. Tax Reform Act that gradually unraveled over the following decades, New Zealand’s reforms proved highly durable (White 2009). The market-conforming tax regime suffered only minor changes during the 1990s and 2000s, and it was eventually reinforced by a reform in 2010 that further shifted the tax burden from labor toward consumption. Why did New Zealand adopt arguably the most radically market-oriented tax policies in the developed world? One common argument is that the sweeping reforms were brought about by the blatant failure of interventionist economic policy in New Zealand (Castles, Gerritsen, and Vowles 1996; Sandford 1993). From 1975 to 1984, the governing National Party—New Zealand’s conservative 55

56

New Zealand

party—pursued a policy of state investments in industry and strict regulation of markets that produced low-quality investments, ballooning fiscal deficits and high inflation (Bollard 1994: 75). The country’s deep economic problems culminated in a financial crisis in 1984, just as the new government was taking office. “The economic crisis in the early 1980s demonstrated the bankruptcy of the traditional economic policy settlement,” argue Castles and colleagues, “leading to a thoroughgoing overhaul of economic institutions” (Castles, Gerritsen, and Vowles 1996: 214). But although there is little doubt that the pathologies of the existing regime motivated a rethinking of policy and that the crisis in 1984 gave policy makers an opportunity to make rapid changes, the breakdown of the old system cannot explain the new policies that arose in its place (cf. Blyth 2002). There is no necessary link between the failure of extensive interventionism and a radical turn toward the market; on the contrary, a pendulum swing of this magnitude is highly remarkable. Another popular account attributes the radical market-oriented reforms to New Zealand’s majoritarian political institutions (Bollard 1994; Nagel 1998; Quiggin 1998). With a first-past-the-post electoral system and a unicameral parliament, New Zealand had a political system that put few if any constraints on the government of the day. This cleared the way for unilateral action by the Labour majority government. Yet, while majoritarian political institutions constituted a critical permissive condition for reform, they did not determine policy choices. To understand the initial ambition for reform and the orientation ­toward market principles it is necessary to look beyond the institutional set up, to the actors involved in policy making. By many accounts, the key agitator for market-oriented policies was Roger Douglas, Labour’s Minister of Finance from 1984 to 1988 (Castles, Gerritsen, and Vowles 1996; Sandford 1993). Douglas, it is argued, championed economic liberalization and exploited his powerful position within the Cabinet to drive through several rounds of tax reform (Sandford 1993: 53–77). But even though Douglas was crucial for the political passage of reform and was positively disposed toward market-oriented solutions, he was not the main architect of the strictly market-conforming policies that were introduced. In fact, Douglas’s tax policy preferences and the reforms he put into place were profoundly shaped by another group of actors. In this chapter, I show how New Zealand’s sharp turn toward the market in public policy was conceived in large part by a group of neoclassical economists at the heart of the state. From inside the bureaucracy, economic experts ag-

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gressively advocated a vision of economic management that placed efficiency front and center. This vision would come to define New Zealand’s economic policies—­and in particular its tax system—well into the twenty-first century. The chapter starts by sketching the historical background for the rise of economists in New Zealand’s bureaucracy and then discusses how economists influenced the path of tax policy in the period from 1980 onwards.

The Transformation of the Treasury New Zealand became an independent state under the British crown in 1853. As in other former colonies, the political institutions of the new state were built on the British system of government. Yet, despite the close ties to the United Kingdom, New Zealand did not adopt Britain’s generalist civil service model. In the UK, the Gladstonian civil service reforms of the 1850s, aimed at limiting patronage and incompetence, introduced centralized recruitment to the civil service based on competitive examinations measuring general skills. But because New Zealand had gained independence only a few years earlier, the new state was not ready to follow suit. Not only was the civil service small and the supply of candidates scarce; politicians also wanted to maintain their newly acquired power by retaining influence over appointments (McKinnon 2003: 39). Recruitment of staff thus remained the prerogative of the single ministries. Whereas most civil servants in the nineteenth century were little more than clerks, the early twentieth century saw the rise of professional groups within New Zealand’s public administration. In the Treasury, the political ambitions for controlling public spending prompted the hiring of accountants, who by the interwar period made up half of the department’s staff (McKinnon 2003: 180). Like other finance ministries at the time, the New Zealand Treasury was predominantly concerned with managing and accounting for the state’s finances, not with managing the economy. The election of a Labour government in 1935 on a program of active state intervention signaled a radical shift in the view of what role the state should play in New Zealand’s economy. Yet, the calls for more active economic management did not immediately lead to an expansion of Keynesian economic expertise in the bureaucracy, as it did in other Commonwealth countries like Australia and Canada (Slater 1995; Whitwell 1986). Distrustful of the bureaucrats who had administered the old regime of laissez-faire liberalism, the New Zealand Labour government “asserted the primacy of politics” and “saw the management

58

New Zealand

of the economy as a political rather than an expert or bureaucratic process” (McKinnon 2003: 151, 170). To be sure, this also reflected the relative weakness of Keynesian economics in New Zealand at the time (McKinnon 2003: 157–159). As a result, the position of economists within the state remained marginal throughout the 1940s and 1950s. New Zealand had achieved one of the highest living standards in the world in the first decade after World War II, based on the demand for its agricultural products from the UK and the United States. But the subsequent downturn in international demand ushered in a long period of economic decline. It was against this bleak backdrop that Henry Lang, the administrative head of the Treasury department, set in motion a plan that would fundamentally reshape the nature of economic policy making in New Zealand. Lang’s reasoning was simple: To revive the economy, the government needed the help of experts. And who was better placed to provide that help than the Treasury? Based on “the notion that the economy needed to grow faster” and “a belief that the government needed expert assistance in managing the economy . . . Lang was determined to create a central role in economic management for the department,” observes Treasury historian Malcolm McKinnon (2003: 235, 272). The cornerstone of Lang’s strategy was to systematically recruit high-achieving university graduates to serve as policy advisors, mostly (but not exclusively) from economics departments (Boston 1992: 197). This constituted a minor revolution in a department that until then had recruited most of its staff right out of high school and offered professional training on the job (Boston 1989: 77; McKinnon 2003: 234). But Lang’s maneuver was made possible by New Zealand’s administrative system, which left hiring decisions to the individual departments. In addition, Lang encouraged staff to deepen their economic expertise through further training abroad: “Lang provided opportunities for young Treasury officers to [go abroad] through secondments to the IMF, the OECD [and] ‘refresher’ courses in public policy and economics at overseas universities, strategies that were maintained after his departure” (McKinnon 2003: 235). Lang’s policies, initiated in the late 1960s, gradually transformed the Treasury from a ministry of accountants into an institution dominated by economists and economic thinking. “The department did gradually begin to see itself as an economists’ organization,” observes McKinnon (2003: 232). To reach top positions in the department it became increasingly important to have higher academic qualifications in economics: In the early 1970s a master’s degree was

Plotting a Market-Oriented Revolution

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sufficient; by the end of the decade the Treasury recruited PhDs (McKinnon 2003: 298). Treasury economists also engaged in internal study groups on economic theory and policy and became central within the New Zealand economics discipline (McKinnon 2003: 232, 234). And they forged ties to the American economics discipline through studies and fellowships at universities such as Harvard and Duke (Goldfinch 2000: 12). The emphasis on economic expertise was further reinforced by the Treasury’s creation of an internal economics “think tank” in the context of deep economic crisis in the late 1970s. The UK’s accession to the European Community in 1973 had cut off New Zealand’s main export market and had, together with the 1973 oil crisis, produced a severe economic recession. The response of the conservative National government in power at the time was a highly interventionist economic program of state-funded investments and strict market regulation that only exacerbated the crisis (Bollard 1994: 75). The brief of “Economics II,” as the new division was called, was to improve the thinking about the problems of the economy and existing economic policy as well as to develop new policies for growth (McKinnon 2003: 239, 285). To lead Economics II, the Treasury recruited Graham Scott, an economist with a PhD from Duke University (1972) who had worked as an economic consultant overseas and was strongly inspired by new economic ideas from the United States. The decision to hire someone who broke with the Treasury’s predominantly Keynesian economic line may seem odd to the outside observer. The Treasury had, admittedly, advocated some careful liberalization measures during the 1960s and 1970s, meaning that Scott’s ideas were not completely alien to the department (McKinnon 2003: 253–256). But more important, Scott was chosen because of his superior economics qualifications. For the Treasury recruiters, it was “clear that we needed to strengthen the economic analytical capacity,” and Scott had “clearly more merit” than any of the candidates from inside the public service (quoted in McKinnon 2003: 298). Under Scott’s leadership, the staff of Economics II came to include several PhDs and developed a “strong professional identification as economists” (McKinnon 2003: 298). The unit was heavily influenced by new microeconomic theory from U.S. universities, deriving from what has been described as “neoclassical economics and related schools of economics such as Public Choice and New Institutional Economics” (Goldfinch 2000: 4; see also Bollard 1994). According to Goldfinch,

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New Zealand

These various economic theories together [constituted] a broadly coherent policy paradigm. The general neoclassical approach to the economy as a self-regulating mechanism peopled by optimising individuals [underpinned] the general approach to economic policy, including micro-economic reform and the scepticism of the value of activist macro-economic policy. (Goldfinch 2000: 6)

Scott attributed New Zealand’s lasting economic crisis to the excess of state regulation, which he likened to the system of economic controls in Hungary. In response, he advocated a profound liberalization and restructuring of the economy: The strategy was to move from an Eastern European regime of economic controls— somewhat similar to those in Hungary at the time— . . . to liberalization of the economy, based on the principle that prices in the world market needed to be reflected in the domestic economy. These prices were being badly distorted by regulation, etc. and the tax system . . . The new economic strategy was to develop wider markets around the world, engage more deeply in international trade, diversify the economy, deepen technological change.1

Whereas this economic agenda was inspired by ideas from the international economics profession, they did not reflect the prevalent thinking within the domestic discipline. McKinnon suggests that a few economics departments in New Zealand—Canterbury in particular—had turned toward more marketbased analysis by the early 1980s (McKinnon 2003: 284). But most accounts emphasize the lack of interaction and intellectual affinity between economists in the Treasury and in New Zealand’s universities. Brian Easton, a prominent economist and commentator, points out that neoclassical microeconomics was not taught at any of New Zealand’s universities and that when the Treasury economists were forming their views in the early 1980s “they were not in dialogue with academics” (Easton 1998: 89). The Treasury’s analysis of and remedies for the country’s economic problems were also severely criticized by local academic economists (for example, Zanetti and others 1984). Goldfinch finds that “the relationship between public sector bureaucrats and New Zealand academic economists . . . was generally not good” and suggests that “the high level of educational achievement of some top public servants . . . led them to be quite confident in their own beliefs and dismissive of those who did not share them” (Goldfinch 2000: 14). Scott and the others in Economics II regarded themselves as the torchbearers for modern economics and viewed their

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academic colleagues as a largely reactionary force. Thus, in their embrace of U.S.-style neoclassical economics, the group essentially bypassed the national profession. The ideological campaign launched by Economics II met little resistance within the Treasury: There was no sustained alternative position in Treasury to the neoliberal line that came from Economics II in these years . . . Scott and the others advanced arguments forcefully and brought coherence and intellectual rigour to bear . . . Economics II could also trade on the zeal for professional expertise in economic analysis that had been at the core of the Lang “revolution.” (McKinnon 2003: 291–292, 296)

The rapid diffusion of neoclassical thinking was also facilitated by older generations of officials being replaced by younger officials, often economists, who were recruited out of university from the mid-1970s onwards. “There was generational change,” Scott pointed out. “A lot of men in their 60s retired and were replaced by lots of people in their 30s and 40s.”2 And the new ideas about economic management found fertile ground among the younger economists in the department. By the early 1980s, the New Zealand Treasury had become a bastion of neoclassical thought (Boston 1992: 200). Interestingly, the neoclassical revolution in the Treasury not only altered the department’s substantive policy ideas; it also influenced the norms about administrative behavior in the department. “While Economics II did shift the Treasury’s stance on policies,” writes McKinnon, “its impact on process was equally significant” (McKinnon 2003: 292). The commitment to economic principles led Economics II to promote a new and more activist approach to policy advice, which implied that the Treasury should always offer clear and intellectually honest advice to politicians. “There was a willingness to advise, regardless of what they [ministers] wanted to hear. And that was so different from other agencies,” observed one Treasury official (quoted in McKinnon 2003: 300). The strengthening of economic expertise and the sharpening of the ideological profile of the Treasury thus went hand in hand with a greater willingness to advocate the expertise and ideas vis-à-vis ministers. To summarize, the breakthrough of neoclassical thinking in the New Zealand Treasury was directly related to the institutionalization of economic knowledge in the department during the 1960s and 1970s. The growing attention to economic expertise and the forging of links to the U.S. economics discipline

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New Zealand

in the late Keynesian era made the organization receptive to the subsequent diffusion of neoclassical economic ideas. Although this may seem paradoxical, it makes sense in light of the theoretical argument about how the links between bureaucratic organizations and professions condition the diffusion of new ideas. By becoming an “economists’ organization” that recruited on the basis of economic merit and interacted with the international economics discipline, the New Zealand Treasury exposed itself to the changing intellectual winds of the profession. This led the Treasury to embrace a range of new microeconomic theories from the United States, including novel ideas about tax policy.

The Market-Oriented Revolution New Zealand’s tax policies in the early 1980s were essentially decided by one man: Sir Robert Muldoon, the domineering leader of the conservative National government in power from 1975 to 1984. Simultaneously Prime Minister and Minister of Finance, Muldoon literally held the levers of tax policy in his hands. And he was not afraid to pull them. The Muldoon government used the tax system actively as an instrument for interventionist economic management, directing the economy through a plethora of different rates and tax breaks for particular sectors and activities. Even though top statutory tax rates were high, the ability of the system to raise revenue was low: The income tax base was hollowed out by tax expenditures, and the sales tax applied to only one-third of consumption and generated few tax dollars. For the economists in the Treasury, the tax system epitomized what was wrong with New Zealand’s economic policies. Not only was the tax system not generating enough revenues to cover government expenditures, producing persistent deficits and rising government debt (Sandford 1993: 60–62). The wide array of different rates and special tax incentives was also distorting the economic choices of individuals and businesses. The use of economic resources, the Treasury economists argued, was guided by arbitrary state interventions through the tax code and not by where the resources would yield the greatest return. In the Treasury, overhauling the tax system was seen as key element of the wider strategy of economic reform advocated by Economics II. The thinking about tax policy in the Treasury reflected the overarching theoretical emphasis on microeconomic issues and economic efficiency but was also shaped by more specific and policy-oriented literature about how to achieve efficiency in taxation. As Graham Scott explained,

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Theoretical economics would say that tax should be levied according to a Ramsey rule, which means that you try to levy tax in the way that has the least distortion on people’s behavior (inverse elasticities). But it requires information you don’t have about what all those elasticities are. Practical tax theoreticians have long reached the conclusion that best practical solution is the broad base and the low rate. Broad base, low rate became the mantra for tax reform in NZ.3

In particular, the 1978 Meade commission report on tax reform from the UK had “an immense influence on the development of tax policy thinking” in the New Zealand Treasury (Dickson and White 2011: 390). As one of the leading officials on tax policy recounted, A lot of the influence was the Meade committee from the UK . . . Those of us in the tax section, we all had a copy of Meade, it was like the Bible really. How to think about tax policy questions—the whole broad base, low rate approach—and how to frame advice was very much influenced by that document.4

Later on, the 1984 U.S. Treasury report on tax reform also constituted a source of inspiration.5 By contrast, supply-side economics and Laffer’s view that tax cuts would lead to higher revenues had little influence on the tax policy ideas of the Treasury. According to officials working with tax policy at the time, there was a “huge suspicion about Laffer” and “no feeling that tax cuts would increase revenues,”6 and, although officials were “pretty sure there were dynamic effects,” they “never took the extreme view of Laffer.”7 Even the economist Brian Easton, an ardent critic of the Treasury’s economic views, concludes that the Treasury in tax policy “never went to the excesses of the Laffer curve analysis,” pointing out that it relied on broadening the tax base rather than cutting tax rates to raise revenues (Easton 1988: 87). The Treasury’s ideas about low-rate, broad-base tax reform were first articulated in the 1982 McCaw tax review (Task Force on Tax Reform 1982) and in reports prepared for the 1982 Budget, which proposed an increase in indirect taxation and a broader personal income tax base. The reports reflected the Treasury’s more assertive approach to providing policy advice. Muldoon, furious at the Treasury’s impertinence, dismissed the proposals and told officials to “not waste further time on this work” (cited in McKinnon 2003: 304). An unsolicited report on tax expenditures prepared by the Treasury in 1983 was rejected in similar style. For all their efforts the Treasury economists were getting

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nowhere with Muldoon—they were, as one official put it, “in quarantine” (cited in McKinnon 2003: 308). But in the offices and corridors of the Treasury, officials continued preparing their proposals for a major tax reform and looked for new ways to get their message across. In the meantime, New Zealand’s economy went from bad to worse. By 1984, the country was in the middle of a serious economic crisis, with dwindling foreign exchange reserves and a level of indebtedness that raised concern among its international creditors.

Douglas, Meet the Treasury

The Labour Party won an absolute majority in parliament in the 1984 elections on a manifesto that was “deliberately vague about economic policy” (Nagel 1998: 251) and gave few hints “that a vote for Labour would be a vote for neoliberal economic management” (McKinnon 2003: 317). However, it came as no surprise that Prime Minister David Lange appointed the already controversial Roger Douglas as Minister of Finance (Nagel 1998: 252). Douglas had gained notoriety after publishing a pamphlet in 1980 entitled There’s Got to Be a Better Way! A Practical ABC to Solving New Zealand’s Major Problems (Douglas 1980), which offered novel solutions to every economic issue in the alphabet. Under “T” Douglas addressed the issue of taxation, an area in which Douglas—who was an accountant by trade—took a “particular interest.”8 Part of Douglas’s tax proposals were similar to the recommendations of economists, such as his proposal for a reduction of income taxes combined with the introduction of a tax on spending, as well as his attacks on the tax breaks favoring vested interests. Yet Douglas also proposed measures that ran directly counter to neoclassical ideas about broad bases and neutral taxation, such as tax credits for saving and investment in “priority industries” (62) and a large standard allowance in the personal income tax (“No one on the average industrial wage with a family to support should pay income tax” [66]). In other words, Douglas’s thinking at this point was a rather eclectic mix of more-market and interventionist ideas (McKinnon 2003: 318). In any case, the pamphlet was sufficiently controversial to get Douglas dismissed from Labour’s front bench (Sandford 1993: 64). But, after David Lange was elected party leader in 1983, Douglas was brought back as finance spokesman. In the most detailed analysis of Douglas’s economic thinking, Hugh Oliver finds that the turn toward more clearly market-oriented views occurred only after Douglas became finance spokesman. In the early 1980s, Douglas was still

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advocating policies with interventionist elements, such as picking winners for investment: “Highly interventionist and regulatory policies,” writes Oliver, “remained characteristic of Douglas’s policy proposals throughout the early 1980s” (Oliver 1989: 13). But through a “rapid shift from interventionist to free market positions in late 1983,” Douglas’s thinking moved “towards the kind of free market economics that were espoused by the Treasury” (11, 18). Oliver points out that this shift “coincided with a period of close collaboration between Douglas and a Treasury adviser seconded to the Opposition” (11–12). The advisor from the Treasury developed close links to Douglas and helped him craft an “Economic Policy Package” in 1983, which offered a set of market-oriented proposals that echoed the thinking in the Treasury. Historian Malcolm McKinnon also cites evidence that senior Treasury officials advised Douglas and other Labour politicians in secret on several occasions in 1983 and 1984—a practice that reflected the new activism of the Treasury and that, as McKinnon puts it mildly, “tested the bounds of constitutional propriety” (McKinnon 2003: 318). It is therefore safe to conclude that Douglas’s turn to market liberalism at least to some extent was the product of his exposure to the economic thinking of the Treasury. At the same time, there is little doubt that Douglas’s existing views, such as about stimulating enterprise and fighting vested interests, made him positively disposed toward the Treasury’s ideas (Oliver 1989: 22). The ideas promoted by the Treasury played to Douglas’s original concerns and helped him crystallize his economic agenda. As McKinnon concludes: “Treasury officials might stimulate his thinking, but they did not instigate it” (McKinnon 2003: 318). The Treasury saw the appointment of Douglas as Minister of Finance “as an almost unbelievable window of opportunity” (McKinnon 2003: 324). In the briefing presented to the incoming minister—later published under the title Economic Management—the Treasury called for a series of radical supply-side reforms, including a major tax overhaul. The Treasury recommended “extending the base, lowering rates, and achieving a uniform rate structure for comparable income,” as well as establishing a system that was “neutral with respect to business decisions, such as investment choices or methods of finance” (Treasury 1984: 213, 220). The briefing argued that the best way to raise revenue was to widen the consumption tax base by introducing a value-added tax with a single rate applicable to all goods and services. The latter proposal was inspired by Alan Tait, a “roving evangelist” from the IMF who advised governments from South Korea to Mexico about the benefits of the VAT.9

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Douglas, however, had a different idea about consumption taxation. He wanted a “quick and dirty” retail sales tax that could raise revenue immediately, a solution the Treasury economists saw as inadequate and potentially damaging. Officials set about convincing Douglas to change his mind, using their “intellectual firepower” to barrage him with detailed economic analyses that illustrated the merits of a broad-based VAT. The leading official on indirect taxation recounted, When Douglas came into office, I set out to persuade him that “quick and dirty” wasn’t a good idea. We argued strongly that you needed a comprehensive tax, and if you have a comprehensive tax you can have it at a low rate and raise a lot of revenue and it won’t cause a lot of distortions, and you can sell it politically as being fairer than what had gone before.10

Likewise, in capital taxation officials strongly advised Douglas to remove all tax concessions for savings, including those for life insurance and retirement savings (Marriott 2008: 244–247). And they urged him to remove the specific tax incentives for industries that played a central role in New Zealand’s economy. In all these areas, “[Douglas] was given a whole lot of technical advice that explained to him why selective interventions through the tax system were very inefficient.”11 This policy advocacy was activist to the extent that it challenged traditional norms about administrative behavior. Reflecting the Treasury’s new and more aggressive approach to policy advice, bureaucrats were willing to venture into the sphere normally reserved for politicians to impose their preferred policy solutions. As one official admitted: “There is no denying that the traditional boundaries observed by public servants in the policy arena were crossed from time to time in the interest of gaining a particular desired state of affairs” (Dickson 2007: 51). Yet Douglas was willing to listen to the Treasury because he perceived officials to be highly competent. In his own words: “I had great confidence in the people that were serving me in the Treasury. They were a smart group of people. They were quite a powerful team. They had tremendous overall economic grasp.”12 It is also important to note that there were few competing sources of economic policy advice in the bureaucracy. As Jonathan Boston points out, the concentration of economic responsibilities and expertise in a single ministry set New Zealand apart from countries such as Australia, Canada, and Germany,

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where economic functions were divided between two or more ministries. As a result, “the degree of multiple advocacy in New Zealand [was] limited” and “the Treasury [had] a firm grip on the levers of economic advice” (Boston 1989: 82). Nagel similarly emphasizes the “near-monopoly position of the Treasury with respect to economic policy advice” (Nagel 1998: 242; see also Goldfinch 2000). This monopoly was reinforced by the virtual exclusion of outside academic economists from policy discussions. As Goldfinch notes in a survey of the ideational influences on reform in the 1980s, “a number of respondents took pains to note the limited role played by domestic academics in the changes” (Goldfinch 2000: 14). In the formulation of tax policy, Douglas worked closely with a restricted group of officials in the Treasury. Through this interaction, Douglas embraced a series of radical tax policy measures, which combined a large reduction of personal income taxes with the introduction of a value-added tax without exemptions and the abolition of all tax incentives for life insurance and pension savings (Dickson 2007: 49; Douglas 2007: 4; Marriott 2008: 204, 246). The question of who took advantage of whom in this policy process is obviously of great interest. Did the economists in the Treasury use Douglas to push their theoretically driven agenda, or did Douglas use the Treasury to legitimate his political agenda? On the one hand, there is broad agreement among scholars that the policies embraced by the Labour government closely reflected the Treasury’s theoretical agenda (Boston 1992; Easton 1994; Nagel 1998; Goldfinch 2000). As previously discussed, the strict adherence to market principles in the design of public policies originated in the Treasury rather than with Douglas. In tax policy, the Treasury’s emphasis on microeconomic efficiency implied not only lower rates but also broader bases and neutrality between different economic choices. In all these respects, Labour’s tax reforms came exceptionally close to the theoretical ideals. On the other hand, these policies allowed Douglas to fulfill his political goals. Douglas’s primary objective in tax policy was to reduce the personal income tax rate to free up enterprise in the economy: “I wanted to dramatically lower top personal income tax rates,” as he put it himself.13 And even if improving neutrality was not his main concern, the removal of tax breaks also raised revenue that allowed Douglas to lower rates. “The objective of neutrality was definitely the Treasury’s idea,” observed one official. “But Douglas liked it. It gave him money to reduce rates. He wanted the money, since it provided him with fiscal lee-room to make changes.”14 Or as Douglas said himself: “Neutrality was fundamental for being able to lower tax rates. You

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couldn’t do one without the other.”15 The relationship can thus perhaps be described as symbiotic: It gave the Treasury traction for its policy ideas but also provided Douglas with a set of policies that furthered his political agenda. And neither actor could have realized these benefits without the other.

Bringing Business and Cabinet on Board

The business community was initially ambivalent to tax reform. The previous government had been receptive to the demands from business for special protection and incentives (McKinnon 2003: 276–277). At the same time business leaders had become increasingly frustrated with the state of the economy and the government’s erratic policies, leading to calls for liberalization and deregulation (Roper 1992). To bring business aboard the bandwagon for tax reform, Douglas opened a consultation process with the private sector that included an economic summit in 1984 and a series of consultative committees (Sandford 1993: 65–69). Douglas presented a broad framework that was nonnegotiable (for example, that there would be no specific tax incentives), but within that framework he was ready to listen to private sector input. The consultation process allowed business to voice its opinion and influence the detailed design of reform, at the same time as it spawned business support for the general principles of low rates and broad bases. “We exerted real influence through consultation,” commented a private sector representative, “but our views were also influenced by officials. We understood the economic reasoning that underpins tax policy . . . we internalized the low-rate, broad-base doctrine.”16 Within the business community, the think tank “New Zealand Business Roundtable” also constituted a vocal proponent of reform. Founded in 1985 and led by Roger Kerr, an economist and former top bureaucrat in the Treasury, the think tank provided external support for the market-oriented policy agenda (Nagel 1998: 250–251). The trade unions, by contrast, were openly hostile to tax reform, which they saw as detrimental to equity and public spending. But within the Labour Party, the union wing had lost out to the more economically liberal current represented by Douglas. And the weak bonds between the Labour government and trade unions gave the unions very little say in policy making: “Attenuated links between the two wings of the New Zealand labour movement meant the virtual exclusion of a union role in policy formation, leaving the way open for . . . a flattening and broadening of the tax system” (Castles, Gerritsen, and Vowles 1996: 11).

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In most countries, the word of the finance minister would not be enough to pass a reform as radical as the one Douglas had in store. But in the Labour government, Douglas could count on the support of Prime Minister David Lange and the two associate finance ministers who both had seats in the inner circle of Cabinet—a setup that “smoothly and effectively [secured] Party backing for the reforms” (Sandford 1993: 69–73). Given the lack of institutional checks on the executive in New Zealand and Labour’s absolute majority in parliament, the reforms were rapidly passed into law. The first rounds of reform included a reduction of the top personal income tax rate from 66 to 48 percent, the introduction of a broad-based value-added tax (the Goods and Services Tax, or GST) at a rate of 10 percent, and the elimination of virtually all tax deductions in the personal income tax base. Although Labour’s policies alienated some of its traditional voters, the government was reelected in 1987 with an increased majority. In fact, a postelection survey showed that nearly half of all voters thought that the government’s economic policies moved in the right direction at the right speed, whereas an additional 23 percent said that policy moved in the right direction but too fast (Vowles 1990). Premier Lange, however, had grown weary of Douglas’s freewheeling and was no longer prepared to sign off on everything coming from the finance minister. The conflict came to a head when Lange shot down Douglas’s sweeping proposal for a flat personal income tax in 1987, leading to the resignation first of Douglas in 1988 and then of Lange in 1989 (Sandford 1993: 72–73). The internal struggle did not preclude the passage of further tax policy changes: The top statutory rate on labor was cut from 48 to a sensationally low 33 percent, and the corporate tax rate was lowered to the same level, while the rate of the value-added tax was raised from 10 to 12.5 percent (Stephens 1993: 49). These changes, however, were passed in the context of a deepening economic crisis. Following a boom in construction and financial services from 1984 to 1987, the global stock market crash in October 1987 hit New Zealand hard. The economic shock exposed the very real costs of the economic restructuring process, as production decreased and unemployment soared to unprecedented levels. The tax reforms, in particular the last round of changes, also contributed to rising income inequalities (Podder and Chatterjee 2002). And, under the surface, a fiscal crisis was looming. In the 1990 elections, a Labour government in disarray was defeated by the National Party.

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To summarize, the market-conforming reforms adopted in New Zealand from 1984 to 1990 were the result of a combination of factors. The economic crisis faced by the Labour government and the concentration of power in New Zealand’s political institutions constituted permissive conditions for radical policy change. Moreover, Roger Douglas’s enthusiastic embrace of marked-­ oriented solutions played a crucial role for the passage of reform. The general supportiveness of the business community and Labour’s weak links to unions also facilitated these efforts. Yet, I have argued that the principal factor in determining the direction of policy change was the New Zealand Treasury’s adoption and advocacy of neoclassical microeconomic ideas about taxation. As shown, the Treasury’s theoretical economic agenda had a visible impact on the policies introduced by Labour during its six years in office. To some extent, this influence reflected the concentration of economic advice functions within a single ministry in New Zealand. But it was also a function of the expertise and activism of the department’s economists, whose intellectual resources and zeal put them in a powerful position relative to other actors in policy making (Boston 1992). The role of the Treasury’s economists in the introduction of market principles in public policy can be illustrated by a counterfactual. Absent neoclassical economists in the Treasury, Roger Douglas would not have been subject to the insistent policy advocacy of the department before and after he became finance minister. Douglas would presumably have pushed ahead with his original agenda, which included large personal income tax cuts but did not emphasize broader bases or neutrality. Most likely, Douglas would have opted for a narrowbased sales tax rather than a broad-based VAT, tax incentives for preferred industries rather than neutral taxation for business, and the maintenance of tax concessions for savings—and used his position in Cabinet to get these measures passed. The result would have been a series of tax policies that deviated significantly from market principles.

Defending the “Perfect” Tax System Voters who desired a change of direction when throwing Labour out of office must have been disappointed with the result. The conservative National government that took power in 1990 proceeded with great determination along the market-oriented course staked out by its predecessor. Not only did it uphold Labour’s economic reforms—tax reforms included. It also used the large

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fiscal deficits left by the Labour government as a justification for a radical retrenchment of social welfare policies and later a deregulation of the labor market, areas that Labour had been reluctant to touch (see, for example, Starke 2008). National’s reforms reinforced the rise in income inequality that had begun under Labour. From the mid-1980s to the mid-1990s inequality in disposable incomes grew faster in New Zealand than in any other OECD country: “Whereas most other OECD countries have also experience increased income inequalities in the 1980s, New Zealand seems to have experienced a particularly strong and rising tide of inequality over the 12 years studied here [1984–1996]” (Podder and Chatterjee 2002: 14; emphasis added). As a result, economic inequality in the previously fairly egalitarian country climbed to a level equal to that in the United Kingdom and not far from the level in the Unites States.17 The reforms added fuel to the growing discontent with the direction of policy and the widespread feeling that New Zealand’s leaders were unresponsive to popular demands. This disaffection found expression in the abolition of the first-past-the-post electoral system after a referendum in 1993 (Boston and Eichbaum 2014: 375). The old winner-takes-all system was replaced by a form of proportional representation (PR) called “mixed member proportional” (MMP),18 which gave smaller parties a chance to be represented in parliament and put an end to the era of single-party majority rule. The Treasury itself also came under attack. Ironic demonstration placards encouraging voters to “Cut out the middleman: Vote Treasury!” alluded to the common perception that the Treasury had replaced elected leaders as the principal deciders of public policy. Politicians, eager to claw back power from the Treasury, advanced various proposals for “taming the leviathan” through institutional changes to economic policy making (Boston 1992: 211; see also McKinnon 2003: 334–340). These concerns constituted one motivation for an organizational reform in 1995 that split the responsibility for tax policy advice between the Treasury and the Inland Revenue Department (IRD), leaving the Treasury with only a small tax team (see Richardson 1994: 79). The backlash culminated with the election of a Labour government on a market-skeptical platform in 1999. The remodeled Labour Party was dominated by the left wing of the party and denounced the market-oriented policies of its predecessors. In the tax area, Labour had ambitions for significant policy changes—not just higher rates on high earners to pay for health and education

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services but also tax allowances for people on lower incomes and tax incentives for savings (Ganghof 2006: 64–66; White 2009: 123). Would this be the end for New Zealand’s market-conforming tax regime?

Treasury Divided—but Not Conquered

Writing in 1992, political scientist Jonathan Boston observed, [Of the] various proposals for reducing the Treasury’s power . . . one option would be for the Treasury to be split into two separate ministries. [But] if the two departments recruited the very same people as are currently employed by the Treasury (which is likely) it is doubtful that they would arrive at significantly different policy conclusions. (Boston 1992: 211–212)

The observation would prove prophetic. Although the 1995 organizational reform of tax policy making ended the Treasury’s monopoly in the area, it did not erase its way of thinking about taxation. The tax policy approach of the Treasury was instead reborn in the special division for tax policy advice that was set up inside the Inland Revenue Department (IRD)—the equivalent of the Internal Revenue Service (IRS) in the United States. The head of the new IRD division, Robin Oliver, and his deputy both had a background from the Treasury; so did several of the economists who joined the division then and later. According to Oliver, little changed apart from the name of the department: Essentially we just moved the operating model for tax policy development from the Treasury to the IRD and continued business there. We rebuilt the whole thing . . . It was continuity rather than change. The economic thinking and the way of approaching things were the same.19

Just like the Treasury of the 1980s, the new IRD division put great emphasis on economic expertise. Shielded from the administrative tasks of the rest of the department, the policy advice division recruited academics and undertook extensive economic analyses. Indeed, with a policy staff that by 2010 had grown to forty people, the analytical strength of the New Zealand IRD stood out in international perspective. The IRD division also conserved the old Treasury’s orthodox neoclassical ideas. As one official observed, the IRD’s policy positions were directly derived from economic theory:

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The IRD tax policy division has a strong emphasis on tax theory and a clear perspective on tax policy, with specific guidance for tax design. Their theoretical analysis therefore directly shapes their policy recommendations—they follow what the model says.20

The IRD was the dominant force in tax policy advice from 1995 onwards (Marriott 2008: 127). Although the responsibility for tax policy was shared with the Treasury, the IRD was the main intellectual driver in the collaboration. The IRD’s ideological commitment to the principles of efficiency and neutrality in taxation made it a fierce defender of the “perfectly aligned” tax system, that is, a system where the top tax rate on labor is equal to the corporate rate and the rates on capital. The IRD’s insistence on a tax structure with aligned rates and without specific tax incentives appears to have discouraged Labour from making large-scale changes to the tax system during its nine years in office. The Labour government did raise the highest statutory rate on labor to 39 percent right after taking office (as promised before the election) and later introduced modest tax credits for families and a small tax incentive for pension savings. It also let many taxpayers move into higher tax brackets by not adjusting cutoff points for inflation—so-called bracket creep (Treasury 2009: 5). But on many other issues the initiatives of Labour’s Minister of Finance Michael Cullen were thwarted by the bureaucracy. “The Minister of Finance was frustrated,” recalled a top IRD official. “He wanted to use the tax system to encourage savings and investment, but at the end of the day we convinced him that he was wrong.”21 A tax official in the Treasury similarly related that the finance minister after 2005 wanted to make tax cuts for people on lower incomes, a move the Treasury opposed on the grounds that tax cuts at the bottom were more costly and less effective than cuts in top rates: “Cullen did not want advice or involvement from Treasury in designing the tax changes, but had to take advice in the end . . . The Treasury ultimately convinced Cullen that tax cuts at the bottom would not be effective.”22 After nearly a decade of Labour rule, the market-conforming structure of the tax system was still very much intact, in no small part because of its defenders in the bureaucracy.

A Joint Push for a New Reform

The Treasury had lost staff and expertise in the organizational split in 1995, leaving it by the mid-2000s with a tax team that “had limited scope for strategic,

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long-term thinking” and “few people with a strong background in tax economics.”23 As a result, it often went along with the views of the IRD on tax issues. However, the Treasury reasserted itself in the tax area in the second half of the 2000s after the tax policy section was strengthened with Norman Gemmell, an academic tax economist from the UK. Gemmell generally shared the IRD’s neoclassical view that taxes were distorting and that high marginal tax rates on labor were not an efficient way to redistribute income. But he was surprised at the IRD’s strong preference for perfectly aligned rates. Aligning the top personal income tax rate and the corporate rate had obvious benefits in terms of preventing income shifting from one tax base to the other. But it also meant that that the corporate rate had to be kept fairly high at a time when globalization was exerting downward pressure on corporate tax rates worldwide. “Alignment,” argued Gemmell, “was yesterday’s target; it was more appropriate when corporate rates were higher.”24 Gemmell instead took the view that with the 30 percent or lower corporate rate then current, it was better to abandon strict alignment as a policy objective. Additionally, a lower corporate rate might contribute to stimulating growth in the economy. This argument about taxes and growth laid the foundation for a revised “nonalignment” tax policy stance in the Treasury. Driven by the new intellectual impulses, the Treasury “raised its profile”25 in tax policy making. This is evident from the policy briefings prepared by the department: Whereas the Treasury’s 2005 Briefing to the Incoming Minister did not even contain the word tax, the 2008 version made taxation one of the main issues and included a separate document with tax policy advice (see Treasury 2005, 2008, 2009). The Treasury’s reengagement in the tax area meant that there were now two departments in the field with former academics in leading positions and with considerable capacity for economic analysis. But rather than setting off an administrative turf war, the upsurge in analysis and advice in the Treasury stimulated discussions about tax policy and interest in a new tax reform. But why did New Zealand need a new tax reform? Seen from the outside, tax policy change did not seem urgent. Alan Auerbach, a tax economist at Berkeley, commented in 2001 that “New Zealand’s current tax system already conforms more closely to the standard objectives of taxation than do the tax systems of many other developed countries [and] is not obviously in need of major overhaul” (Auerbach 2001: 1). A 2007 OECD review likewise found the New Zealand tax system to be “one of the most efficient within the OECD”

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(OECD 2007b: 107). Yet from 2005 onwards, the IRD and the Treasury issued a series of policy documents that expressed concerns about the state of the tax system and put forward proposals for change (see IRD 2005, 2008; Treasury 2009). Whereas the IRD bemoaned that tax rates were no longer aligned, the Treasury emphasized the pressures from globalization on the tax system. But despite differing problem definitions, both departments were fundamentally motivated by microeconomic thinking and advocated tax reform as a means to improve economic efficiency. Their key piece of advice to ministers was to cut personal income tax rates, and officials suggested that this could be done by shifting taxes from labor to consumption—a so-called tax switch (see IRD 2008: 44; Treasury 2009: 1). In the 2008 elections, the National Party defeated Labour and formed a government based on confidence and supply agreements with three small parties.26 But National initially had no ambitions for tax reform. In its manifesto, National had proposed a series of modest personal income tax reductions, but it was not planning to make more significant changes. “In the government, there was not a groundswell of interest for tax reform, nor a sense of urgency to revise tax policy. Tax reform was simply not on the agenda,” commented one former official.27 Prime Minister John Key had promised before the elections that he would not raise the GST, New Zealand’s value-added tax. A tax switch from labor to consumption was therefore not a move National had considered: “The government was not initially thinking about a tax switch,” explained officials in the Treasury. “It was not something they had thought about when they came to government in 2008.”28 The Minister of Revenue Peter Dunne, who represented the centrist United Future Party, confirmed this account: “I think it’s fair to say that we didn’t have clear and formed ideas [about what to do in tax policy]. I don’t think the government quite envisaged the scope of the changes in 2008.”29 The briefings presented by the IRD and the Treasury to the incoming ministers failed to spark political interest in tax reform. Frustrated by the lack of traction for their policy ideas, officials started looking for other ways to raise the issue on the agenda. A practitioner close to the bureaucracy observed that “officials were looking for a different format to push their agenda. They realized that in order to create a political climate for tax policy changes they would need to bring the tax debate out to the public.”30 The first initiative was a public tax conference in February 2009. The conference was organized by the Center for

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Accounting, Governance and Taxation Research at the Victoria University of Wellington in cooperation with the IRD and the Treasury. The Center, just a stone’s throw from the government buildings in the center of the capital, included former ministry officials and had close ties to the IRD and the Treasury. The conference brought together a number of leading tax economists from abroad to discuss New Zealand’s tax system. And one of the reform options that were debated was a tax switch from labor to consumption. The conference kindled the interest of the ministers of finance and revenue in looking into tax policy changes for the longer term—though in a noncommittal way. “After the tax conference both ministers were quite keen for a debate on tax policy to occur, but for it to be outside the ambit of government,” commented one official.31 For the Minister of Revenue, The international tax conference was a very high-powered conference, and quite a lot of good stuff was on the table . . . The thought then crystallized that there was a chance for an independent group to have a good look at the system and come up with some recommendations.32

To do so, the ministers endorsed a working group to be set up at the Victoria University. The “Tax Working Group” was organized by the tax research center at Victoria and chaired by Bob Buckle, dean at the university and a former macroeconomic advisor in the Treasury. The group was composed mainly of officials from the IRD and the Treasury and people from the private sector, plus two legal experts from the university. The group did not include economists from other universities in New Zealand. Just like the tax conference, the working group was “largely an officials’ initiative”33—officials came up with the format and selected the participants. The group constituted “a new policy advice ‘institution’” (Gemmell 2010: 63): Even though it was endorsed by ministers, it was formally independent and did not have the status of an official commission of enquiry. Officials came in with a well-formed notion about where they wanted the group to go and set the agenda by suggesting a tax switch in the background documents prepared for the group (see Treasury and IRD 2009a, 2009b). The private sector representatives on the committee were sympathetic to this agenda. Ever since the reforms in the 1980s, business in New Zealand had been firmly committed to the low-rate, broad-base tax regime. “We want to keep the tax system as pure as possible,” stated a business representative. “We have no

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desire for stimulating economic activity through the tax system. We fight businesses that want tax incentives—we don’t want to go back to the 1980s.”34 The private sector was thus “to a great extent aligned with the IRD and Treasury”35 in the campaign for a tax switch. Yet, according to the actors involved the role of business was clearly secondary to that of bureaucrats. “Fundamentally tax policy was driven by officials with broad agreement and consent from the private sector,” observed one private sector representative on the working group.36 “The dominant influence on policy was officials,” added another member, “while the private sector provided input.”37 The trade unions, by contrast, were opposed to the tax switch on equity grounds and instead favored more active use of tax policy as a lever in economic management.38 But although the unions were invited to attend the sessions of the working group, they were not formally represented in the group and played a negligible role in the policy process. The final recommendations of the working group closely corresponded to the policy views of officials. The group proposed to reduce top (and if possible all) personal income tax rates and increase the GST rate to 15 percent, combined with base-broadening measures (see Tax Working Group 2010: 10–11). For officials, the working group was thus as much a vehicle for policy advocacy as a forum for genuine policy development. The group served as “a lorry to transport ideas into the public” and a means “to socialize and road-test their proposals,” observed two private sector representatives.39 As one key official put it, “The New Zealand review was probably more weighted towards generating and influencing public debate around tax reform” than other tax reviews (Gemmell 2010: 85; see also Buckle 2010).

National’s Switch

As the tax conference and the Tax Working Group process unfolded, the government’s attitude to reform changed (Buckle 2010: 130). Ministers listened attentively to the tax policy advice provided by officials and by the working group. And competing ideas about tax policy design were few and far between: None of the policy makers interviewed gave any indication that ministers sought alternative ideas from other experts. As a result of this process, ministers who had previously been uninterested in reform came to see the merits of a tax switch from labor to consumption. The Minister of Finance and the Minister of Revenue were won over fairly early in the process and subsequently championed reform within the Cabinet. Prime Minister John Key was initially more reluctant,

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mainly because of his 2008 election promise not to raise the GST rate. But the international economic downturn provided Key with a justification for increasing the GST.40 In his opening speech to parliament in January 2010, Key came out in support of reform. What convinced the Cabinet to embrace tax reform? On the one hand, ministers were won over by the economic arguments for a tax switch. Throughout the process, officials had drawn on the authority of the international economics discipline to validate their arguments about the benefits of reform. And coming out of recession and in a precarious fiscal situation, the prospect of stimulating work and savings without losing revenue proved attractive to politicians. Ministers “bought into the growth agenda”; they were “convinced that reform of the tax system was integral to growth,” observed sources close to the government.41 On the other hand, the activities of the Tax Working Group influenced the political calculations of the government. The debates raised by the group increased the public’s acceptance of tax reform. An opinion poll in January 2010 showed that 79 percent of New Zealanders thought the tax system needed reforming, and that 56 percent thought lower top personal rates and broadening the tax base would make New Zealand more attractive for skilled labor and investors (cited in Buckle 2010: 129). Although the government did not have an electoral mandate for reform, the public support for the proposed measures convinced ministers that the tax switch would not be a liability in electoral terms. Following the premier’s endorsement, the ministers of finance and revenue together with Treasury and IRD officials hammered out a tax policy package. The reform the government adopted in the budget in May 2010 followed the recommendations of the Tax Working Group to a remarkable extent (Buckle 2010: 134). All statutory tax rates on personal income were significantly reduced—with the top rate dropping from 38 to 33 percent—while the rate of the value-added tax was raised from 12.5 to 15 percent (see Treasury 2010). The reform also lowered the tax rates on corporations and various savings instruments from 33 or 30 percent to 28 percent, combined with some base-­ broadening measures. Politicians left their mark on the reform mainly by ruling out some of the additional proposals discussed in the Tax Working Group (such as the introduction of a land tax or a capital gains tax) and by spreading the personal income tax cuts more evenly across the rates in order to avoid an adverse impact on the income distribution (Gemmell 2010: 83). Although the reform made the tax system considerably less progressive, compensatory

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increases in social benefits meant that the net effect on the level of inequality was small (Treasury 2010: 9). With the 2010 reform, New Zealand took one step further toward a tax structure made up of low uniform rates applied to the broadest possible base, arguably moving closer than any other country to realizing a perfectly marketconforming tax system. Even though the reform was less spectacular than the tax policy revolution under Roger Douglas, the dynamics behind the reform closely resembled those at work in the 1980s: The ideas for reform came predominantly from neoclassical economists in the bureaucracy; officials took an activist approach to policy advice, using their technical expertise to set the agenda and convince ministers; and political leaders endorsed core elements of these proposals (Christensen 2012). The line running from the IRD and Treasury 2008 ministerial briefings, through their background documents for the Tax Working Group and the group’s recommendations, all the way to the final reform is visible evidence for the considerable influence of state economists in this case. The powerful position of neoclassical economists within the state—and the prominence of these economists within the broader knowledge regime—was at times hotly contested. But as we have seen, neither public criticism nor the organizational displacement of economists was enough to loosen their grip on tax policy making.

Conclusion New Zealand’s embrace of market principles in tax policy was the result of a confluence of factors: the breakdown of the old economic regime, the concentration of power in the country’s political institutions, a shrewd political entrepreneur, and, as emphasized in this chapter, the vocal advocacy of economic experts within New Zealand’s public service. The internally driven buildup of economic knowledge in the New Zealand Treasury in the 1960s and 1970s led to the establishment of ties to the international economics discipline and the recruitment of economists with training from the United States to key positions. As a result, the New Zealand Treasury came to embrace a set of neoclassical economic ideas that inspired a radical program of economic restructuring. The impact of Treasury economists on economic policy making in the 1980s reflected their expertise and central position within the country’s knowledge regime, as well as their willingness to aggressively promote their ideas to political leaders. Despite severe criticism and organizational reforms, the sway of

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state economists over tax policy largely persisted over the following decades, culminating in a further strengthening of the market-conforming profile of the tax system in 2010. In international perspective, the policy role of economists in New Zealand was quite remarkable—indeed, as we will see in the next chapter, it differed sharply from the role of economists in Irish policy making.

Chapter 4

Ireland Populist Politics in a Generalist System Up until now very little value has been placed on economic expertise. While the Government Economic Service in the UK has trained economists and placed them all over the public service, we have had nothing like that in Ireland. It has remained a purely generalist system. There have been very few economists in the civil service, particularly at the senior level. That applies to the Department of Finance, the Revenue Commissioners, and several other departments. —Economist, University College Dublin, interview, April 2010

T

HE period from the early 1990s until the onslaught of the global economic crisis in 2008 was an era of economic prosperity in most of the Western world. But in no place could they match Ireland’s miraculous economic boom. From 1993 to 2007 the Irish economy expanded at an annual pace of 7 percent, much quicker than in any other OECD country. Ireland’s chronically high unemployment rate fell from 16 percent in 1994 to just 4 percent in 2000, and growth in exports was followed by a prolonged boom in property and construction. House prices increased by 240 percent from 1997 to 2007—that is, more than in countries like the United States, the UK, and Spain. The astonishing success of the “Celtic Tiger” came to an abrupt end with the collapse of the property market in 2007. Plummeting house prices left a hole both in the government’s tax revenues and on the balance sheets of Irish banks. The crisis in public finances and in the banking sector quickly spread to the rest of the economy, producing a sharp drop in economic output and employment. The government’s hasty decision to bail out the banks led to a manifold increase in government debt, forcing Ireland to accept a rescue package from the EU and the IMF that entailed substantial expenditure cuts and tax increases. Ireland’s economic roller-coaster ride was fueled by a particular set of tax policies. These policies have often been portrayed as strongly market based. In the standard narrative, Irish policy makers used a low corporate tax rate to attract foreign direct investments and cut taxes on labor in order to incentivize enterprise and growth (Allen 2000; Kirby 2002; see also Ò Riain 2008). Yet, the more closely one looks at the Irish tax regime, the less market conforming it 81

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appears. On many counts, the tax policies pursued by Irish governments from 1980 onwards ran directly counter to market principles. Whereas conformity to the market would imply level playing fields and neutral taxation, Irish tax policy was all about directing and influencing economic choices. The “distortions” so reviled by economists were rampant in Ireland. The Irish property boom, for instance, was fueled by a plethora of specific tax incentives for investments in construction projects ranging from the building of seaside resorts to inner-city development. More generally, Irish tax policies from the 1990s onwards were a peculiar combination of tax cuts on labor, the maintenance of a very narrow tax base, and the expansion of tax incentives for particular economic activities—that is, a profoundly different set of policies from the lowrate, broad-base, neutrality-oriented reforms that were introduced in New Zealand (Christensen 2013). Why did Ireland pursue an economic policy of stimulating selected sectors rather than of leveling playing fields? Why did it adopt a tax regime of narrow bases and specific incentives rather than market-conforming policies? One common explanation links activist economic management to the openness of the Irish economy. Both in terms of trade and inward foreign direct investment, Ireland ranked among the top three countries in the OECD (OECD 2011d). “As one of the most open economies in the world, Ireland also experienced incentives to manage its economic fortunes more actively than the market-­ conforming liberal model might suggest,” assert Dellepiane and Hardiman (2012: 84). The Irish state stimulated industrial development to promote competitiveness within international markets (Ò Riain 2004: 163). This argument makes explicit reference to Katzenstein’s theory about how small European states resorted to state-managed growth policies to cushion the shocks from an open economy (Katzenstein 1985). But although this argument can help us understand Irish economic policies in the decades after World War II, it is not a convincing explanation for the continued and intensified use of selective incentives after 1980. This was after all an era when other small open economies like the Scandinavian countries moved resolutely away from active interventionism through the tax system. Another account highlights the populist character of Irish party politics. The insignificance of the economic left–right dimension and the weakness of the Labour Party set the Irish party system apart from the systems of other Western countries (Mair 2003). Irish politics was dominated by two parties

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with origins in the movements that opposed each other in the Irish Civil War (1922–1923)—the Fianna Fáil and the Fine Gael—both ideologically flexible “catchall” parties (McGraw 2012: 47). An electoral system where voters rank individual candidates also contributed to forging close links between members of Parliament and their local constituencies, giving rise to a constituency-based politics not unlike what we find in the United States (Adshead and Tonge 2009). For some scholars, “The electoral context can help explain why there has been no shift towards stark neoliberalism in Ireland” (Smith 2005: 186). Irish parties have seemed more interested in catering to their constituencies than in implementing a coherent set of tax policies (Hardiman 2000: 835–836). This is no doubt an important part of the story, as political parties were the main drivers of tax policy change in Ireland. But it is not the whole story: The ability of Irish politicians to monopolize policy setting was related, among other things, to the character of the country’s administrative system. In this chapter, I contend that an important reason why Ireland did not adopt market-conforming tax policies, and why it rather pursued a policy of stimulating the economy through specific tax breaks, was its generalist civil service. The persistence of generalist, competition-based recruitment to administrative posts effectively blocked the rise of economists within the state. Whereas economists came to play a growing role in finance ministries around the world, the Irish Department of Finance constituted an exception. In 2010, only thirty-nine out of 542 officials in the department—that is, 7 percent— had economics training at the master’s level or higher, a number described as “extraordinarily low by international standards” (Independent Review Panel 2010: 45). This meant not only that efficiency-centered economic ideas about taxation lacked carriers within the bureaucracy but also that officials lacked the economic skills to stand up to politicians—both features that had significant implications for the direction of Ireland’s economic policies.

On the Margins of the Generalist State Ireland gained independence from Britain in 1922 after the War of Independence and the Irish Civil War. The new Irish state effectively inherited the administrative institutions that had been set up under British rule, including the generalist civil service regime. “The Irish civil service adopted an organisational practice and structure similar to that of the British Whitehall system,” write Hardiman and MacCarthaigh. “The core features of Whitehall—an apolitical

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and generalist administration . . . came to characterize the new post-colonial civil service” (Hardiman and MacCarthaigh 2010: 370). As in Britain, Irish civil servants were recruited through centralized competitive examinations on the basis of general skills. The recruitment of generally trained officials to a unified civil service rather than to a specific department differed from the decentralized and increasingly specialist recruitment regimes in New Zealand and the Scandinavian countries. From the outset, most senior officials in the Irish Department of Finance were “amateurs” trained in the liberal arts who had held positions in the British civil service (Fanning 1978: 532–545). Very few of the officials in the department had higher university education, and experts were generally held in low esteem. Like their colleagues in other treasuries, Irish officials were concerned with managing the state’s finances and not the economy (Fanning 1978: 560–561). On achieving independence, Ireland was one of the poorest countries in Europe, with a predominantly agricultural economy. In the young state, the question of sovereignty dominated, as expressed in the uninterrupted reign of the nationalist Fianna Fáil party from 1932 to 1948. The national orientation of the government led Ireland to pursue an economic policy of protectionism and import substitution that did little to pull the country out of underdevelopment. It also kept debates about more active economic management off the table for a long time. “Indeed the relative lack of public interest in economic policy qua economic policy is a remarkable feature of the first quarter of a century of the state’s history,” observes historian Ronan Fanning (1978: 406; original emphasis). The Irish Department of Finance did nevertheless obtain a certain familiarity with Keynesian economics during World War II. So when the government changed and politicians expressed a more positive attitude to economic planning in the late 1940s and 1950s, the department was ready to take a leading role in economic management (Fanning 1978: 562, 634). The architect of economic planning in Ireland was T. K. Whitaker, a young civil servant who was trained in economics and had risen rapidly through the ranks of the Department of Finance. On his initiative, the department in 1950 set up an economic secretariat led by Whitaker and hired its very first “economist qua economist” (Fanning 1978: 556; original emphasis). The publication of Economic Development, a policy document prepared by Whitaker and his staff in 1958, not only spurred a more planned approach to economic development; it also launched an internationally oriented economic strategy that involved trade liberalization, the

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attraction of foreign investments, and the promotion of exports through a tax exemption on profits from export production (Department of Finance [Whitaker] 1958; see Smith 2005: 97–105). During the work with Economic Development, Whitaker also identified the need for more research on the Irish economy. This led to the creation of the Economic Research Institute (later the Economic and Social Research Institute, or ESRI) in 1960, with initial funding from the Ford Foundation. To ensure that its research was independent from government and political influence, the institute was set up outside the civil service (ESRI 2015). The central role of Department of Finance officials in economic management in the 1950s and 1960s was not, however, accompanied by a general rise of the economics profession within the department. An important reason was that the centralized recruitment system made it difficult for the department to hire the economists it wanted. C. H. Murray, who would later become secretary of the department, wrote in 1969 regarding the recruitment of economists: There is something formal and off-putting about going through the Civil Service Commission or an interdepartmental competition for such posts. Our whole approach to recruitment is geared to 19th century thinking and to meet issues which were more relevant to that century than to the present. We cannot afford the luxury of an elaborate system of recruitment which does not get us the people we want. (cited in Fanning 1978: 620)

It is worth noting that Murray made these comments at the exact same time as Henry Lang initiated the systematic hiring of economics graduates to the New Zealand Treasury. It was thus not so much the demand for economic expertise that differed between the two countries as the administrative mechanisms available for hiring economists. Whereas New Zealand’s decentralized recruitment system allowed Lang to rapidly build up economic knowledge in the Treasury, the central recruitment competitions of the Irish civil service effectively hindered the accumulation of this kind of professional expertise in the Department of Finance. In the United Kingdom, which had an equally generalist civil service as Ireland, the government had addressed the issue of economic expertise with the creation of the Government Economic Service in 1964, which was meant to strengthen the position of economic specialists in Whitehall (Fourcade 2009: 169–172). But Ireland did not set up a body of this kind for another half a century. (It would eventually establish an economic service in 2012 in the aftermath

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of the economic crisis.) The gradual professionalization that occurred in Whitehall was thus not replicated in the Irish civil service. The number of economists in the principal economic departments remained very limited. The economic entities in the Department of Finance were further weakened by organizational changes in the 1970s. The economic secretariat was integrated in a larger economic division in 1971, which was then made into a separate Department of Economic Planning in 1977 (Fanning 1978: 626). Yet, the new ministry was shut down only three years later and its staff transferred to other departments, in particular to the Prime Minister’s Office (Lee 1989: 503; Regan 2012b: 5). The Irish Department of Finance thus never became an economists’ organization like the New Zealand Treasury. And the main reason lay in Ireland’s administrative institutions. As in the rest of the civil service, recruitment and promotion in the department were based on general skills and administrative experience rather than advanced academic qualifications. The Department of Finance of the late 1970s and 1980s was dominated by generalists without advanced economics training and had weak links to the economics profession. The detachment from the economics discipline made the department unreceptive to the neoclassical ideas that spread within the economics discipline at the time. Microeconomic notions about efficiency and level playing fields that were so in vogue elsewhere lacked carriers in the Department of Finance. As opposed to in New Zealand, where economists in key positions in the Treasury were the most fervent advocates of market-oriented reform, Irish Finance officials were skeptical to this kind of policy ideas. As we will see, this had implications for economic policy making.

The Tax Reform That Never Transpired In 1979 and 1980, people took to the streets of Ireland in revolt against the tax system. The protests were led by regular employees, who were fuming at what they perceived as an unbearable tax burden. Because of its narrow tax base and privileged treatment of farmers and the self-employed, the tax system imposed disproportionately high tax rates on those with a regular salary (Hardiman 2000: 821–827). Statutory income tax rates in Ireland had increased sharply during the 1970s to make up for a rapid growth in government expenditures. Yet, due to a wide array of tax breaks as well as rampant tax evasion, the tax system was not producing sufficient revenue. At the beginning of the 1980s, Ireland was

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running deficits in the double digits every year, amassing debt at a vertiginous pace. At the same time, inflation had reached nearly 20 percent, and unemployment was rising fast (Sandford 1993: 179). In response to the protests, the government set up an independent Commission on Taxation made up of experts and interest group representatives to have a close look at the tax system. The secretary of the commission was Donal de Buitléir, a former civil servant who had obtained a PhD in economics with a dissertation about horizontal equity in tax policy. De Buitléir was inspired by neoclassical thinking about taxation and had a major influence on the work of the commission.1 In a series of reports, the commission proposed a radical restructuring of the tax system that involved the introduction of a single tax rate on all types of income plus a progressive direct expenditure tax, as well as the elimination of most tax deductions and exemptions (for a summary, see de Buitléir 1983). The reports have been described as “a more comprehensive blueprint for tax reform than any of the other tax reform documents of the 1980s” (Sandford 1993: 170). Indeed, they constituted a more detailed plan for large-scale tax reform than the U.S. Treasury’s report Tax Reform for Fairness, Simplicity, and Economic Growth or the New Zealand Treasury’s policy program Economic Management. But, unlike in these countries, ideas about tax reform were not embedded in the Irish bureaucracy. Most fundamentally, this reflected the marginal position of neoclassical economists in the Irish Department of Finance. But it was also a result of the fact that the work of the Irish Commission on Taxation was disconnected from the bureaucracy. The commission did not have members from or formal links to the finance or revenue departments; it was “outside the normal sphere of government” (Sandford 1993: 185). Officials therefore had little or no exposure to the neoclassical perspective that directed the proposals of the commission. As a key member of the commission observed, The commission was set up at arm’s length and asked to go do their thing. As a result tax policy preferences changed among the people on the commission, but there was no such shift in thinking in the political or bureaucratic environment.2

The Department of Finance was skeptical if not hostile to the commission’s tax reform blueprint, describing it as “crazy,” “theoretical,” and “too academic.”3 The radical nature of the proposals clashed with the conservatism—both fiscal and otherwise—of the department. The prospect of a single tax rate raised

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r­ evenue concerns, and the idea of a direct expenditure tax was dismissed on the grounds that it was untested in practice (Sandford 1993: 187). “The permanent civil service,” relates a political adviser at the time, “did not support the recommendations of the Commission . . . Senior officials took pains to express their doubts publicly” (Honohan 1988: 33). Hence, rather than promoting tax reform, the Department of Finance was stubbornly working against it. Initially, the political community also showed little interest in reform. During the commission’s deliberations the government had changed, and the commission lacked political sponsors in the governing parties. The government in power from 1982 to 1987 was also an uneasy coalition between the centrist Fine Gael party and the Labour Party, “two parties who were likely to have fairly sharp differences of view of the questions involved” (Honohan 1988: 31). Whereas the Fine Gael was economically pragmatic, Labour held traditional leftist views on economic policy and was committed to a high tax, high spending economy. “Labour believed they could solve any problem by increasing the level of taxes . . . They were not interested in restructuring the tax system,” related Alan Dukes, Fine Gael’s Minister for Finance in the coalition government.4 The government also faced an acute fiscal crisis that consumed most of its time and energy. Persistent deficits in the double digits had left the country in a situation where the entire proceeds from personal income taxes were used to pay interest on the government’s debt (Sandford 1993: 179–180). “Under the circumstances [of fiscal crisis], major tax reform was difficult to contemplate,” argued Alan Dukes. “There was no discussion in political circles about the restructuring of the tax system because the fiscal deficit was seen as the main problem.”5 Unlike in New Zealand, where fiscal problems provided part of the rationale for overhauling the tax system, Irish politicians saw the fiscal crisis as a barrier to tax reform. Without support in the political-administrative apparatus a tax reform process never got under way in Ireland. “With administrative as well as political opposition swamping the theoretical arguments,” remarked one close observer, “it was perhaps inevitable that the Government all but buried the proposals” (Honohan 1988: 34). On publication, the commission reports were met with complete silence by the executive: “There was virtually no response: no acceptance of the Commission’s reports, nor any public repudiation of them, nor . . . any official process of consultation conducted on the basis of them” (Sandford 1993: 185). Instead of reducing rates and broadening bases, the government raised statutory tax rates on labor—with the top rate hitting 76 percent

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in 1984—and allowed the tax base to erode further (NESC 1986: ch. 4; 1990). By 1987, the pathologies of the tax system were even more pronounced than before: “Not only had no progress been made in the structure of the tax system since 1980, but the distortions, which had caused the outbursts of 1979 and 1980, were now very much worse” (Hardiman 2000: 829). The political context did, however, change dramatically in the late 1980s. The catchall Fianna Fáil party came back to power in 1987 and was joined in government by the small, economically liberal Progressive Democrats (PDs) in 1989. Whereas the Fianna Fáil showed little interest in tax issues, the PDs had an economic agenda that included a restructuring of the tax system. The party was supportive of the ideas put forward by the Commission of Taxation and took advice from Donal de Buitléir, the economist who had shaped the proposals of the commission.6 In fact, the PDs made tax reform a condition for joining the coalition in 1989. In the government program and a later progress report, the coalition government stated explicitly its intention to bring tax rates down and to reduce tax-created distortions in the economy by systematically cutting back “the vast range of exemptions, shelters, allowances and concessionary tax rates” (cited in Sandford 1993: 189; see also Hardiman 2000: 833). Unions and employers also expressed support for major tax policy changes through the tripartite National Economic and Social Council (NESC). NESC was an advisory body made up of representatives of industry and trade unions as well as government officials and independent experts. The council built on an earlier body that had been set up in the 1960s to produce economic analysis and advise the prime minister on social and economic policy (Regan 2012b: 89–91). As a tripartite institution, NESC gave employers and trade unions access to technical analysis capacity these organizations did not have themselves and provided a channel for presenting joint analyses and proposals to government. In its 1986 report, NESC enthusiastically endorsed the proposals of the Commission on Taxation. It stated that “a major restructuring of [the tax] burden is both feasible and desirable” and argued that: Tax reform may now be the most powerful instrument available to Government to promote faster growth in output and employment in the short to medium term. . . . [Tax reform] offers the opportunity of stimulating economic activity in the medium term at a time when neither reductions in the overall burden of tax, or expansionary fiscal policy can. (NESC 1986: 228)

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The work of NESC laid the foundation for the 1987 tripartite Social Partnership agreement, in which unions agreed to wage moderation in exchange for personal income tax reductions (Hardiman 2000: 830). But although the agreement raised the prospect of tax cuts, it did not address the structural problems of the Irish tax system. In its 1990 report, NESC repeated its proposals for a tax reform that involved a significant broadening of the tax base (NESC 1990). These proposals were echoed by economists at the Economic and Social Research Institute, who in reports highlighted tax reform along the lines drawn up by the Commission of Taxation as a way to improve the long-term efficiency of the economy (Bradley and Fitz Gerald 1989; Fitz Gerald 1989). With an economically liberal party in a pivotal position and support for tax reform among the social partners and external experts, the conditions seemed conducive to reform. The government did reduce the tax rates on labor somewhat, bringing the top statutory rate down from 70 percent in 1987 to 61 percent in 1992 (Department of Finance 2010b). But it did little or nothing about the narrow tax base. In its 1990 report, NESC had observed that “despite some limitation of mortgage interest and life assurance relief, the wide range of discretionary allowances, reliefs and exemptions have remained substantially in place and have, in a few cases, been extended” (NESC 1990: 175). Three years later, Sandford made the same observation, finding that the “progress on widening the tax base has been limited and uneven” (Sandford 1993: 194). Income tax allowances and reliefs still amounted to more than two-thirds of the income tax base, and a wide range of tax reliefs for corporations remained in place. In other words, the policy changes from 1987 to 1992 did not represent a significant move toward the adoption of market principles in the tax system. Not only were top statutory tax rates on labor still high; the deep deductions and targeted incentives of the Irish tax regime remained untouched. Why were the concrete proposals for market-oriented reform in Ireland not turned into policy? One possible explanation is that the fiscal crisis precluded major reform. Yet there is good reason to be skeptical about this argument. A restructuring of the tax system could have been used to raise revenues without increasing tax rates or to stimulate growth without losing revenue, both prospects that would seem attractive to a government short on cash. In New Zealand, fiscal crisis was seen as part of the rationale for reforming the tax system, and it is difficult to see why this could not have been the case in Ireland too. Another possibility is that tax reform lacked strong proponents among interest groups

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and external experts. But as shown, tax reform was repeatedly advocated by the tripartite council where both trade unions and business were represented. And it also had the support of economic experts in research institutes outside the state. A more powerful argument is that the political-partisan context prevented reform. “What was primarily lacking in Ireland 1982–87 was the political will,” asserts Cedric Sandford in a comparative study of tax reform in the Anglo-Saxon world. “Neither of the major parties in Ireland embraced tax reform as part of a programme for deregulation in the way in which it figured in the other five countries [the United States, UK, Canada, Australia, and New Zealand]” (Sandford 1993: 175–176). The center-left coalition in power from 1982 to 1987 lacked both the ambition and the cohesion to adopt large-scale policy changes. And from 1987 the Fianna Fáil, a party with little interest in tax reform, had both the prime minister and minister for finance. This political context was undoubtedly significant for the absence of market-oriented reform. Yet, the persistent lack of reform after the Progressive Democrats joined the government in 1989 represents a challenge for the partisan argument. Another factor that arguably contributed to the absence of tax reform was the lack of support in the economic bureaucracy—a feature that distinguished Ireland from the countries that adopted market-conforming policy changes. In the predominantly generalist Department of Finance, economists were scarce, and neoclassical ideas about taxation had few supporters. This meant that during the period of great economic uncertainty in the 1980s there was no one within the state promoting tax reform as a solution to the country’s fiscal and economic woes. In the years 1982–1987, low-rate, broad-base tax reform lacked advocates altogether among policy makers. And in the period 1989–1992, the Progressive Democrats were deprived of a bureaucratic ally in their efforts to pursue a more market-oriented course. In other words, there was nothing impossible about tax reform in Ireland; reform of the tax system according to market principles was one potential outcome that did not materialize—due primarily to the political context but likely also to the marginal position of economists in the Irish civil service. The scarcity of economic expertise in the bureaucracy would have more visible consequences during the Celtic Tiger years.

Celtic Tiger Tax Policy Charlie McCreevy has been described as “the most influential finance minister in Irish history” (Leahy 2010: xi) and was easily one of the most controversial,

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too. Minister for finance for Fianna Fáil from 1997 to 2004, McCreevy held the reins of economic policy during Ireland’s spectacular economic boom, often referred to as the “Celtic Tiger” era. McCreevy came to office with a clear vision about what he wanted to do in tax policy: cut taxes. He was “absolutely committed to tax reform,” comments Pat Leahy, “by which he meant significant cuts in all areas of taxation” (Leahy 2010: 127). McCreevy believed that high taxation had stifled the animal spirits of the economy and saw lower taxes as the means to increase work incentives and stimulate entrepreneurship and enterprise. Yet, McCreevy’s worldview was not that of a neoclassical economist. An accountant by trade, his views conformed more closely to those of a small businessman. According to civil servants who worked closely with McCreevy, he was fundamentally a political pragmatist with a business-oriented perspective: “McCreevy was not very inspired by academic economics,” commented one official. “As an accountant, he shared the world view of business . . . And he was a politician, thinking about this constituents, sectors. [He was] very much a pragmatist.”7 And, as another official observed, he had “a very strong ear for business.”8 This meant among other things that McCreevy supported the use of tax incentives to stimulate the economy, reflecting the business view that incentives were necessary to create wealth. On the other hand, he was dismissive of academics and academic knowledge: McCreevy had a “reasonably disrespectful approach to economists”9 and said several times in public that he rejected the advice of economists. Officials who worked closely with McCreevy did point out that he had some external advisors he consulted. Yet, as one official put it, he was “more influenced by himself.”10 Although McCreevy represented the Fianna Fáil, he had strong affinities with the junior coalition partner—the Progressive Democrats. The alliance between the two parties put McCreevy at the “centre of policy-making” (Leahy 2010: 98). Prime Minister Bertie Ahern vested McCreevy with nearly unlimited power over economic policy and in particular over tax policy. “McCreevy decided Irish tax policy by himself. He ran tax policy as his own fiefdom, completely independent of his colleagues in Cabinet,” related a senior civil servant.11 In fact, McCreevy did not even disclose the tax measures in his first budget to the premier or any of the other ministers until a few hours before the budget was presented (Leahy 2010: 131). McCreevy used his position in the government to pursue a radical twopronged tax strategy. The first element was a series of tax cuts on labor intro-

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duced between 1997 and 2004. Whereas the first cuts were targeted at higher incomes, the attention soon turned to reducing taxes for people on lower and middle incomes through the widening of tax bands and increases in standard allowances. Compared to New Zealand, the Irish cuts in marginal tax rates were modest—for instance, the highest statutory rate on labor was reduced only from 60 to 53 percent. However, the reductions in average tax rates were dramatic. From 1997 to 2004 the average labor tax rate on a single worker on average earnings dropped from 34 to 24 percent, and for a one-earner married couple on average earnings the rate fell from 24 to 6 percent (OECD 2008c). The second element of McCreevy’s tax policies was the expansion of tax incentives for construction and property. The government introduced a series of new tax breaks for construction projects (rural renewal, town renewal, and so on) and extended other schemes that had been introduced by the previous Fine Gael-Labour government (relief for building hotels, multistory car parks, and the like). These tax breaks came on top of the wide array of existing tax relief schemes for pension savings, private health services, mortgage interest payments, and so on (Commission on Taxation 2009: pt. 8; Madden 2008: 109). Combined with the already favorable tax treatment of housing, the tax incentives for construction fuelled an explosion in new property developments and a steep increase in house prices (Barham 2004; Rae and van den Noord 2006). It is no secret that many of these tax expenditures were direct responses to pressures from local constituencies and construction interests. The Fianna Fáil had a history of clientelism as well as “long-established ties with construction and property development interests” (Hardiman 2012: 10–12). During the property and building boom, construction interests had privileged access to policy making. A civil servant close to McCreevy recounted: The pressure for tax incentives for property came from the construction sector, which had close links to the Fianna Fáil. The Construction Industry Federation was quite powerful. Every year before the Budget there were three meetings that mattered: the ones with ICTU [trade union confederation], IBEC [business confederation] and the Construction Industry Federation. And the construction industry usually got its way.12

Under normal circumstances the combination of rate cuts and increased tax expenditures would not have been sustainable given that both imply a loss of tax revenue. But the economic situation in Ireland was anything but normal.

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With the economy expanding at a pace of 8 percent annually, tax revenues were pouring in and generating surpluses year after year (see Honohan 2009: 3–4). The apparent success of the government’s policies helped generate a broad political consensus around the further reduction of taxes for people on middle and lower incomes. It became an explicit objective to “keep people on minimum wages out of the income tax net and people on average wages out of the top rate.”13 This objective had the support of all the major political parties. In Ireland’s ideologically flexible party system, neither Fine Gael nor Labour found it opportune to oppose the highly popular tax reductions. On the contrary: The first calls for tax cuts in the 2007 election campaign actually came from the Labour Party (Leahy 2010: 256). It was also supported by interest groups as expressed through a series of Social Partnership agreements. IBEC, the main employers’ organization, was for tax cuts based on the “view that the best policy for a small open economy is to have a tax system on the low side, in particular for mobile factors like labor.”14 Trade unions, which had endorsed tax reductions in the late 1980s, continued to support tax cuts in the late 1990s and well into the 2000s. “In tax policy, cutting taxes for the low-paid was clearly our priority. We wanted people on low incomes not to have personal income tax,” said a representative of the main trade union confederation ICTU.15 The support of Irish trade unions for tax cuts—no doubt unusual in comparative perspective—is often attributed to the nonideological character of the unions and their orientation toward the Fianna Fàil rather than the political left (Regan 2012a: 9). The tripartite National Economic and Social Council, which produced the reports that underpinned the social partnership agreements, also gradually turned its attention away from structural tax reform and base broadening toward the reduction of income taxes. In the Council’s 1999 report, the main focus was on further reductions in income taxes, especially for the low paid (NESC 1999). Usually, though, McCreevy outbid the social partners. A business representative related how one year, when the trade unions wanted €1 billion in tax cuts and IBEC asked for €900 million, the government answered by cutting taxes by €1,5 billion.16 The result was that by 2007 nearly half of all income earners had been taken out of the income tax net; that is, they were not paying income tax at all (Commission on Taxation 2009: 54, 101). The significant tax cuts at the lower end of the income distribution appear to have contributed to a slight decline in income inequality during this period, although the numbers differ depending on

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the source.17 At the same time, the revenue hole left by lower income taxes was plugged primarily with the buoyant tax revenues from construction and property. This implied that the government was more and more reliant on sources of revenue that were highly sensitive to the business cycle and thus vulnerable to an economic shock (Honohan 2009: 3–4). By the mid-2000s, some economists were expressing concern about the growing signs of a property and construction bubble in the Irish economy. Researchers at the ESRI showed that the construction sector had grown so big that it crowded out other economic activity (Morgenroth and Fitz Gerald 2006). And, in a much-cited op-ed, Morgan Kelly, an economic historian at the University College Dublin, warned of an imminent collapse of the property market. “If the experiences of economies similar to ours are anything to go by,” wrote Kelly, “we may be looking at large and prolonged falls in real house prices of the order of 40–50 per cent and a collapse of house-building activity” (Kelly 2006). Yet, these were lonely voices in the Irish debate. In spite of the warnings, the government continued to tax stimulate the construction sector. The eventual phasing out of some tax relief schemes from 2006 proved too little, too late. The Irish property bubble burst in 2007, leading to a dramatic drop in tax revenues and marking the beginning of a fiscal and economic crisis that would last well into the 2010s.

Amateurs, Not Professionals

Missing from the preceding narrative are forces that opposed or restrained the policies of tax cuts and specific incentives. And, in fact, the absence of counterforces is a major part of the story. The ability of the government to proceed undisturbed on its march toward calamity was to some extent a product of the dominant position of the executive in Ireland’s political institutions. In Ireland, the lack of checks on executive power and a weak parliament entailed an “unusually strong concentration of powers in the hands of the political executive, that is, the government of the day” (Hardiman 2012: 16). But it was also, I argue, a function of Ireland’s administrative institutions. The development toward narrower tax bases and lower effective rates could go as far as it did in part because it was unchecked by the permanent bureaucracy and in particular by the Department of Finance. The Irish civil service may have been a copy of the British system, but it proved more resistant than the model. Even after the UK abandoned c­ entralized

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recruitment to administrative posts, Irish civil servants continued to be selected through a central agency on the basis of general skills and then allocated to departments as posts became vacant (OECD 2008b: 103).18 The persistence of generalist recruitment had a profound impact on the professional makeup of the Irish Department of Finance. In 2010, only thirty-nine out of 542 officials in the department (7 percent) had economics training at the master’s level or higher. As an external review of the department pointed out, “39 economists in the Department of Finance is extraordinarily low by international standards. Even excluding the public service cadre of 135 people, this represents less than 10 percent of the total staff complement in the core of Finance” (Independent Review Panel 2010: 45). Among the economists, only two had a PhD. The proportion of economists was no higher within the department’s Budget, Taxation and Economic Division: Merely 8 percent of the policy staff had a master’s degree in economics (Department of Finance 2010d). More generally, less than 30 percent of the department’s staff had a master’s degree at all (Department of Finance 2010a). Officials typically had as their highest qualification a bachelor’s degree in the arts, economics, business, or public administration or a diploma in law— clear evidence of the endurance of the “amateur” civil service model in Ireland. The scarcity of economists meant that the Department of Finance lacked technical economic expertise. It was “underequipped on the economic side,” as one university economist put it.19 According to the external review, the department did “not have critical mass in areas where technical economic skills are required” and had “too many generalists in positions requiring technical economic and other skills” (Independent Review Panel 2010: 6). In the tax area the department had little analytical capacity, in the sense that it lacked the tools for rigorously evaluating tax policy (Independent Review Panel 2010: 32). The marginal position of economists also implied that neoclassical thinking held little sway in the department. There were, as one academic economist observed, “very few neoclassical economists in important positions.”20 In fact, Finance bureaucrats were rather hostile to academic economists and their theories. In interviews, officials took pains to distance themselves from economists at the universities: We do applied economics, not academic. People think within an economic framework, but in this business we have to reach conclusions. This is not giving four hours of lectures a week, going around and presenting papers, and earning a high salary. This is doing a job, sixty hours a week.21

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This antagonism was confirmed by academics. One tax economist described an “anti-intellectual atmosphere among the senior people in the Department of Finance” and an administrative leadership that believed “that economists had nothing to contribute” and was “less open to the views of academic economists than other departments.”22 In other words, academic economists were held in low regard and had little influence on the premises for tax policy making. Officials’ strong identification as civil servants rather than as members of a profession also appears to have shaped their norms about administrative behavior. Whereas officials in the New Zealand Treasury saw it as their duty to explain to ministers how economic policy ought to be run, Irish bureaucrats regarded their role as more subordinate to politicians. Officials in the Department of Finance emphasized loyalty over autonomy, asserting that the “minister is the boss” and that they were “very much the minister’s servants.”23 These features of the Irish Department of Finance limited its ability and willingness to counteract the politically driven erosion of the tax base. Most fundamentally, the department’s failure to provide a solid factual basis for decision making meant that ministers were never forced to fully appreciate the economic consequences of their proposals. “Bureaucrats should give cold, technical advice,” one observer pointed out, “but there was no method of doing that in the Department of Finance.”24 An egregious example was the department’s lack of control with tax expenditures (Madden 2008: 95). The department never carried out a full review of tax expenditures, although this is regular practice in finance ministries across the developed world. Officials did not even have an overview of the revenue cost of Ireland’s many tax expenditures. After looking into the issue in 2009, the Irish Commission on Taxation noted: [There were] many instances where basic cost and benefit data were not available for tax expenditures. Where costs were available, we note that the quality of these estimates was variable. . . . It is difficult to see how accountability and control in the allocation of public resources can be adequately secured where basic information on the annual cost of so many tax expenditures remains unavailable or unreliable. (Commission on Taxation 2009: 240)

In other words, the failure to provide costings of tax expenditures made it easy for politicians to use the tax system to dole out benefits to constituents and special interests.

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The absence of a clear economic ideology—neoclassical or other—put officials at a further disadvantage in the policy process. Finance Minister McCreevy came to the job with a clear (if crude) idea about what he wanted to do in tax policy, and officials were never able to present a competing vision. Officials themselves claimed to have taken a fiscally conservative position. But their support for the goal of taking low-income earners out of the income tax25—which was a huge revenue giveaway—sits awkwardly with that claim. The department’s stance on tax policy is better described as pragmatic, in the sense that it was highly susceptible to the changing political and economic context. The lack of a clear stance in the bureaucracy made it easier for McCreevy to control the policy agenda throughout his seven years in office. The inability of the department to restrain the government’s tax policies was exacerbated by officials’ subservient approach to advising political leaders. Instead of insistently offering “free and frank” policy advice, officials were at times “giving advice that [conformed] to what politicians wanted to hear,” as one former official observed.26 The external review of the department found that officials provided critical advice on certain but not all of the questionable elements of the government’s tax policies: [The department] should have shown more initiative . . . in its advice on the construction sector, and tax policy generally . . . [T]here was no analysis or advice on the broader risk to the tax system from a more general downturn in economic activity from levels created in part by pro-cyclical fiscal policy. This lack of policy initiative is again disappointing, given the very active tax agenda of the Government over the last ten years. (Independent Review Panel 2010: 6, 32)

In fact, there is evidence that critical voices in the Department of Finance were silenced by senior officials. In one case made public by the Irish Independent, a junior official expressed serious concerns about the sustainability of the construction boom and the tax revenues deriving from it but was told by her superiors that these warnings were inappropriate. In official advice and public statements, “senior officials repeatedly removed, erased and dismissed such warnings in favor of more optimistic language” (Irish Independent 2012). Another former Finance official interviewed in the same article described an environment of “unquestioning obedience,” where officials were told off by their administrative superiors for questioning government policy. This environment, he pointed out, rendered the department incapable of informing the govern-

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ment of the “sheer recklessness of its policies.” In other words, the consequence of organizational norms that emphasized obedience to the political leadership over professional integrity was the unchecked domination of political goals and concerns in the setting of tax policy. To be sure, it can be objected that the prevalence of politicians over bureaucrats in policy making during the Celtic Tiger era was the result of other factors than the marginal position of economists. One argument—often evoked by officials themselves—is that strong economic growth and buoyant tax revenues weakened the controlling influence of bureaucrats. For instance, one official asserted that “under the extended period of economic growth the importance of the department diminished, since resources were not scarce.”27 It seems plausible that in a situation of abundant revenues it was difficult to persuade politicians to scale back existing tax expenditures or not to introduce new ones. But whether this was the decisive factor is doubtful. Officials also had trouble controlling the expansion of tax expenditures when resources were scarce. Many of the tax incentives for construction were introduced in the late 1980s and in 1994–1995, that is, at a time when Ireland was still running budget deficits (Department of Finance 2010c). Another argument points to the strong personality of Charlie McCreevy. McCreevy knew what he wanted to do and was not interested in listening to officials’ advice. Yet, although it is true that the influence of bureaucrats reached a low point under McCreevy’s reign, their influence was limited also before and after his period in office. There is also reason to doubt this argument on the grounds that another “strong personality,” New Zealand’s Roger Douglas, allowed officials a great say in policy making. In fact, a comparison of policy making under McCreevy and Douglas can illustrate the importance of the role of economists in the bureaucracy for the direction of economic policy. The similarities between Douglas and McCreevy were striking: Neither one was an economist or market ideologue; both were trained as accountants and held economic beliefs that were based more on gut feeling than analytical arguments. The two came into office with fairly similar ideas and ambitions in tax policy, which revolved around the desire to stimulate enterprise and reward effort through tax cuts. Yet while Douglas was confronted with the economic expertise, neoclassical ideas, and policy activism of the New Zealand Treasury, McCreevy faced a Department of Finance that lacked both technical skills and a clear perspective on tax policy and that showed little determination to give critical advice. Whereas the Treasury was

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able to challenge Douglas’s policy proposals and translate his desire for reform into market-­conforming policy measures, the Department of Finance was incapable of countering McCreevy’s proposals or of warning ministers about the risks related to the increasingly narrow and volatile tax base. One cannot avoid speculating that if Irish politicians had faced the New Zealand Treasury rather than its own Department of Finance, Ireland would have steered clear of some of the policies that contributed to the economic meltdown in 2008. The economic crisis did, however, prompt a broad reconsideration of Ireland’s political-administrative institutions. The question of professional expertise in the civil service—and especially within economic and financial regulation—was raised by investigative reports as well as by a number of commentators (for example, Drennan 2009; Molloy 2010). In response, the Irish government in 2009 appointed Patrick Honohan, a prominent economics professor, to lead the Central Bank of Ireland. This ended the tradition of appointing the former Secretary-General of the Department of Finance to the post. In a broader shake-up of the top management at the bank, career civil servants were replaced by experts in economic and financial regulation, many of them recruited from abroad. The hiring of outsiders with strong academic credentials and relevant experience was meant to address what one politician characterized as a “critical absence of intellectual firepower” among the staff at the bank (Irish Independent 2010). The Fine Gael–Labour government that came to power in 2011 took further steps in this direction. It quickly established the Irish Fiscal Advisory Council, an independent body composed of economic experts that was given the task of assessing and commenting on the government’s fiscal policies. It also created the Irish Government Economic and Evaluation Service, a recruitment and training unit aimed at supporting “better policy-making across the system, through enhanced economic and policy analysis expertise” (Minister of Public Expenditure and Reform Brendan Howlin, cited in O’Brien 2012). Styled on the equivalent British service, the new unit was charged with training and inserting economic experts into administrative positions. And in 2012, for the first time, an outsider was appointed to lead the Department of Finance. Even so, the top brass of the Department of Finance remained dominated by career civil servants with few economics qualifications. When the head of the department resigned in 2014, the search for a successor was confined to civil service insiders. As it turned out, the man chosen for the job was the same official who

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had presided over the department’s tax policy work in the period leading up to the crisis.

12.5 Percent: The Accidental Creation of an International Brand At the height of the financial crisis, the Irish state—no longer able to finance its operations—was forced to accept a rescue package from the EU and the IMF. In exchange for 67 billion euros of loans, the government committed to substantial cuts in public expenditures and tax increases across the income spectrum. Remarkably, the only element of the tax system that was sheltered was Ireland’s 12.5 percent corporate tax rate, which the government described as “a cornerstone of our pro-enterprise, outward-looking industrial policy” (Government of the Republic of Ireland 2010: 8). By far the lowest in the OECD, the corporate tax rate was credited with attracting large foreign investments to Ireland and often hailed as a key factor in Ireland’s past and future economic success (Commission on Taxation 2009; OECD 2009, 2011c). The low rate and relatively broad base of the corporate tax distinguished it from the rest of the Irish tax system. Why was corporate taxation so different? How can we account for the marketconforming profile of this part of Ireland’s tax regime? The Irish tax regime for companies had its roots in the internationally oriented economic strategy instituted in the late 1950s. As part of the efforts to promote exports, profits from export production were exempt from corporate taxation. This effectively created a two-tier corporate tax system, where a high tax rate applied to all other types of production. The preferential rate for manufactured exports was increased from 0 to 10 percent in 1981 (while the regular rate remained at 50 percent), mainly as a response to pressure from the European Commission (Smith 2005: 111). However, debates within the European Union about unfair tax competition intensified after several large companies moved their operations from continental Europe to Ireland in the mid-1990s. This led the European Commission to declare in 1996 that Ireland’s preferential tax rate was in breach of the European rules about discriminatory “state aid,” that is, state policies that give a competitive advantage to selected companies or industries. Given that this was formally a matter of competition policy, the issue landed with the Irish Department of Enterprise. The Department of Enterprise and the quasi-independent Industrial Development Agency (IDA) had since the early 1960s been the main engines of Ireland’s outward-oriented economic strategy

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(see Ò Riain 2000, 2004; Smith 2005). Based on the explicit goal of attracting and developing foreign direct investment, these institutions maintained close ties to the cadre of foreign companies operating on the island. The perceived success of this industrial strategy, as well as the agencies’ knowledge and extensive networks with private interests, gave them significant power and political clout (Ò Riain 2000). The prime concern of the Department of Enterprise and the IDA was to maintain an attractive environment for enterprise in Ireland, and they saw the pronouncement of the European Commission as a direct challenge to one of the cornerstones of this system. Even though Ireland could appeal the decision, a pending legal case would have created uncertainty and scared away foreign investors. The only viable option was therefore to change the corporate tax regime. It was also clear that, in order not to be discriminatory, the new system would have to be based on a single rate for all companies. But what exactly that single rate would be was not obvious, given the large gap between the preferential rate of 10 percent and the normal rate of 43 percent. Officials in the Department of Enterprise approached the question by sounding out stakeholders in the foreign investment sector and decided that a low single rate would be most appropriate: We spoke to big accountancy firms, senior companies, and senior officials in the IDA. The view was that 20 percent was too high—we would lose business. Fifteen percent was stretching it; 12.5 percent was more elegant. A low single rate would be a useful rate to promote firm growth. I could see no way forward without a low single rate.28

The Department of Finance, by contrast, was concerned about the potential revenue losses and initially favored a 20 percent rate.29 Yet in the ensuing discussions it lost out to the Department of Enterprise, which managed to convince the center-left government that a low rate would attract foreign companies and stimulate the Irish economy. As one participant observed, The Department of Finance made a big effort to stop it [the 12.5 percent rate]. But the Department of Enterprise mustered a coalition to bring it through, drawing on the support of the IDA and the multinational corporations. Politicians were persuaded; they became intellectually convinced [about the benefits of a low rate].30

In the final reform, the introduction of a single 12.5 percent rate was combined with a moderate reduction of depreciation allowances to shore up tax revenues. This gave the new corporate tax a relatively broad base, at least on paper (OECD

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2011c: 20). At the same time, Ireland maintained a number of loopholes in the corporate tax and continued to issue favorable tax rulings to large multinationals, allowing companies such as Apple and Google to pay considerably less than the statutory rate.31 The overhaul of Irish corporate taxation fits our definition of market-­ conforming policies, as it lowered and evened out the taxation of corporations at the same time as broadening the tax base somewhat (although the latter is disputed). Yet, the dynamics that produced this policy change differed markedly from the driving forces behind the adoption of market-conforming policies in New Zealand. The introduction of the low single tax rate on corporations was not a planned intervention motivated by concerns about economic efficiency. It was rather a response to an exogenous shock to Ireland’s industrial development regime. Prior to the EU decision, there were no plans for a single low rate. The idea emerged as a direct consequence of this intervention. “We clearly went from specific incentives to a general relaxation of tax,” commented a business representative. “But this was not something we were looking for. It was rather an unintended consequence of the EU intervention.”32 In other words, the change would not have occurred without the challenge from the EU. At the same time, the policy response was defined by Ireland’s powerful industrial development complex. Top officials in the Department of Enterprise took the lead in this process, using their close relations to other agencies and multinational corporations to generate proposals and secure political support. The choice of a single low rate was not rooted in neoclassical economic principles but in a view that emphasized enterprise and competitiveness. What are the implications for the central arguments of the book? Whereas I highlight state economists as key agents of market-oriented reform, other forces accounted for the introduction of the 12.5 percent corporate rate in Ireland. As such, this policy process demonstrates the limits of the argument about economists and the adoption of market-conforming policies. Policy moves toward low, uniform rates and broader bases happened also for other reasons than economic experts pushing efficiency-based proposals. At the same time, the field of corporate taxation in Ireland was characterized by some rather idiosyncratic features that conditioned policy making in the area. The first was the legacy of preferential tax rates for export production and manufacturing. This set Ireland apart from the other countries in this study and meant that Irish discussions about corporate tax policy started from a very different status quo. A second

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and related feature was the power of the industrial development institutions. Similar complexes of state agencies embedded in clusters of multinational businesses did not exist in the other countries. These case-specific features may to some extent explain why the politics of corporate taxation in Ireland diverged from the politics of taxation elsewhere. A second issue concerns the relation between economic expertise and bureaucratic power in policy making. On the one hand, the inability of the Department of Finance to control the setting of the corporate tax rate conforms to the image presented in this chapter of a department with weak influence over policy formulation. On the other hand, we see that the leading policy role of the Department of Enterprise was not based on professional expertise but rather on its close links to other agencies and multinational corporations. This highlights that bureaucratic autonomy can be derived from a variety of organizational resources, not only the intellectual resources that I emphasize. In fact, the type of bureaucratic autonomy we observe here, forged through building coalitions with key stakeholders, corresponds more closely to Daniel Carpenter’s argument about autonomy based on organizational reputations embedded in broad networks (Carpenter 2001). These elements add nuance to the account presented so far.

Conclusion In this chapter, I have showed how Ireland’s tax policies from the 1980s onwards diverged markedly from the market-conforming reforms adopted in New Zealand. Irish governments pursued a tax policy of narrow bases and targeted incentives, aimed at stimulating economic activity on the island. Although successful in fueling economic growth, these policies contributed to the country’s economic meltdown at the end of the 2000s. I have argued that this set of policies not merely was the result of economic openness or a political system prone to populism but also was related to its administrative institutions. Despite the demand for economic expertise in the postwar period, the persistence of centralized, generalist recruitment to the civil service effectively impeded the institutionalization of economic knowledge within the state. The marginal position of economists made the Irish finance ministry unreceptive to the spread of neoclassical ideas in the 1970s and 1980s. Together with an unfavorable political context, the lack of bureaucratic advocates for market principles arguably hindered the adoption of market-conforming tax policies in the 1980s and early

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1990s. The scarcity of economic knowledge in the bureaucracy later left the door wide open to the uncontrolled, politically driven erosion of the tax base that led up to the economic crisis. Ireland’s corporate tax regime did, however, constitute an important exception from this story. Conceived by the country’s industrial development bureaucracy in response to EU pressures, the single 12.5 percent corporate rate was hailed as a success in terms of attracting foreign investments and survived the crisis as one of Ireland’s key tools for returning to economic growth.

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Chapter 5

Norway Economic Experts in the Social-Democratic State I pushed for the introduction of modern economic thinking in the ministry. Not everything could be solved with demand, as the Oslo School economists thought. It was necessary to deal with the structural problems of the economy. All the markets needed to be changed: product markets, the labor market, financial markets. It was necessary to make the markets work, to decentralize decisions to the market; the planned economy was no longer an option. All this was mainstream neoclassical economics; it was Solow, Arrow, Stiglitz, Shultz on the labor market, Romer. It wasn’t shocking for regular economists, but it was new to the older generation of economists and to politicians. —Former official, Norwegian Ministry of Finance, interview, January 2011

C

ONVENTIONAL notions of what tax policy looks like in a social-­ democratic country were put to a severe test by the Norwegian tax reform of 1992. In a blockbuster deal, the Labour government and the conservative opposition agreed on a tax overhaul that put an end to the postwar social-­ democratic regime of high rates on high incomes and deep deductions for priority investments. The reform not only drastically reduced the top statutory tax rate on labor income but also introduced a flat tax on capital income at a rate far below the rates on labor, thereby explicitly privileging the return on capital over income from “honest work.” In fact, the reform left Norway with the lowest statutory tax rate on dividends in the OECD (van den Noord 2000: 15). To be sure, this market-conforming tax reform was neither fully comprehensive nor perfectly durable: Areas such as the taxation of housing were not touched by the reform, and certain reform measures were reversed over the following decade. But a new reform in 2006 reaffirmed the commitment of policy makers to low rates and broad bases. Though less extreme than in New Zealand, the changes in Norwegian tax policy from 1990 onwards adhered closely to the principles of efficiency and neutrality in taxation. “In few countries,” observed one tax expert, “have modern income tax reforms been governed by overall economic principles to the same extent as in Norway” (Christiansen 2004: 9; see also van den Noord 2000; Sørensen 2005). Why did a social-democratic country like Norway adopt this kind of marketconforming tax policies? Many would instinctively attribute the lowering of tax 107

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rates in Norway to the abundance of oil revenues. The extraction of petroleum and natural gas in the North Sea has since the 1980s generated enormous incomes for the Norwegian state, some of which are used over the budget every year. As a result, Norway needs to raise less revenue through the tax system than countries with similar spending levels, such as Denmark or Sweden. Other things being equal, we would expect this to increase the political pressure for lowering tax rates while making it more difficult to broaden tax bases. To some extent these predictions fit the empirical picture: Norway went far in lowering rates on both labor and capital. And it refrained from expanding the tax base of housing, which as we will see was linked to the revenue question. Yet, the radical broadening of other tax bases and the insistence on neutrality in capital taxation cannot be explained by the abundance of petroleum revenues. The most compelling evidence against the oil-centered account, though, is the timing of reform: The 1992 tax reform was conceived at a time of falling oil revenues and in an economic context of crisis rather than prosperity (Lie and Venneslan 2010: 8). Another account ties market-oriented reform to the “Third Way” politics of the Norwegian Labour Party. In the Third Way narrative, the failure of Keynesian interventionism in the 1970s prompted social-democratic parties to seek more market-based policies to achieve the goals of equality and full employment (for example, Giddens 1998; Green-Pedersen, Kersbergen, and Hemerijck 2001). In Norway, the Labour Party turned toward economic modernization and a greater acceptance of markets in the 1980s, leading the party to support structural reforms of the economy (Lie and Venneslan 2010: 400–402). Yet, although Labour was crucial for the political passage of low-rate, broad-base tax reform, we should not overstate the market orientation of the party. Among Labour politicians, economic efficiency was not a central concern in the 1980s. The party leadership wanted tax reform mainly for equity reasons, given that the many deductions and loopholes in the tax code were undermining the redistributive effect of the system. And it lacked concrete ideas about tax policy design. In other words, the ideas for efficiency-based economic reform did not come from within the party. Rather, this chapter shows how the initiative and solutions for marketoriented reform in Norway came primarily—though not exclusively—from economists within the administrative apparatus. In dialogue with academic economists and in collaboration with sympathetic forces within the two main

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political parties, economists in the finance bureaucracy made the blueprints for what would become broad political compromises on tax reform. Paradoxically, the central role of state economists in the turn toward market-conforming policies was a direct legacy of the powerful position granted to Keynesian economic experts in the postwar social-democratic state.

The Science of Social Democracy The end of Danish rule and the adoption of a constitution in 1814 did not give Norway full independence, as the country was forced into a lopsided union with Sweden that would last until 1905. Yet it did lay the foundations for an expanding administrative state. The constitution conferred considerable powers on a small elite of civil servants composed of lawyers, priests, and military officers. This group held most of the important political positions and effectively governed Norwegian society in the nineteenth century, leading historians to characterize the period as “the civil servant state” (embetsmannsstaten). In the growing state administration lawyers made up the overwhelming majority, and for most positions a degree in law was a prerequisite. This professional hegemony persisted into the first half of the twentieth century. As late as the interwar period more than three-fourths of the academic staff in the ministries had law degrees (Lie 1995: 20). The dominance was even stronger in the Ministry of Finance, where 92 percent of officials had legal training. In terms of policy, the lawyers in the Norwegian Ministry of Finance were primarily concerned with managing the state’s finances, very much like the accountants who dominated the New Zealand Treasury and the generalists in the Irish Department of Finance. The budget was seen as something that needed to be balanced and not as a tool for managing the economy (Lie 1995: 13). However, this minimalist view of the state’s role in the economy came under attack in the 1930s and 1940s (Lie 1995: 13–16). Not only was the balanced budgets approach discredited by the economic hardships of the interwar years; it was also challenged politically and intellectually by two emerging forces that would come to define economic policy making in the postwar period. The political force was the Norwegian Labour Party, which came to power in 1935 on a social-democratic program and would go on to win an absolute majority in parliament in each election from 1945 to 1961. Labour wanted to reorient economic policy toward the objectives of full employment, high production, and equitable distribution and “expressed a will to give the state a far greater

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role in the economy than earlier” (Lie 1995: 15). The intellectual force was the “Oslo School” of economics, a group of economists led by later Nobel laureates Ragnar Frisch and Trygve Haavelmo. The Oslo School espoused a Nordic version of Keynesianism, which called for active state intervention but placed greater emphasis on central planning and macroeconomic modeling than Keynes himself (Tranøy 2011). In particular, it made a vital contribution to the development of national accounting and budgeting, which involved mapping and modeling the aggregate measures and relationships in the macroeconomy. In 1935, Frisch set up a new economics education at the University of Oslo that initiated a growing number of students into Keynesian macroeconomics and sophisticated econometrics. The close collaboration between Labour and the Oslo School put economic expertise at the center of the social-democratic state that was constructed in the decades after the war: For the new generation of social economists from the University of Oslo, 1945 was the starting point for a lasting hegemony as provider of scientific premises for economic policy. Within the profession there was strong academic and political consensus, and the economists’ view of the world fit very well with the plans of the Labour Party, which needed scientific efforts and legitimacy to be accomplished. (Lie 1995: 63)1

In other words, the political hegemony of Labour was tantamount to the intellectual hegemony of the Oslo School economists. After initial discussions about the location of this economic expertise, an economic division was established inside the Ministry of Finance in 1952. Entrusted with carrying out the economic analysis that was the basis for planning, including national budgeting, the division was staffed exclusively by economists. The division spearheaded a novel set of economic policies, administering state interventions in key export sectors, the construction of a universal welfare state, and the use of low interest rate policies and credit controls (Fagerberg et al. 1990: 64; Tranøy 2000: 55–56). It also introduced new administrative practices, basing recruitment and promotion on academic excellence rather than on the seniority principle that had previously dominated in the ministry (Lie 1995: 189–192, 338). As the head of the division explained in a letter to the finance minister: The position I have proposed should be filled by young people with excellent exam results. At the same time as they are useful, they will learn a lot and qualify for higher

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positions within the division or important economic positions elsewhere in the administration. (letter from Eivind Erichsen to Minister of Finance Trygve Bratteli, 1952, cited in Lie 1995: 189)

The Economic Division systematically recruited the highest-achieving graduates from the economics department at the University of Oslo, thereby forging a close bond to the academic discipline and fostering a culture of “academic autonomy” in the division (Lie and Venneslan 2010: 161). With the unwavering support of Labour and its finance ministers, economists gradually expanded their role in the Ministry of Finance (Lie 1995: 185). Nearly every time a lawyer retired from a top position in the ministry, he was replaced not by one of his own but by an economist. By 1965, economists had taken control over most of the leading positions in the ministry; only the area of taxation remained firmly in the hands of legal professionals. The ascent of economic experts was remarkable: “The social economists had”—in only twenty years—“gained hegemony in the previously completely lawyer-dominated ministry” (Lie 1995: 442). The Norwegian Ministry of Finance had become, earlier than the New Zealand Treasury, an economists’ organization—that is, an institution where ideas and behavior closely mirrored the principles of the profession. It should be emphasized that this was anything but a marginal institution. The Ministry of Finance, responsible for both financial and economic management, was the most powerful ministry in the Norwegian government administration. The integration of financial and economic functions, argues economic historian Einar Lie, . . . created a ministry that was far more powerful and influential than what would have been the case with any other organizational solution. The combined finance and economy ministry got greater opportunity to exert influence since it gathered several functions in the same institution. (Lie 1995: 447)

Among the ministries, Finance’s responsibilities and expertise gave it a nearmonopoly in the provision of economic policy advice. And within the broader knowledge regime, the “iron triangle,” made up of the Ministry of Finance, the Department of Economics at the University of Oslo, and the Central Bureau of Statistics, set the intellectual premises for economic policy. “There was,” as Lie and Venneslan observe, “a strong perception both inside and outside the professional community that the triangle institutionalized the best economic

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competences we had, and that it was decisively important for giving policy a scientific basis” (Lie and Venneslan 2010: 479). Competing centers of expertise were largely missing: Norway had neither an independent expert body such as an economic or fiscal council nor powerful policy research organizations in the economic area. It is thus no exaggeration to say that in the social-democratic state that was erected in the postwar decades the Ministry of Finance was the control room and economists were operating the levers.

From Oslo School to U.S. Style

Yet, by the 1970s, the Golden Age of social democracy was coming to a close. Confronted with an unstable international economy, Labour maintained and even reinforced its interventionist approach. Public spending was increased, selective industrial policies were expanded, and the state intervened more actively in income policies (Mjøset 1987: 429). The discovery of oil in the Norwegian sector of the North Sea in 1969 raised the prospect of large incomes sometime in the future. But, in the short term, it prompted huge public investments in the petroleum industry financed with international loans and political pressure for more spending (Lie and Venneslan 2010: 174–175, 206). Labour managed to maintain full employment throughout the 1970s. But the price to pay was growing imbalances in the internal and external economy: government deficits and debt soared, labor costs increased while productivity growth was weak, and the returns to investments dropped. Within the Ministry of Finance, the limited success of the existing economic strategy was starting to raise questions about the appropriateness of traditional policy tools. Lie and Venneslan argue that the negative experiences with state interventionism and growing problems on the supply side of the economy were the principal reasons for the subsequent shift toward a more market-oriented approach: The lessons from the 1970s became important in the slow but over time far-reaching orientation away from steering-based thinking . . . The most important shift towards market-conform thinking in the Ministry of Finance was caused by the supply side putting itself at the center of attention. (Lie and Venneslan 2010: 134, 408)

Yet, significantly, the budding skepticism to the existing regulatory approach in the ministry also coincided with the hiring of a handful of economists trained outside the University of Oslo. Among them were Thorvald Moe,

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a former tennis champion who had obtained a PhD in economics from Stanford in 1970s with a thesis in econometrics, and Trond Reinertsen, who had received his doctorate in economics from the University of Utah in 1974 with a dissertation in the field of monetary theory. As opposed to their colleagues, who were schooled predominantly in the Keynesian macroeconomics taught at the University of Oslo, Moe and Reinertsen had training in the analysis of markets, microeconomic questions, and the supply side of the economy. When he came to the ministry in 1976, Reinertsen “was surprised that no one discussed questions related to the supply side of the economy, Keynesianism vs. monetarism, etc., as he was used to and interested in from his years in the U.S.” (quoted in Lie and Venneslan 2010: 249). “While at the University of Oslo they were most concerned about planning and rejected monetary theory, I had more training in market-based economies,” commented Reinertsen. “And I was up to date on the international literature about these questions.”2 This new group of economists saw the weak productivity development and low returns on investment as symptoms of an inefficient allocation of resources in the Norwegian economy. Due to the many selective interventions in the economy, capital did not flow to the economic activities where it would yield the greatest return. The solution, they argued, did not lie in Keynesian demand management. In line with neoclassical economic theory, they instead advocated a greater focus on the structural problems on the supply side of the economy. For the allocation of resources in the economy to work properly, a broad restructuring of the markets for products, labor, and capital was needed. The emphasis on the supply side of the economy did not mean that they subscribed to the type of “supply-side economics” associated with U.S. economists Robert Mundell and Arthur Laffer. In the Norwegian context, the term “supplyside economics” (tilbudssideøkonomi) was used more broadly to connote an emphasis on all kinds of issues related to the supply side of the economy—as opposed to the prevailing Keynesian focus on demand—and should be understood as roughly equivalent to “neoclassical economics.” The new economic agenda that emerged in the ministry was thus rooted in mainstream neoclassical economics. However, the older generation of economists in the ministry was skeptical about the new economic ideas. “The old guard led by Eivind Erichsen [administrative head of the Ministry of Finance from 1958 to 1986] was skeptical,” recalled one civil servant. “Arne Øien [head of the Economic Division from 1971 to

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1978] was not interested in the supply side, yet he wasn’t against it either.”3 Yet, this generation of economists was nearing the end of their careers. Indeed, the generational shift that was underway in the ministry facilitated the turn toward neoclassical thinking. Many of the Keynesian economists hired right after the war went into retirement around 1980, giving way to a new generation of economists. Moe and Reinertsen had by the end of the 1970s reached the top positions in the Economic Division. And they actively recruited bright young economists straight out of university or from neighboring institutions. Due to differences in training and experience, the young generation was more open to neoclassical perspectives: Many of the people who had their formative years before, under, and right after the war had a strong belief in regulation and a correspondingly weak belief in the market. For Norwegian economists this was reinforced by the academic training from their university years. New cohorts of economists would to a greater degree be shaped by common analytical terms with roots in market-based theory . . . Ideas about liberalization and market-orientation first and most easily got a foothold among younger officials. (Lie and Venneslan 2010: 102–103)

In other words, the ministry’s traditional attachment to Keynesian principles and aversion to market-based economics gradually faded with the departure of the postwar cadre of economists and the entry of a younger generation of economic officials. The ideational shift was reinforced by the ministry’s reorientation toward more neoclassical elements of the Norwegian economics profession. Whereas the ministry’s traditional academic point of reference—the University of Oslo—remained predominantly Keynesian, Moe strengthened the ministry’s ties to the more market-oriented economics community in Bergen. In particular, Bergen economists were used in a number of major public commissions: “The economists at the Norwegian School of Economics in Bergen, who had more training in market-based theory, for a period crowded out University of Oslo economists in major commission work” (Lie and Venneslan 2010: 250). Through the interaction with academics on public commissions, Finance officials deepened their knowledge of neoclassical theory and policy prescriptions. The advent of neoclassical economists in the Ministry of Finance also brought with it a change in the norms about administrative behavior, much as in the New Zealand Treasury. Moe and his successor as head of the economic

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division, Svein Gjedrem, promoted a doctrine of “free and frank” policy advice, which implied that “officials should not be afraid to give scientifically based advice that goes against what politicians want.”4 “The Gjedrem doctrine,” added another official, “implied that we were supposed to give advice to politicians in a straightforward way and not be constrained by what we thought politicians would think about an issue at any given time.”5 To be sure, the previous generation of economists—the Keynesians—had not been afraid to state their opinions to ministers. Yet, by the late 1970s, the new generation of neoclassical economists felt that the ministry was not being clear enough in its advice to the government about the deficiencies of the Norwegian economy. There was an urgent need to change course, they believed, and politicians needed to hear it. The embrace of neoclassical thinking within an institution steeped in the Oslo School brand of economics raises interesting questions about the relationship between domestic intellectual traditions and U.S.-style economics. Strong national intellectual traditions are usually seen as a barrier to the incorporation of U.S.-trained economists in public bureaucracies (Fourcade 2006: 174). Yet, in Norway, the distinct strand of Keynesian economics developed by Frisch and Haavelmo appears to have represented a stepping-stone rather than a stumbling block for the later adoption of American neoclassical economics. Not only were neoclassical economists recruited based on the existing commitment to economic expertise; they could also draw on the authority accumulated by the Oslo School economists. And the formalized character of neoclassical economics resonated with the Oslo School’s emphasis on econometrics. To be sure, the older generation also represented a barrier to the new agenda, which the new leading economists in the ministry had to circumvent by teaming up with more market-oriented parts of the national discipline. But this never amounted to open conflict, in part due to generational changes among the staff but also due to the professional continuity between Keynesian and more market-oriented economists. Thus, even if the swift breakthrough of neoclassical economics in the profoundly Keynesian Ministry of Finance may seem paradoxical, the two things were in fact closely related: The institutionalization of economic knowledge in the ministry during the Keynesian era made it receptive to the subsequent intellectual shifts in the discipline. This institutionalization consisted not only in economists holding key administrative posts but also in the practice of recruiting based on academic qualifications and in the regular interaction with

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a­ cademics in the field. As in New Zealand, neoclassical thinking was introduced by economists with training from the United States, who were hired not because of their ideology but because of their professional credentials. And it spread as a result of strategic efforts to recruit “modern” economists and reconfigure the links to the national profession. By the middle of the 1980s the ministry had become a stronghold of neoclassical economics. This would have important implications for the subsequent direction of economic policy, not least in the field of taxation.

The Tax Reform of the Century One of the areas that attracted the critical attention of economists was the tax system. The sine qua non of the social-democratic welfare state, an extensive progressive tax system had been created in the postwar decades to pay for the expansion of social benefits. Norwegian governments also used the tax code actively as a tool of industrial policy and housing policy, among other things, aiming to stimulate politically desirable economic behavior such as reinvesting profits in the company or buying a house. The statutory tax rates on labor were raised to more than 70 percent for the highest incomes, and the corporate tax rate stood at 50 percent. This was combined with a host of tax deductions and exemptions, the most significant of which was the deduction for mortgage interest payments that offered tax relief up to the highest personal income tax rate. On paper this looked like an equitable tax system. But in the early 1980s there was growing evidence that despite the steep formal progression the tax system produced little effective redistribution. In particular, the mortgage interest deduction allowed high income earners to erase their tax liability by taking up large loans. And economists were starting to raise more fundamental questions about the effects of the tax system on the Norwegian economy. The field of taxation was the last stronghold of lawyers in the Ministry of Finance. It was controlled by the powerful Division of Tax Law, which for a long time had resisted the encroachment of economics by outright refusing to hire economists (Lie and Venneslan 2010: 29). The basic attitude of the lawyers was that taxation should be based on the ability to pay: People who had the same ability to pay taxes should face the same tax burden (Lie and Venneslan 2010: 109). At the same time, the legal division and its auxiliaries were in charge of administering the extensive system of tax incentives for businesses, which gave them a stake in the existing regime of tax breaks and exemptions. As one official observed,

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Corporate taxation was important among economists after the war and was part of their tool box for allocating resources and favoring one type of activity over another. And this met great resistance among the lawyers. Yet the lawyers came to inherit the idea that it was OK to discriminate between different businesses and between different types of investments. It became taken for granted among the lawyers that it was appropriate to have certain types of tax rules that allocated resources to industry, for example. Although the economists abandoned this idea at a certain point, the lawyers were left guarding the holy texts. . . . There was an entire division of lawyers—Den Alminnelige Skatteavdeling—whose task was to grant dispensations and exemptions.6

However, the dominance of lawyers over tax policy inside the ministry was soon challenged. Starting in the 1970s, the Economic Division strengthened its emphasis on taxation, drawing largely on personnel and models from the Central Bureau of Statistics. These efforts and the subsequent creation of the Division of Tax Economy in 1978 boosted the role of economists in the field. Initially, the division focused mainly on analyses of the redistributive implications of personal taxation, in line with the prevailing emphasis on the redistributive aspects of taxation at the University of Oslo.7 But, from the early 1980s, the division started to pay increasing attention to the efficiency aspects of taxation, that is, how the existing system of high rates and deep deductions influenced economic choices and the allocation of resources in the economy. In part this shift was based on practical experience: There was increasing evidence that companies made investment decisions based on the tax code—not based on what was most profitable before tax—contributing to an inefficient use of resources and low productivity growth. As one official observed, “The high rates and narrow bases [of the tax system] implied that what was profitable after tax could be completely different from what was profitable before tax—in other words, an irrational allocation of capital.”8 But the efficiency-centered analysis of tax policy was also influenced by new economic theory and modeling tools, particularly from the United States and the UK. The most important sources of inspiration were the work of Mirrlees and Diamond on “optimal taxation” from the early 1970s, the 1978 Meade Commission Report from the UK, and later work on how to model and estimate the efficiency losses from taxation.9 These works introduced notions such as “tax wedges,” “deadweight losses,” and “neutral taxation” to officials in the ministry, providing the impetus for economic analyses of the impact of the tax system on the allocation of resources. Significantly, these were some of the same reports

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and articles that New Zealand Treasury officials were reading at the time (see Chapter 3). Moreover, efficiency-oriented ideas about taxation were disseminated through the OECD. As one official recalled, The steady flow of documents from the OECD was an important source of inspiration for the ministry’s economists. In the OECD they met like-minded officials and professionals from other countries, who were much more interested in this [tax economics] than Norwegians economists were.10

The ideas of supply-side economists such as Arthur Laffer, on the other hand, had little traction among economists in the ministry. Even though officials believed there were certain dynamic effects of lower taxes on labor supply, no one thought that tax cuts would increase revenues. As one official observed, The idea that tax cuts would be self-financing has never been prominent in the ministry, to put it mildly. And there is hardly any empirical evidence for it . . . But that there are dynamic effects is something that we have been attentive to. Calculations of deadweight losses are indeed based on the premise that taxes have an adverse effect, in particular through the labor market.11

Yet, as another official pointed out, the main focus of the tax economic thinking in the ministry did not lay on the effects of taxes on labor supply but rather on their impact on the allocation of resources.12 The concern about economic efficiency gradually transformed the thinking about tax policy design among the ministry’s economists. As a previous official who returned to the ministry in the late 1980s observed, There was a remarkable change in tax policy views in the Division of Tax Economy during the decade from when I left the ministry in 1980 until I came back in 1989. One had become much more attentive to how taxes influenced the economy.13

The ministry’s new perspective on tax policy was first partly articulated in the 1984 report of the Aune commission on personal taxation. The commission was composed of politicians, interest group representatives, civil servants, and a professor in economics from the Norwegian School of Economics in Bergen, and its secretariat was led by officials from the Ministry of Finance. In addition to its regular members, several academic economists wrote background reports for the group. The central message of the Aune report was that the existing tax structure contributed to “distortions of economic activity” and “irrational use

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of resources” (NOU 1984: 61) and that due to generous deductions the progressivity of the system was “more nominal than real” (12). To “improve the use of resources in society,” the report recommended “a significant expansion of the tax base” combined with “a relatively strong reduction in tax rates” (16). The Labour Party supported a tax reform along these lines. Already in the late 1970s Labour had proposed a reduction of the mortgage interest deduction combined with modest cuts in statutory tax rates. Yet, Labour wanted reform for a different reason than the economists. In the party, the growing recognition that the mortgage interest deduction was strongly regressive and that many wealthy individuals paid zero taxes under the existing regime (the so-called nullskatteytere) had raised serious concerns about the equity of the system (Tranøy 2000: 233–234). The issue of efficiency, on the other hand, was not something the party was concerned about at the time. “Efficiency and neutrality were not a major part of the debate during the 1980s,” observed a former Labour Minister of Finance. “Deadweight losses and neutrality were things that appeared right around 1990. In political debate the redistributive effect was much more important.”14 But while Labour was positively disposed to reform, it no longer commanded an absolute majority in parliament. The decades of Labour hegemony after the war had given way to a period of greater political pluralism. From the mid-1960s onwards, nearly all governments were minority and/or coalition governments—either pure Labour cabinets or center-right coalitions—that had to seek support in parliament on a case-by-case basis. In the 1981 elections, an unprecedented shift to the right had brought the Conservative Party to power at the head of a coalition of bourgeois parties. The Conservative Party made no secret of its opposition to tax reform. Although the Conservatives were eager to reduce tax rates on labor and companies to encourage work and business, they were unwilling to give up the generous tax breaks of the existing system. In the eyes of many conservatives, deductions ensured that tax burdens under the Norwegian high rate regime were tolerable: Many businesses faced zero or negative effective taxes because of tax incentives, and high income earners could use the mortgage interest deduction to cancel substantial parts of their tax bill. The resistance to tax reform was also related to the marginal position of economic thinking in the party. Beyond the basic argument that high tax rates discouraged work and production, ideas about neutral taxation and an efficient allocation of resources were

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not prominent. “The Conservatives’ tax arguments never had a strong basis in economics,” observed one economist later affiliated with the party. “The party had well-known positions on taxation. But there was little focus on how taxes influenced the economy.”15 When the Aune report was published in 1984, Prime Minister Kåre Willoch brushed away its recommendations for reform, citing the need to maintain deductions for expenses incurred (Lie and Venneslan 2010: 430). The unlimited deductions for mortgage interest were, however, starting to have a destabilizing effect on the Norwegian economy. Combined with high inflation and an interest rate that was set artificially low, the mortgage interest deduction provided strong incentives to borrow money. In fact, posttax interest rates were negative throughout the first half of the 1980s. As long as there was credit rationing, this was mainly a problem in terms of equity because people with high incomes got loans more easily. But the Conservative government’s liberalization of credit in the early 1980s turned it into a huge macroeconomic problem. Unlimited borrowing led to a hyperexpansion of credit and uncontrolled growth in private consumption from 1984 to 1987 (see Tranøy 2000: ch. 3). In addition, the oil price plummeted in 1986, producing a shortfall in the government’s incomes from the petroleum sector (Lie and Venneslan 2010: 362). In this “atmosphere of national crisis and urgency,” the political parties were forced to the bargaining table (Tranøy 2000: 256, 188–191). In 1987, Labour, Conservatives and the center parties agreed to curtail the interest deduction by introducing a gross element in the income tax (that is, a tax component not subject to deductions) and by gradually reducing the top statutory tax rate on labor from 71 to 63 percent (for a detailed account, see Synnes 1988). However, in macroeconomic terms this intervention was “too much, too late” (Tranøy 2000: ch. 5). The reduction of the interest deduction contributed to a rapid rise in real interest rates, which brought the Norwegian economy to an abrupt halt in 1988 and produced the first years of negative growth in mainland GDP since the late 1950s. At the same time, oil revenues continued to drop, with net revenues from petroleum activity falling from 10 percent of mainland GDP in 1985 to zero in 1989 (Finansdepartementet 2012). Twenty years after oil had been discovered in the North Sea, the economic picture was anything but rosy: “After many years as a newly rich oil-producing country, the Norwegian economy was characterized by large imbalances, high international debt and

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weak public finances” (Lie and Venneslan 2010: 8). It was in this context of economic crisis that the plans for a major tax reform took shape.

A Blueprint for Reform

Even though the 1987 agreement constituted a first step toward lower rates and broader bases, it did not deal with corporate and capital taxation or the interface between labor and capital taxation. The economic downturn only strengthened the conviction of the economists in the Ministry of Finance that a more comprehensive reform was needed. Officials convinced the Labour government to set up a working group to look into these issues (Lie and Venneslan 2010: 431). Institutionally, the “Aarbakke group”—named after its chairman— was an innovation. It was not a regular public commission with political and interest group representation like the Aune commission but an expert committee made up solely of bureaucrats and academics. The ten-member group included five officials from the Ministry of Finance as well as a tax economist from the Norwegian School of Economics (NHH), an economics researcher from the Norwegian Business School (BI) and the chairman Aarbakke, who was a professor in tax law. The work of the group was organized independently from the regular activity of the Ministry of Finance. This arrangement reflected the activist policy approach of the economists in Finance. The group was set up so as to maximize their control over the process and minimize the interference of other actors. Most important, there was no political representation: “Politicians were absent,” observe Lie and Venneslan, “underpinning the idea that the ministry wanted to make proposals without too much political involvement” (2010: 431). The group was also organized at arm’s length from the Division of Tax Law, making it easier for tax economists to set the agenda. According to one official, The reason why tax economic ideas broke through was that the policy work was lifted out of the regular bureaucratic structure. First you had the Aarbakke group, and then the rest was organized as project work outside the regular structure. Lawyers did participate in the policy work, but they were young officials who had been part of the Aarbakke group and were well socialized into the economic way of thinking.16

Finally, the expert group format—as opposed to the traditional public commission—effectively kept interest groups on the sidelines during policy formulation. As Espeli points out: “The government and the Ministry of Finance kept

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the issue outside the corporatist arena and were largely unreceptive to the reactions from the business community” (Espeli 1998: 16). As such, the Aarbakke group was not only a forum for policy development but also a vehicle for advocating a specific policy agenda. The interaction of academics and ministry economists on the commission stimulated the flow of tax economic knowledge to the bureaucracy. For instance, an official on the commission recalled how one of the academic economists in the group, Kåre P. Hagen, “arrived carrying books about the American tax reform” (Hans Henrik Scheel, quoted in Lie and Venneslan 2010: 432). The principles and design of the 1986 U.S. Tax Reform Act and the Swedish tax reform that was under preparation constituted particularly significant influences on the work of the group (Lie and Venneslan 2010: 432). In 1989, the Aarbakke group presented a blueprint for reform that corresponded closely to neoclassical economic thinking (see NOU 1989). The group argued for a system based on the principles that taxation should be neutral with respect to economic choices and symmetric between positive and negative income. The model it proposed was a dual income tax system that combines a low uniform tax rate on capital income with progressive taxation and higher top rates on labor income. The rationale for this explicit differentiation was to ensure neutral taxation of capital without giving up the revenue and redistribution associated with progressive taxes on labor. The proposed dual system implied not only a substantial reduction of statutory tax rates but also the systematic removal of tax breaks both for individuals and businesses. The recommendation for a dual income tax was unanimous. But the economists in the group disagreed on the secondary issue of whether the net wealth tax should be retained or not. Whereas the majority argued that a tax on wealth was compatible with economic principles if designed in a neutral way, the business school economist asserted that the wealth tax was contrary to the principle of neutrality and therefore should be abolished (NOU 1991). The Labour government just had time to comment positively on the report before it was forced to step down after the 1989 elections. And it was far from obvious that the new Conservative-led government would follow up on the group’s proposals. The commitment to preserving the deductions and exemptions in the tax code was deeply rooted in the Conservative Party, including in the party leadership. And for the many businesses that profited from the loopholes in the existing system a reform made little sense. As one official observed,

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a reform “would mean removing a number of generous deduction schemes that for some businesses led to a smaller tax burden than lower rates could ever produce.”17 Unlike in New Zealand, where business quickly became an enthusiastic supporter of tax reform, the prevailing attitude in the Norwegian business community was one of profound skepticism.

The Translators

Even if the Conservative leadership was ambivalent to reform, the people given charge of economic policy belonged to the small, economically oriented current within the party. Finance Minister Arne Skauge was a centrist with a background in economics. Trond Reinertsen, the undersecretary (statssekretær)18 appointed to support him, had spent far more time over economics textbooks than at party meetings. This was the same Reinertsen who, as a civil servant in the late 1970s, had been one of the pioneers of neoclassical economics in the Ministry of Finance. Reinertsen had never engaged actively in politics but was chosen based on his expertise in the field: I believe I was picked because the prime minister wanted someone who knew a bit about the Ministry of Finance and economic policy making. There were few Conservatives with this background. But I felt a closer relation to civil servants than to politicians—that was where I came from.19

Reinertsen became an important ally for the economists in the ministry. As soon as the new government had taken office, the top tax officials approached Reinertsen to convince him that the Conservatives needed to go forward with reform. As Reinertsen recalled, The top people on tax wanted to have a meeting just with me. They did not want the minister to be there. They wanted to test their ideas in a smaller forum before bringing in the minister. It was a pretty important meeting. We went through a long list of important issues and quickly agreed on how we wanted to do this.20

While Skauge and Reinertsen worked to garner support for reform among the Conservative leadership, the bureaucracy continued developing the blueprint presented by the Aarbakke group. These efforts culminated in the publication of a white paper on tax reform in 1991, which set out some basic parameters for a revision of the tax system: a uniform 28 percent rate on capital (including corporations), a top rate on labor below 50 percent, and broad bases. Labour

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responded with a detailed proposal that endorsed the main principles in the white paper but suggested somewhat higher rates. A few months later, Labour was back in office after the center-right government had unraveled over the question of Norwegian EU membership. With the economy mired in a lengthy slump, both Labour party politicians and officials in the Ministry of Finance were eager to make structural changes and pushed ahead with the preparation of reform. These efforts were spearheaded by Labour undersecretary Svein Harald Øygard, a brilliant young economist who had previously worked in the ministry’s Division of Tax Economy and as an economic advisor for Labour in parliament. The ministry quickly produced a tax reform bill that built on the principles outlined in the Aarbakke report and the Conservative white paper. LO (Landsorganisasjonen i Norge), the largest trade union confederation, quietly supported the proposals (Espeli 1998: 29). Not only did the confederation have close links to the Labour government, which kept them informed throughout the process; it also did not possess the analytical resources to investigate alternative reform options. An LO official involved in the process stated this bluntly: Corporate taxation is so complex that the Ministry of Finance has a knowledge monopoly that no one can match. . . . In LO we had four economists at the time, which meant that maximum one dealt with taxation. To match the ministry a major effort would have been needed . . . Tax policy is driven by civil servants: We are dependent on the central people in the ministry.21

Instead of developing their own proposals, union leaders trusted their allies in the Labour Party to keep an eye on what the ministry was doing. Employers were less trustful. Fearing that a reform would imply a significant tightening of what was effectively a very lenient tax regime for corporations, they opposed the bill: “Even if the Norwegian employers’ associations in principle agreed on the need for fundamental reform, they took a very critical and dismissive stance to many of the concrete reform proposals” (Espeli 1998: 16). Employers wanted a different model for capital taxation, major cuts in the net wealth tax, and more liberal transition measures. But they had limited expertise of their own to substantiate these proposals. Even if NHO (Næringslivets Hovedorganisasjon), the largest employers’ association, worked more on tax policy than LO, it could not match the Ministry of Finance.22 As a top

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NHO official observed, “A lot of the expertise is located in the civil service, so you really need to be in government to access the scientific expertise.”23 With Labour unwilling to listen to their objections, employers put pressure on the Conservative Party to extract concessions from the government. But the Conservatives had already committed to the main lines of the reform and found it hard to turn down a proposal that dramatically reduced the tax rates on both labor and capital. After intense negotiations in parliament, Labour and Conservatives agreed on an overhaul of the tax system that constituted “the most comprehensive reform of income taxation since 1911” (Lie and Venneslan 2010: 433). The reform adopted the dual income tax model, introducing a flat 28 percent rate on corporate profits and other capital income combined with progressive rates on labor income that did not go higher than about 50 percent. The reform also eliminated or limited a wide array of deductions, special incentives and other loopholes. One expert who wrote books about tax planning on the side recalled how his extra incomes dropped overnight: “The reform cleared away almost everything. I earned three times as much from my books before the reform.”24 The most important exception was income from owner-occupied housing, which continued to be treated more leniently than other types of capital income. An inherent challenge in the dual income tax model was the gap between the rates on labor and capital. To prevent people from reclassifying their labor income as capital income, the reform introduced an “income-splitting model” that applied to the self-employed and active shareholders.25 Even though the Conservatives gained acceptance for certain alleviations in the income-splitting model, the employers’ confederation was unhappy and launched a series of acrimonious attacks on the Conservative Party in the media (Espeli 1998: 44). Employers pressed hard for further concessions but to little avail: “Despite extensive lobbying,” concludes Espeli, “organized interests managed to influence the broad lines of the reform only to a very limited degree” (Espeli 1998: 31). The reform instead marked a victory for the Ministry of Finance economists in their campaign to restructure the Norwegian economy. Efficiency and neutrality, notions advocated by officials since the early 1980s, had become the guiding principles of the new tax system in all areas except for the taxation of owner-occupied housing (Christiansen 2004: 11). Academic economists marveled at the theoretical purity of the system:

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The Norwegian reform is remarkable for the almost merciless consistency with which it pursues the goals of tax neutrality, symmetry, and a lowering of marginal tax rates through base-broadening measures aimed at establishing close correspondence between taxable income and true income. (Andersson et al. 1998: 122)

Another tax economist observed that the reform “introduced the cleanest version of the dual income tax found so far” and was “remarkable for its boldness and consistency” (Sørensen 2005: 4; see also van den Noord 2000: 6). A good example of this was the abolition of double taxation of corporate income, which left Norway with the lowest statutory tax rate on distributed profits in the OECD (van den Noord 2000: 15). To summarize, the main impetus for market-oriented reform in Norway did not come from politicians or interest groups but from neoclassical economists strategically placed within the state. Inspired by economic thinking from the United States and the UK, these economists pursued tax reform as part of a broader restructuring of the economy. Reform solutions were refined through interaction with academic economists on public commissions and actively promoted in commission reports and through direct interaction with ministers of the left and the right. In a consensus-oriented political system where bipartisan agreement was a prerequisite for lasting reform, the “technical” proposals of economists in the bureaucracy provided a compelling middle ground. At the same time, the political convergence around market-oriented reform was facilitated by particular features of the economic and political context. Economic crisis had endowed politicians with a sense of urgency in the efforts to stabilize the economy. And, incidentally, the frequent alternation in government in this period exposed both of the main parties to the policy agenda of the finance ministry. Politically appointed undersecretaries also played a key role, using their double background to translate the economic reasoning of officials into viable political arguments.

The Erosion and Reconstruction of the Tax System The 1992 tax reform coincided with the beginning of a long period of strong economic performance in Norway. Oil revenues picked up again from 1990 onwards, providing the government with an abundant income stream throughout the 1990s and 2000s. And economic reforms introduced around 1990, including the overhaul of the tax system, are widely believed to have contributed to the upswing:

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There is no doubt that the strong, prolonged economic upturn in part was due to the restructuring that was undertaken before and during the crisis years, where the tax reform had a central role. . . . The tax reform—combined with changes in industrial policy and the energy and telecommunications sectors—appears to have laid the ground for a more efficient and well-functioning social economy in the years that followed. (Lie and Venneslan 2010: 9, 475)

According to economists, the reform improved the allocation of resources in the economy, thereby generating higher returns on capital and an increase in “total welfare” (Holmøy and Vennemo 1995; for a discussion see NOU 2003: 62). In terms of equity the results were more ambiguous. Even though equity was a central political motivation for reform, the policy changes did not produce an increase in redistribution through the tax system. But, unlike the reforms in New Zealand, the Norwegian tax overhaul did not lead to a significant increase in income inequality either (Fjærli and Aaberge 2003). Although the posttax income dispersion in Norway increased somewhat in this period, this was primarily due to greater pretax inequality and not to less redistribution through the tax system (Thoresen 2004). In the tax system, the main problem in terms of inequality was the income-splitting model, which came under attack soon after the reform. The broad agreement underpinning the 1992 reform had momentarily suspended the traditional political conflicts over taxation. But it quickly became evident that this was a fragile compromise. Over the following years, the political bargain of lower rates in exchange for broader bases unraveled, much as it did in the United States after the 1986 Tax Reform Act (Patashnik 2008). The Conservatives, under pressure from business, sought to alleviate the tax burden by undercutting the income-splitting model, passing a number of minor changes that made it easier to reclassify labor income as capital income (Christiansen 2004). And Labour partly reverted to its traditional high-rate policies, raising the top statutory tax rate on labor again by introducing extra employers’ social security contribution on very high incomes in 1993 and by pushing through an extra bracket in the surtax in 2000 while in opposition. For taxpayers who faced a 60 percent top rate on labor, a 28 percent rate on capital, and very little preventing them from jumping from the former to the latter, the choice was simple. Owners of small businesses and people in the liberal professions emigrated en masse from the labor tax base to the capital base, undermining the equity, efficiency, and revenue-raising capacity of the dual income tax system.

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Nowhere were they more concerned about this than in the Ministry of Finance. Even if a stringent income-splitting model was viable in theory, economists in the ministry soon realized that the imperfect version of the model grossly distorted economic behavior. The model needed to be replaced, and by 2000 officials had developed a fairly clear idea about how to deal with the problem. What officials suggested was to fill the gap between the tax rates on labor and capital by reintroducing double taxation of dividends above a normal rate of return at the same time as reducing the top statutory tax rate on labor (see Finansdepartementet 2000: 31–41). There was also a growing recognition in the political community that the existing system was unsustainable. In the Labour Party and the trade unions, the inequity of the system raised the greatest concern: The combination of the ineffective income-splitting model and the nontaxation of distributed profits meant that people with high incomes could get away with paying very little taxes. For this reason Labour introduced a temporary personal tax on dividends in 2001, while signaling its intention to make more permanent changes (Finansdepartementet 2000). The Conservative Party was also interested in reform, though for partly different reasons. On the one hand, they were eager to “get rid of the income-splitting model,” which had become highly unpopular.26 On the other hand, both the party and the broader business community wanted tax cuts: not only lower top marginal tax rates on labor but also the removal of the tax on imputed income from housing and a reduction of the net wealth tax (Prime Minister’s Office 2001).

“A New Round of Training”

Against this backdrop, the Ministry of Finance proposed to set up a new commission on taxation to examine the options for reform. The ministry’s aim was not only to develop concrete policy measures, but also to remind the political community about the arguments for a low-rate, broad-base tax structure. “It was necessary to have a new round of training and to entrench the principles of the tax system again, in order to generate an understanding that these were reasonable principles to build on,” explained a top official.27 The coalition of the Conservatives, the Christian People’s Party, and the Liberals that came to power in 2001 was interested in moving forward on the tax issue and quickly appointed a commission made up of officials, tax practitioners, and three academic economists. Employers and trade unions, by contrast, were repre-

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sented only in an advisory forum tied to the commission. The commission was headed by Arne Skauge, a Conservative who had been involved in the previous reform as Minister of Finance from 1989 to 1990. Despite Skauge’s background in the party, there was very little political involvement in the commission’s work. “The commission worked independently. There was not much political contact with the commission,” related a central Conservative policy-maker. “We needed to get the support of our coalition partners, so we wanted an independent report.”28 The Ministry of Finance had a “strong agenda” and set the premises for the work of the commission.29 The ministry organized the commission in a way that would allow officials to exert a significant degree of control over its deliberations. In the terms of reference that guided the work of the commission, the ministry defined the problem and suggested a direction for solutions, thereby limiting the number of possible reform alternatives. As one actor observed, there was “little room for maneuver—a lot followed directly from the premises.”30 The head of the Division of Tax Economy also served full-time on the commission for more than a year and played a key role in its work. And the secretariat of the commission was made up of tax policy officials from the ministry. According to Skauge, all these features were “carefully premeditated” by the ministry.31 This can be seen as a reflection of norms about administrative behavior in the ministry that emphasized the active advocacy of its policy preferences in the decision-making process. The final proposals of the commission corresponded closely to the policy view of officials. “The recommendations did not deviate significantly from what the Ministry of Finance would have proposed itself,” commented Skauge.32 The proposals were “anchored in tax economics”:33 they advanced lower rates and broader bases and emphasized neutrality and symmetry. The commission endorsed the reform option favored by officials, which was to close the rate gap between labor and capital income through double taxation of distributed profits and a lower top rate on labor. To do so, it chose a model that would tax distributed profits only above a normal rate of return and therefore would be neutral with respect to decisions about investment, financing, realization, and organizational form (see NOU 2003: 303–323; Sørensen 2005: 12). This highly theoretical model was the brainchild of the Danish tax economist and commission member Peter Birch Sørensen. The commission rejected an alternative model that had been proposed by Norsk Investorforum, a lobby organization

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for Norwegian investors, and investigated by a well-known tax economist and lawyer. The commission also recommended shifting the tax burden from wealth to property to reduce the distortion of investments—but this was mostly for the record, as everyone knew that it was “a dead frog” politically.34 Just like in the early 1990s, there were few competing sources of expertise in this policy process. The tax model proposed by investors constituted an exception but was easily brushed aside by the ministry. As discussed earlier, political parties, employers, and trade unions had limited independent economic expertise at their disposal. And advocacy research organizations were still a novel phenomenon in Norway. In Sweden, employers had already founded a highly influential free-market think tank, Timbro, in the late 1970s (Blyth 2002). But a Norwegian equivalent, Civita, was established only in 2003. Civita was also more focused on political-philosophical issues than on technical economic ones. “Apart from one or two people, there was not much economic expertise in Civita,” commented a leading figure in the main employers’ association.35 On the political left, an independent research institute established by the trade unions—Fafo—had been active since the early 1980s. But it dealt primarily with social and labor market issues rather than with economic policy issues. Only in the late 2000s and early 2010s were a series of left-leaning think tanks established in Norway. The tax commission’s proposal to double the taxes on distributed profits was, predictably, not greeted with enthusiasm on the political right. That the Conservatives should be responsible for raising the taxes on businesses and capital-owners seemed unthinkable for some. As a central Conservative policymaker observed: “We faced quite a challenge with regard to the tax on distributed profits. To introduce it was a political cost for us—there was resistance within the party. But,” he continued, . . . the commission had found a good solution, a system that maintained many of the neutrality properties. And the tax on distributed profits made it possible to remove the surtax on labor and reduce the wealth tax. We saw that it was politically feasible, and we didn’t see any better alternatives.36

In other words, Conservatives could reluctantly accept higher taxes on dividends because this allowed them to remove the income-splitting model and lower top marginal tax rates—their main goals coming into the process. Also, the design of the dividends tax—in particular the exemption of normal returns and the

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exclusion from double taxation of profits flowing between companies—­made it easier to defend in business circles. The final reform adopted by the center-right government followed the commission’s proposal about lowering the marginal taxes on labor (from 65 to 54 percent) and taxing distributed profits. This actually increased the redistributive effect of the tax system, as the higher taxation of dividends more than compensated for the cuts in the highest statutory tax rates on labor (Thoresen et al. 2011). But the government rejected the tax switch from wealth to property, choosing instead to reduce the taxes on owner-occupied housing—as it had promised in its program from 2001. Whereas the bulk of the reform was passed with the support of Labour, the alleviations of property taxation went through with the votes of the Progress Party, a populist right party. Labour, which soon after returned to power at the head of a majority coalition, upheld its commitment to the reform and made only minor adjustments to the tax cuts. The reform was thus an uneasy combination of market-conforming and market-distorting elements. On the one hand, it reaffirmed the commitment to the guiding principles of the 1992 reform, significantly reducing the top marginal rates on labor and increasing the neutrality of the tax system along important dimensions (Finansdepartementet 2010a: 14–16). Like in the 1980s, the reform model was provided by ministry economists and their academic allies, who used a public expert commission to develop and advocate specific policy solutions. Yet, the influence of economic experts was more restricted this time around. Both of the main parties already had ambitions for reform and a general idea about its necessary features. And politicians did not hesitate to pick some of the proposed policies and combine them with other measures. On the other hand, therefore, some elements of the reform ran directly counter to neoclassical principles. In particular, the abolition of the tax on imputed income from owner-occupied housing reduced the effective taxation of housing and increased the distortion in favor of investing in real estate (OECD 2012c: 33–34). The move only reinforced the very favorable tax treatment of owner-occupied housing, which before the reform had been characterized as “the most blatant violation of the principles of symmetry and neutrality” in the Norwegian tax system (Christiansen 2004: 11). How can we explain this exception from the general trend toward market-conforming tax policies in Norway? Why did neoclassical thinking have so little influence on the taxation of housing?

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Limits to Market Conformity: The Taxation of Housing The maintenance of a very favorable tax regime for housing cannot be ascribed to a lack of activism among economists. Nearly every public commission report on economic policy in this period called for increased taxation of property, including the Aune, Aarbakke, and Skauge reports (see NOU 1984, 1989, 2003, 2009, 2011). Instead, the lenient taxation of housing can be attributed to the interaction between two features of the Norwegian political economy: the high rates of home ownership produced by postwar housing policies and the abundant revenues from the petroleum sector. Norwegian governments dramatically expanded home ownership in the postwar decades by financing the construction of houses and fixing the prices of these houses well below market value (Sørvoll 2011: 171). It also pursued low interest rate policies and offered generous mortgage interest deductions that made borrowing cheap. As a result, owner-occupancy increased from a small portion of the population to about 60 percent in 1960 and almost 80 percent in 1990 when you include those owning shares in cooperative housing (Torgersen 1996: 39–40).37 These home ownership rates were high by international standards; among the countries studied here only the Irish rate was similar, whereas the percentages in New Zealand and Denmark were significantly lower.38 The ubiquity of home ownership in Norway created a powerful constituency of actual and prospective owners opposed to the taxation of housing.39 The electoral weight of home owners conditioned the policy positions of the political parties. On the right, widespread home ownership made opposition to taxes on housing an attractive political issue. “There is no doubt,” commented a leading Conservative politician, “that low taxation of housing is a good political issue in debates with the left.”40 For the center-left, it became too costly politically to endorse more realistic taxes on houses. Even if Labour leaders were intellectually convinced by the arguments for more neutral taxation, the party kept the issue off the table. Labour “acknowledged the force of popular sentiment on this issue and did not dare to challenge it,” remarked one observer.41 As several interviewees pointed out, the economic arguments for taxing houses like other capital assets met so little understanding among home owners that any political attempt to openly promote the issue was doomed to fail. “The political force of gravity,” commented one policy maker, “was so strong that economic arguments did not break through.”42

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Adding to this, the buoyant revenues from petroleum and gas extraction made it easier for politicians to leave the property tax base nearly untouched. In response to the growing incomes from oil and gas extraction, Norway in 1990 established a sovereign wealth fund (popularly known as the “Petroleum Fund”) and a budgetary rule that limited the annual use of oil money over the budget to 4 percent of the fund’s value.43 Although this meant that most of the oil revenues were saved for later, a sizeable portion was still routed into the economy. During the period 1980–2010, the annual use of oil revenues over the budget corresponded to between 2 and 6 percent of mainland GDP, depending on the business cycle (Finansdepartementet 2012). These revenues gave Norway greater fiscal room for maneuver than other countries, sparing politicians from making hard choices regarding spending and revenue. Norway could maintain a high level of public transfers and services without exploiting all possible tax bases. In other words, there was no revenue argument for tapping into the tax base of housing. The lack of convincing answers to the question “Why increase the taxes on housing when we have more revenues than we can spend?” weakened the case for higher property taxes. As a Conservative politician put it, “We buy the argument that property is a good tax base. But this isn’t a challenge in Norway—we have plenty of tax bases.”44 Given the abundance of revenues in the oil-driven economy, politicians were content to draw a clear line in the taxation of housing between what was economically efficient and what was politically desirable. The lenient taxation of housing highlights the limits of the argument about economists and the introduction of market-conforming policies. Despite their best efforts, the influence of economists did not extend to all parts of the tax system. The taxation of housing proved particularly contentious, with pronounced disagreements between economic experts and politicians. As I have argued, this can largely be seen as the result of particular structural features of the Norwegian political economy. High rates of home ownership and abundant tax revenues made it difficult for economic arguments to gain political traction, just as the economic crisis in the late 1980s had constituted a favorable context for reaching agreement on large-scale reform. At the same time, we should not exaggerate the causal importance of the economic environment. Even if the abundance of oil revenues created structural pressures on the tax system, Norway did not pursue the kind of drastic narrowing of the tax base that we saw in Ireland during the Celtic Tiger.45 Norway did not use the oil revenues to hollow

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out the income tax or to introduce a myriad of tax breaks. And although housing taxation was further alleviated, other tax bases were maintained and even strengthened. In other words, the economic environment did not determine the direction of reform; it rather provided the structural context within which policy choices were made.

Conclusion This chapter has argued that the adoption of market-conforming tax policies in Norway not only was the result of structural economic factors or the agendas of political parties but also was linked to the strong position granted to economic experts within the postwar social-democratic state. The close ties established between the finance ministry and the economics discipline in this period made the bureaucracy receptive to the subsequent shift toward neoclassical economics. As the older generation of Keynesian economists retired, new economic ideas were brought into the ministry by U.S.-trained economists hired to key positions in the organization. This spurred the formulation—in dialogue with academic economists—of a broad efficiency-oriented reform program and the active advocacy of reform to political leaders. This program had a major impact on the economic policies introduced by Norwegian governments from the mid1980s onwards. To be sure, the influence of economists was more limited than in New Zealand, as Norwegian politicians explicitly rejected economic advice in areas such as housing taxation. Market-oriented tax reform also had different effects than in New Zealand, as closer attention to the redistributive dimension in Norway precluded a dramatic widening of income differences. Still, the central role of economic expertise in the formulation of tax policy was noteworthy and—as we will see in the next chapter—distinguished Norway from neighboring Denmark.

Chapter 6

Denmark Equality before Efficiency, Politicians before Experts I don’t think I brag when I say that the tax reforms were very politically driven. We came into office with a very precise conception of what we wanted to do. . . . The bureaucracy didn’t have a clear agenda in tax policy. It was a very political agenda from the beginning to the end. —Mogens Lykketoft, Minister of Finance from 1993 to 2000, interview, September 2010

A

S recently as in 2009, a Danish worker with a salary just above the average would pay 63 of the last 100 kroner she earned in taxes. That is, 72 kroner, if you consider the value-added tax that was levied when she spent the money. If she had money in the bank, the government would collect as much as 90 percent of the real interest she earned. In the era of globalization, the persistence of very high tax rates on labor and capital in a small open economy like Denmark was extraordinary. While Norway cut statutory tax rates on labor and introduced low, uniform taxation of capital, a series of Danish reforms in the 1980s and 1990s entailed only modest reductions of labor rates and broadening of bases and maintained high, uneven, and partly progressive taxation of capital income. Danish tax policies thus stood in stark contrast to the marketconforming doctrine of low marginal rates, broad bases, and neutral taxation. Only in 2010 did the Danish government make significant cuts in the highest statutory tax rate on labor. The persistence of very high top rates in Denmark is even more puzzling if we consider the peculiar structure of the Danish tax system. As one of few countries in the OECD, Denmark taxed labor almost exclusively through personal income taxes rather than social security contributions. In 2009, 55 percent of the country’s total tax revenues came from personal income taxation and only 2 percent from social security contributions (OECD 2011e). This makes little difference for the incidence of taxation because both types of levies hit labor. But it does matter in terms of visibility, as personal income taxes actually show up on a worker’s paycheck whereas contributions paid by employers do not. In other words, Denmark retained very high top rates on labor even though their taxes were among the most visible in the world. 135

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Why did Denmark resist market-conforming tax policies for so long? Many would argue that Denmark needed the high taxes to pay for an extensive welfare state. With one of the widest social safety nets in the world and without large oil revenues like Norway, the Danish state had to raise larger revenues from regular taxation. Yet, revenue statistics show that the highest tax rates contributed only marginally to financing public expenditure. The top tax bracket on labor generated only about 2 percent of total tax revenues, and the tax receipts from the high rates on positive capital income were minuscule (Finansministeriet 2008; Skattekommissionen 2009: 261). The absence of market-conforming tax reform in Denmark has also been linked to political parties, in particular to the Social Democrats (Socialdemokratiet or Socialdemokraterne). The Social Democrats played a key role in Danish politics throughout the 1980s and 1990s, and it has been argued that the party’s commitment to economic equality precluded the reduction of top tax rates on labor and capital (Ganghof 2006: 82–85; Sørensen 1998: 4). Yet, the argument is unconvincing in a comparative optic. As we have seen in previous chapters, market-oriented reforms in New Zealand and Norway were passed by labor parties. It is difficult to sustain that the Danish Social Democrats were markedly more traditionalist than their sister party in Norway, given that they pursued typical Third Way policies in the welfare and labor market areas (GreenPedersen, Kersbergen, and Hemerijck 2001). Another possibility is that political institutions worked against market-­ oriented reform. A strictly proportional electoral system and increasing fragmentation of the party system made minority governments the rule in Denmark from the 1970s onwards. The conventional wisdom is that minority governments are unable to govern effectively and pass reforms because they lack stable support in parliament (see Strom 1990 for a discussion). But in Denmark, minority government did not constitute an insurmountable obstacle to change. The capacity of the political system to produce decisions was high, as parties across the political spectrum willingly participated in negotiating and passing policy changes (Green-Pedersen 2001; Larsen and Andersen 2004: 193). Policy makers found it relatively easy to alter the tax system, as witnessed by what has been characterized as the “permanent tax reform” of the 1980s and 1990s (Larsen and Andersen 2004: 130, 180). Some would object that the bargains and compromises necessary to strike deals across the aisle precluded sweeping market-oriented reform. But this argument does not hold in com-

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parative terms, given that the far-reaching tax reform in Norway was based on broad political compromise. In this chapter, I instead discuss how the organization of economic expertise in Denmark contributed to the limited extent of market-conforming tax reform. Unlike the strong and concentrated position of economists in Norway in the postwar period, economic knowledge in the Danish state was scattered across a number of bodies. One consequence of the institutional fragmentation of economic expertise was that neoclassical economic thinking failed to break through within the Danish finance bureaucracy in the 1980s and 1990s. As we will see, this had important implications for the interaction between politicians and bureaucrats in policy making and for the content of Danish tax policies.

The Fragmentation of Economic Expertise in the Danish State An independent kingdom since the eighth century, Denmark established administrative structures long before the introduction of democracy. The abolition of the absolute monarchy in 1849 led to the formal division of political and administrative roles, thereby laying the foundations for an apolitical civil service. From its inception, the Danish civil service was the realm of lawyers. In fact, law graduates had a formal monopoly on most civil service positions until 1919 (Østergaard 2007: 171). And even after this provision was abolished, the Danish ministries were “completely dominated by lawyers, legal thinking and work forms, which consisted mainly in evaluating single cases” (Økonomiministeriet 1997: 6). This included the Ministry of Finance. Until World War II the ministry was staffed almost exclusively by lawyers, who took a passive approach to financial management. It was, as one of the first economists in the ministry remarked, an institution “where no one was interested in the national economy or economic policy” (cited in Østergaard 2007: 198–199). As elsewhere, this hands-off approach to the economy was discredited by the events of the 1930s and 1940s. The rise in unemployment under the Great Depression and the experience with a centralized war economy led to demands for a more active role for the state in the economy. On the left, these developments created “a belief in the potential of a planned economy, but also more broadly an understanding of the need for a greater extent of economic planning” (Østergaard 2007: 198). In Denmark, the Keynesian economic agenda was supported in particular by the Social Democrats but also by figures in the Liberal Party. The ambitions for more active economic management were

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a­ ccompanied by calls for a greater role for economists in the lawyer-dominated civil service: The official trained in law lacks . . . the economic schooling that is necessary to prepare and enact these interventions [in the economy] . . . The most simple remedy must be that the central administration to a greater extent than before complement their legal staff with economics candidates. The alternative must be the creation of a ministry of the economy, with economically trained officials and with the task of [dealing with questions of economic policy]. (Holger Koed, director of the Danish Price Board, in 1938, cited in Økonomiministeriet 1997)

When the Social Democrats came to power in 1947, these concerns were at the top of the agenda. The new government created a committee of ministers to coordinate economic policy and set up a permanent secretariat to support it (Økonomiministeriet 1997). The Economic Secretariat (Det Økonomiske Sekretariat) was given responsibility for analyzing the overall economic situation and evaluating the economic merits of policy proposals. This included preparing a national budget similar to the one that had just been published in Norway, which set out not only the state’s incomes and expenses but also aggregate measures of economic activity. The secretariat stood out from the older government departments: It was staffed almost exclusively by young Keynesian economists, several of whom were active members of the Social Democratic Party (Økonomiministeriet 1997: 9). In this respect, the secretariat closely resembled the economic division that was created inside the Norwegian finance ministry. A crucial difference, however, was that the Danish economic secretariat was set up outside the existing bureaucratic structures, leaving it in a rather vulnerable position. From the outset, the secretariat met with disapproval from officials in the old ministries, who saw the new body as a threat to their own role and competences (Økonomiministeriet 1997: 9). As soon as a center-right government took over, the secretariat was annexed by the Ministry of Finance and stripped of some of its main responsibilities. The Social Democrats resurrected the secretariat when it came back to power in 1953, and in 1958 it was made into a permanent Ministry of the Economy. Yet the new ministry lost both tasks and influence after its administrative head moved to the Ministry of Finance a few years later (Østergaard 2007: 209; Økonomiministeriet 1997: 14). In other words, the Keynesian economists in the Economic Secretariat failed to establish

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a stable position of power inside the administrative system similar to what their colleagues had achieved in Norway. In 1962, another economic expert body was established, this time at the request of the Social Liberal Party (Radikale Venstre), the junior partner in a coalition government led by the Social Democrats. The Economic Council (Det Økonomiske Råd), as the body was called, was not a government department but a semipublic research organization. It was made up of a chairmanship of three economics professors (the so-called Wise Men), an independent secretariat staffed mostly by economists and a council with representatives from interest groups, government departments, and academia. The rationale for the creation of the council was to support corporatist economic coordination through the generation of independent expert advice (Mikkelsen 1987: 185). Twice a year, the Wise Men and the secretariat would prepare a public report based on analyses of the economic situation, which the council could comment on but not influence. As such, the Economic Council undoubtedly strengthened the role of economics in public debate. However, the creation of this kind of independent expert body outside the bureaucracy was also controversial. The act establishing the council passed with the votes of a narrow and unenthusiastic majority in parliament. And top civil servants argued that the council allowed politicians to bypass the regular administration and cast doubt on the independence and expertise of the civil service (Mikkelsen 1987: 186–88). Whatever the merits of this criticism, it did highlight the fragmented character of economic expertise in the Danish decision-making system. Rather than concentrating economic expertise within a single ministry, this kind of knowledge was scattered across a series of institutions. The greater institutional fragmentation of economic expertise in Denmark than in Norway can in large part be attributed to the absence of social-­ democratic hegemony. Unlike its Scandinavian sister parties, the Danish Social Democrats never had a majority in parliament and therefore needed the support of smaller parties in the center or on the left to govern (Green-Pedersen 2001: 58).1 Despite being the main political force of the postwar decades, the Social Democrats were not in a position to fundamentally reshape the state as was the Norwegian Labour Party. The role of economic knowledge in government was subject to the constant push and pull of competing political forces, leading to instability and fragmentation in the institutional landscape for economic policy advice. Adding to this, Denmark lacked a domestic economic ­profession

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with sufficient authority to place itself at the center of policy making like in Norway or Sweden. “Danish economists,” writes Pekkarinen, “accepted Keynesianism rather early [but] they did not provide an indigenous school as in Oslo or Stockholm of a sort that could exercise special influence over policy makers” (Pekkarinen 1989: 342–343). In other words, the two forces that had driven the rise of Keynesian economists within the Norwegian civil service were significantly weaker in Denmark, with the result that economic expertise was not firmly entrenched at the center of the state. The Danish Ministry of Finance did eventually expand its economic expertise in the late 1960s and 1970s. Not only did the ministry recruit a number of young economists to fill new positions; it also developed econometric models for macroeconomic analysis to use in economic policy making (Østergaard 1998: 284, 2007: 117). Yet the ministry simultaneously hired a contingent of political scientists, making it the first “bridgehead” for this new education in the central administration (Østergaard 2007: 117). Political scientists would go on to play an unusually prominent role in the finance ministry, making up a significant portion of its staff and top brass (Jensen 2008).2 The point is not that economists were absent in the ministry. But economics never became the “only game in town” as in the finance ministries in New Zealand and Norway. Economists did not have a monopoly on top administrative positions, and the ministry did not develop the same close links to the academic discipline or culture of academic autonomy as had the Norwegian finance ministry. Furthermore, concerns about the excessive workload of the finance minister contributed to the splitting of the ministry in the early 1970s, with its tasks being distributed across three distinct ministries—Finance, Economy, and a new Ministry of Taxation (Østergaard 2007: 238–243). The partitioning was partly a result of the fact that Danish ministers did not have the assistance of political advisors or undersecretaries and therefore had to shoulder the political workload on their own (see Finansministeriet 1998). Yet it had some important consequences: The split not only made the Ministry of Finance more narrowly concerned with macroeconomic issues but also led to a further fragmentation of economic knowledge in the bureaucracy. To summarize, the specific configuration of economic knowledge in the Danish state was the product of a highly contingent process. The institutional role of economists was shaped and reshaped by a series of political initiatives and administrative changes, leading to a marked fragmentation of economic

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expertise. The analytical tasks that in Norway were handled by a single ministry were in Denmark spread across the Ministry of Finance, the Ministry of the Economy, the Ministry of Taxation, and the Economic Council. Significantly, this organization of economic expertise would condition how Danish officials responded to the subsequent rise of neoclassical economic ideas.

The Failed Supply-Side Revolution

Like many other countries, Denmark ran into serious economic problems in the 1970s. In the aftermath of the second oil crisis, the Danish economy was plagued with large deficits on the balance of payments and the budget, low levels of investment, and rising unemployment (for example, Mjøset 1987: 427–428). The situation was not much different from the troubled economic environment in which efficiency-oriented thinking broke through in the finance bureaucracies of New Zealand and Norway. Yet, in the Danish Ministry of Finance, neoclassical economic perspectives on the crisis found little resonance. The ministry instead responded to the economic balance problems by becoming increasingly specialized in Keynesian macroeconomics (Jensen 2008: 39). The dearth of neoclassical economic thinking in the ministry appears to have been the result of a series of factors. One was that, in Denmark’s fragmented economic bureaucracy, the Ministry of Finance was more narrowly focused on macroeconomic questions and had less exposure to issues relating to the supply side of the economy. Another factor was the persistent dominance of Keynesian economics at the University of Copenhagen, where most of the ministry’s economists were trained.3 And a final element was the absence of ties to the international economics discipline—ties that in New Zealand and Norway represented crucial channels for the diffusion of new economic ideas. The prevailing Keynesian approach did, however, come under attack from outside the bureaucracy in the late 1980s. The heaviest assault came from the political sphere, where Anders Fogh Rasmussen, a rising star in the Liberal Party, launched an ideological campaign inspired by economic ideas imported from the United States. Fogh Rasmussen had met Chicago economist Robert Lucas during a trip to America in the early 1980s and was strongly influenced by his ideas about rational expectations and the futility of Keynesian fiscal policies (Asmussen 2007: 123). He had also picked up Arthur Laffer’s idea that, above a certain tax level, raising taxes influences labor supply so negatively that tax revenues decrease. Convinced that this was the case in Denmark, Fogh

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­ asmussen advocated a drastic reduction of the tax level, which he argued R would have substantial dynamic effects on labor supply (Asmussen 2007: 124). When Fogh Rasmussen was appointed minister of taxation in 1987, he created a special “Tax Policy Secretariat” (Skattepolitisk Sekretariat) to advance this economic agenda. The unit was staffed with economists who identified with supply-side thinking, drawn mostly from outside the regular bureaucracy (Asmussen 2007: 126). Fogh Rasmussen’s challenge also coincided with a shift in economic thinking within the Danish Economic Council. The report released by the Wise Men in the spring of 1988 was the first to draw heavily on neoclassical economic ideas. It stressed the importance of economic incentives for behavior on the labor market and highlighted the incentive problems of Danish wage setting and labor market policy—issues that until then had received little attention (Asmussen 2007: 120–124). The shift reflected changes within the Danish economics profession. Although the staunchly Keynesian economics department at the University of Copenhagen had traditionally been dominant, more market-­ oriented economists from Aarhus University were now making themselves heard. The 1988 report of the Economic Council was strongly influenced by an Aarhus economist, Wise Man Peder J. Pedersen, and relied extensively on articles and working papers produced at the university (Asmussen 2007: 120–121). The thinking of the Aarhus economists shared some elements with Fogh Rasmussen’s ideas, in particular the emphasis on rational expectations. However, their analysis was firmly rooted in mainstream neoclassical economics and did not encompass the more extreme “supply-side economics” embraced by Fogh Rasmussen. This, of course, did not prevent Fogh Rasmussen from making frequent reference to the report from the Wise Men as justification for his economic agenda (Asmussen 2007: 124). For a while, Fogh Rasmussen and the Tax Policy Secretariat exerted considerable influence over the economic stance of the center-right government and the ministries, including the Ministry of Finance. The finance ministry started writing about incentive problems in its policy documents and was even forced to incorporate substantial dynamic effects of tax cuts in its macroeconomic models (Asmussen 2007: 134, 142–143). However, officials in the ministry remained deeply skeptical to the new unit: The Tax Policy Secretariat was filled with neoliberal economists taken in from the street. They were not regular civil servants. We only got ideological statements from them. In

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the Ministry of Finance it was perceived as political theater, not as economic discussion. It was never taken seriously.4

The supply-siders’ intellectual siege of the economic bureaucracy dragged on for a couple of years. But, given that the government lacked a majority in parliament, it had little impact on policy. As soon as the government changed, the supply-side economists were marginalized. The Ministry of Finance took back control over economic policy—tax policy included—and reaffirmed its commitment to Keynesian economics and demand-side issues (Asmussen 2007: 144–145; Jensen 2008: 55). Although some supply-siders remained in the Ministry of Taxation, the ministry was left with a secondary role in tax policy making: “subordinated to the Ministry of Finance” and the “little brother” in the relationship.5 To summarize, new economic thinking—either of the “supply side” variety or of the mainstream neoclassical kind—ultimately failed to take root at the core of the Danish economic bureaucracy. The most direct reason for this was that these ideas emerged outside the state. The shift to neoclassical economics within the Danish Economic Council had limited impact on the economic thinking in the ministries. And supply-side ideas were seen by officials as externally imposed and lost their relevance as soon as their political sponsors were voted out of office. Yet, more fundamentally, the fact that new economic ideas failed to break through at the center of the state can be seen as a result of the fragmentation of economic expertise in the Danish administration. In Norway and New Zealand, the institutional concentration of economic expertise and close ties between the finance ministry and the international economics profession channeled theoretical innovations right to the heart of the state apparatus. In Denmark, economists never enjoyed this kind of strong, concentrated administrative position or disciplinary ties, impeding the shift from Keynesian to neoclassical economics. As we will see, the persistence of Keynesian macro­ economic thinking in the Danish finance bureaucracy had important implications for Danish economic policy-making in the final decades of the twen­ tieth century.

Tax Reform Danish-Style The end of the 1970s is considered one of the low points in Danish economic history. With the economy reeling from the second oil crisis and the Social Democratic government unable to find effective remedies, the Minister of

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Finance famously admitted on TV that Denmark was headed straight toward the void: “Some people say that we are driving along the edge of the abyss. We are not, but we are heading toward it, and we can see it.” (Den Store Danske 2016). The Danish economy was plagued with large balance of payments deficits and budget deficits as well as low levels of investments. One of the main problems was the disincentives for savings, many of which were related to the tax code. Denmark had a tax system with high statutory rates and deep deductions, and as in Norway a generous interest deduction and high capital tax rates provided incentives to borrow rather than to save money (Ganghof 2006: 79–80; Jensen 2008: 50–51). Against this background, a public commission was appointed to look into the taxation of capital. The Commission on the Taxation of Interest (1982) and a follow-up expert group sponsored by the Danish Savings Bank Association (1984) both had academic economists in prominent roles. To increase the level of savings and improve the allocation of capital in the economy, the commissions proposed a dual income tax with a uniform 50 percent rate on all types of capital and corporate income and a higher top rate on labor income (Sørensen 1998: 4). The Ministry of Finance, based on its concern about macroeconomic issues, was positive to the proposed system. The generous interest deduction was detrimental both to revenues and to the balance of payments, and officials saw the proposal as “a breakthrough in terms of reducing the value of the interest deduction.”6 However, in the discussions about reform, officials played a secondary role to politicians. The reform proposals became the subject of extended negotiations between the government—made up of the Conservative Party (Det Konservative Folkeparti) and the Liberal Party (Venstre)—and the opposition Social Democrats.7 Whereas the government wanted to adopt a pure dual income tax with uniform flat taxation of capital, the Social Democrats were not willing to abandon progressive taxes on capital. As a central participant recalled: “We spent three to four months negotiating about all elements of the reform. So politicians were really inside the machine room in the formulation of the tax reform.”8 In the end, the Social Democrats succeeded in preserving progressive taxation of certain types of capital income, thereby diluting the “neutral” character of the reform (Sørensen 1998: 4). The reform reduced the highest statutory rate on labor by a few points to 69 percent and limited the value of the interest deduction to 50 percent. At the same time, it raised the corporate tax rate from 40 to

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50 percent to align rates. Thus, while the reform had some market-conforming elements, it lacked the reductions in marginal rates that were central to the low-rate, broad-base tax doctrine and “left Danish marginal income tax rates at a rather high level” (Sørensen 1998: 22). The tax reform was an integral part of the Conservative-Liberal government’s efforts to stimulate savings and dampen private consumption and borrowing in the mid-1980s—often referred to as the “potato diet” (kartoffelkuren). These austerity policies succeeded in stabilizing the Danish economy. But they also ushered in a period of anemic growth and rising unemployment. The sluggish economy prompted a search for new policy responses toward the end of the decade. As previously discussed, supply-side thinking gained currency within the Conservative-Liberal coalition, primarily due to the advocacy of Tax Minister Fogh Rasmussen. In its 1989 long-term program, “The Plan of the Century” (Århundredets Plan), the government proposed major tax reductions, arguing that lower taxes would increase the incentives for work and enterprise (Asmussen 2007: 130, 135). The emphasis on the disincentives of taxation was also present in the reports of the Economic Council, even if the Wise Men were more cautious in their recommendations about reform (Danish Economic Council 1989). The calls for a reduction of the tax burden moreover had the backing of Danish employers (Larsen and Andersen 2004: 191–192). Yet, the government lacked a majority in parliament and needed the support of the Social Democrats. In fact, the Social Democrats had also proposed to reduce the tax burden—albeit in a socially responsible way. But repeated attempts at reaching an agreement stalled, both because of the Social Democrats’ opposition to unfinanced tax cuts and because both parties were unwilling to stretch too far with new elections coming up (Asmussen 2007: 136–137). The only significant measure passed in this period was the reduction of the corporate tax rate from 50 to 34 percent, a move motivated largely by concerns about corporate tax competition (Ganghof 2006: 82). Unable to get any further, the government appointed a public commission on taxation, which was asked to investigate a new personal income tax model that involved lower marginal tax rates, in particular on labor income (Sørensen 1998: 22–24).

A Very Political Agenda

The Personal Tax Commission was, in contrast to the Aarbakke group in Norway, completely independent of the bureaucracy. It did not have members or a

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secretariat from the Ministry of Finance, nor did it have any other links to the ministry (Asmussen 2007: 162). The commission was composed of outside experts in law and economics, with lawyers playing a greater role than in Norway. Whereas the few tax economists on the commission wanted a pure dual income tax, the lawyers favored a “global income tax” with a progressive schedule for both labor and capital. The compromise was a hybrid system: The commission recommended a significant reduction in tax rates on labor and a moderate restriction of the interest deduction but proposed to retain progressive taxation of positive capital income (Personskatteudvalget 1992). The proposals for lower rates and broader bases did have a recognizable market-oriented profile, even if they were modest compared to those put forward in Norway. Yet, neoclassical ideas about tax policy did not have many proponents in the finance ministry. As discussed earlier, the Danish Ministry of Finance had emerged from the ideological and jurisdictional battles of the 1980s not only as the prime venue for the setting of economic policy but also as a very macro-­oriented ministry. As a result, the officials in charge of taxation policy in Denmark were not neoclassical microeconomists as in Norway but rather macroeconomists whose main concern was the balance problems of the economy—­in particular related to the fiscal balance and the balance of payments (Asmussen 2007: 176–186). As a senior official in the ministry observed, There has been no tax economics in the Ministry of Finance; it’s been all about macro. The officials in charge of tax policy in the ministry have not been tax economists, but macroeconomists concerned about the broad lines of tax policy.9

Moreover, the absence of links between the Personal Tax Commission and the Ministry of Finance impeded the spread of tax economic thinking to the ministry. “The way the commission was set up there was no interaction with the ministry,” observed an economist on the commission. “As a result, the bureaucracy did not get ownership to the principles in the commission proposals. Tax economic reasoning was not anchored in the ministry.”10 Finance bureaucrats thus remained unconcerned about microeconomic principles such as neutrality and efficiency: “No one in the Ministry of Finance was interested in neutrality and symmetry in tax policy. They were willing to deviate from neutrality in order to achieve a particular change in behavior or reach a macroeconomic goal,” observed the same economist.11 This did not mean that the ministry rejected all the commission’s proposals. Given that the

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generous interest deduction was detrimental both to revenues and to the balance of payments, officials supported reductions in the value of the deduction. But the ministry was indifferent to the uniform taxation of capital and skeptical to large rate cuts on labor because of the potential revenue losses. And beyond these general concerns, the ministry lacked a strong agenda about how tax policy should be designed.12 The 1993 elections brought the Social Democrats back to power at the head of a majority coalition with the Social Liberals and two other small centrist parties. The Social Democrats, keen to correct the image of economic incompetence from the 1970s, were committed to fiscal responsibility and macroeconomic stability (Jensen 2008: 43). But with unemployment surpassing 10 percent and the economy showing no signs of recovery, party leaders became convinced that it was necessary to stimulate demand (Asmussen 2007: 163). The Social Democrats saw tax reform as a means to reconcile these two objectives, that is, kick-starting the economy at the same time as improving its overall structure (Socialdemokratiet 1989; Finansministeriet 1993: 3). This implied reducing the value of the interest deduction to stimulate savings and reduce borrowing, as well as lowering marginal tax rates on labor. Some scholars have claimed that the Social Democrats’ interest in reducing tax rates was animated by “the idea that taxes are detrimental to competitiveness and that the labor market is troubled by supply-side problems” (Larsen and Andersen 2009: 256). This is inaccurate and empirically unfounded. Policy documents and interviews with decision makers indicate that the Social Democrats’ main rationale for cutting marginal tax rates was not to increase labor supply but to stimulate the demand for labor. Not only were leading Social Democrats skeptical to supply-side arguments about the dynamic effects of rate cuts on labor supply; they were also interested in temporarily reducing labor supply to share work (Andersen 2011: 24; Regeringen 1993: 4). In the words of Mogens Lykketoft, Minister of Finance for the Social Democrats at the time: I didn’t believe that there were any large dynamic effects, and we certainly didn’t count on it. It’s important to remember that in 1993 the unemployment rate was 12 percent, so stimulating labor supply was not exactly our main concern.13

The aim of cutting tax rates was rather to increase businesses’ demand for labor. “The main goal was to stimulate the demand for labor,” commented Ole Stavad, then Minister of Taxation for the Social Democrats. “We wanted to make it more

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attractive to hire workers.”14 Furthermore, the Social Democrats saw tax reform as a matter of “redistributive policy,”15 just as their sister party in Norway did. This meant that they were eager to broaden bases and close loopholes but skeptical to large cuts in the rates on high incomes. The main trade union confederation LO (Landsorganisasjonen i Danmark) and the Economic Council of the Labor Movement (AE), an affiliated research organization, largely shared these tax policy views, reflecting the close links between the organizations within the labor movement.16 The interest in tax reform was strong also in the Social Liberal Party, though for different reasons. The Social Liberals, who were closely aligned with academic economists, supported “low-rate, broad-base reform to increase savings and stimulate labor supply”17 and made tax reform a condition for joining the government. Tax reform thus became a cornerstone of the government’s program of economic recovery (Regeringen 1993: 10–11), much as in Norway two years earlier. But, unlike the Norwegian tax reform, which was formulated by economists in the finance bureaucracy, the Danish intervention was designed by politicians and largely reflected political concerns. The main architect was Minister of Finance Mogens Lykketoft, who had prime responsibility for economic policy in the Nyrup Rasmussen government (see Jensen 2008: 455). Lykketoft had a background in Keynesian economics and extensive experience with tax policy. He had been involved in political discussions about taxation since the 1970s, serving as minister of taxation from 1981 to 1982 and as head negotiator for the Social Democrats in the 1985 reform talks. Lykketoft came to office in 1993 with “a very precise conception” of what he wanted to do in tax policy. As one close ally, tax minister Stavad, explained: Tax reform reflected a political project created before the Social Democrats had support from the civil service. It was a political project in the sense that the main lines were politically drawn. It was not a project drawn by civil servants that politicians endorsed; the project was a political creation.18

A civil servant confirmed this description: “Tax policy under the Nyrup Rasmussen government was to a great extent politically controlled in the sense that the ministers of finance and economy set the direction.”19 Although Lykketoft was more a politician than an economist, his training and experience with tax matters constituted important resources in the policy process. As one official recalled, “Lykketoft literally made tax reform

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himself at his desk with his pocket calculator. He could understand the technical stuff by himself.”20 Another official suggested that it had more to do with self-­confidence: “Lykketoft and Stavad thought they were smart—they weren’t receptive to advice.”21 In any case, the Ministry of Finance offered little resistance. The ministry had limited expertise in tax economics and lacked a strong independent tax policy agenda. Thus, in the formulation of tax reform, officials were relegated to a secondary role and fell into line with the political agenda (see Asmussen 2007: 169). In other words, although Finance officials played a powerful role in areas such as budget policy and public management in the 1990s (Jensen 2008), they had little clout in the field of taxation. Behind closed doors, Lykketoft and the Social Liberals’ Minister of Economy hammered out a reform bill and put it before the rest of the government for immediate approval. “The reform came as a thief in the night,” recalled a top civil servant. “They sent out a 120-page-long proposal to be discussed the next morning.”22 The alliance between the two main coalition parties ensured that the tax reform bill sailed through cabinet and parliament. “The reform was pushed through with no time for debate or objections,” observed the same official. Organized interests were not included in policy formulation, severely limiting their influence over the direction of reform (Larsen and Andersen 2004: 191–192). The final reform lowered statutory tax rates across the board by 5 to 8 percent—the top rate dropping from 69 to 62 percent—and reduced the value of the interest deduction from 52 to 46 percent. At the same time it extended the progressive taxation of capital income to include gains from stocks (in addition to positive interest and dividends, which were already taxed under a progressive schedule) (Finansministeriet 1999: 253). The reform also included a temporary demand stimulus. In total, the reform produced an increase in the redistributive effect of the tax system, as the gains in disposable income were higher for people on lower incomes than for high income earners (Finansministeriet 1999: 260). Some Danish scholars have portrayed this intervention as a “neoliberal” reform, though without specifying why it would fit this description (Larsen and Andersen 2009). Yet, a careful assessment of the reform shows that it did not have a pronounced market-conforming profile. Although the reform reduced marginal tax rates on labor somewhat, rates remained at a high level—well over 60 percent for high income earners. The broadening of bases was also modest: The six-point reduction in the value of the interest deduction was little compared to cuts of twenty to thirty percentage points in Norway and Sweden in

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the early 1990s (Finansministeriet 1999: 238). And in capital taxation, Denmark moved away from the principle of low neutral taxes on capital income (Sørensen 1998: 23–24). Denmark retained a tax system that differentiated between positive and negative capital income and between different types of positive capital income and introduced higher and more progressive taxation on some forms of positive capital income. It is thus fair to conclude that the Danish tax reform only had some very modest market-conforming elements, which, moreover, were blended with measures that ran counter to market principles. This can be seen as a reflection of the fact that the reform incorporated a wide range of motivations—demand stimulus, macroeconomic stabilization, redistribution— that had little to do with increasing efficiency and leveling playing fields. Why did the Danish tax reform not follow the market-oriented thrust of the reforms in New Zealand and Norway? As borne out by the narrative, the character of the reform in Denmark was strongly shaped by the governing Social Democrats and their political agenda. To some extent, the dominance of politicians over policy setting can be ascribed to idiosyncratic factors, such as the political skills of finance minister Lykketoft. But it was also, I argue, linked to the marginal role of neoclassical tax economics in the Danish finance ministry. The Keynesian macroeconomists who dominated the ministry had little interest or expertise in the microeconomic aspects of taxation. This made the ministry unable to control tax policy formulation, as it lost out to politicians who not only had a precise idea about what they wanted to do but also had a certain grasp of the technical issues involved. Counterfactual reasoning can bolster this argument. If Danish politicians had faced, say, the Norwegian Ministry of Finance instead of their own, the policy process could have looked very different. Bureaucrats would have had strong analytical expertise on tax issues and used this expertise to advocate ideas about efficiency and neutrality in taxation to ministers. In Norway, this kind of advocacy had a significant impact on the attitudes of social-democratic party leaders. And it is not implausible that this policy advice would have found resonance also with Danish finance minister Lykketoft, who was a reform-oriented politician. Lykketoft and the Social Democrats would easily have secured a majority for market-conforming tax reform with the votes of the Social Liberals, who were strongly in favor of such measures. The result could have been a reform with greater rate cuts, a more radical broadening of bases, and consistently neutral taxation of capital.

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Macro, Not Micro

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The 1994 tax reform succeeded in kick-starting the stagnant Danish economy, marking the beginning of a period of growth. By 1998, the wheels of the economy were spinning so fast that it raised alarm both within the Social Democrat–led government and among the experts in the Economic Council (Danish Economic Council 1998). Rapid growth in private demand, credit, and house prices, combined with increasing balance of payments deficits, convinced the government that it was necessary to step on the brake.23 The government wanted to tighten fiscal policy and curtail the incentives for borrowing, and it saw tax reform as a means to do so. Most important, the government sought to reduce the interest deduction to discourage loan-financed investments in property, and it aimed to offset this with careful reductions in statutory tax rates. In other words, reform was motivated by macroeconomic—not microeconomic—concerns. “It was,” as Tax Minister Stavad put it, “primarily a tightening of fiscal policy carried out not in a traditional way but in the context of a tax reform.”24 As in 1993, Lykketoft and Stavad set the direction for reform and formulated concrete policy proposals, whereas civil servants and interest groups sat on the sidelines. “Civil servants played the same role as in 1993,” commented Stavad, “the main construction was political.”25 But having lost its majority in 1994, the government needed support from the opposition. The government first approached the parties on the right, but the Liberals already had their eye on the next elections and turned down the offer. The government therefore struck a deal with the opposition parties to its left instead, which produced a reform with a sharper redistributive profile than originally proposed (Ganghof 2006: 84–85). The reform cut the value of the interest deduction from 46 to 33 percent and adjusted the rate structure in favor of people on lower incomes. Whereas bottom and middle rates were reduced by a couple of points, the top rate was raised by 1 percent—which was clearly at odds with efficiency-oriented ideas about tax reform. Instead, the reform further increased the redistributive effect of the tax system (Finansministeriet 1999: 260)—a rarity among the many tax reforms worldwide in this period. To summarize, the period of “permanent tax reform” in Denmark was not a period of ever greater conformity to market principles in taxation. Taken together, the reforms from 1985 to 2001 produced only a modest drop in the highest statutory tax rate on labor, from 73 to 63 percent. And rate reductions were effectively canceled out by bracket creep: The portion of the workforce facing

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the top rate increased from less than 15 percent in 1986 to almost 40 percent in 2001 (Skattekommissionen 2009: 247). The reforms did gradually broaden the tax base by limiting the interest deduction. But at the same time they maintained high and uneven rates on capital income, in stark contrast to the principle of neutral taxation of capital. As opposed to the tax reforms in New Zealand and Norway, which were motivated largely by microeconomic concerns about efficiency, the Danish reforms primarily had a macroeconomic rationale. This emphasis on macroeconomic stability is often seen as a consequence of the breakdown of economic management in the 1970s (Jensen 2008: 33–43). Yet, other countries saw similar crises as a motivation for microeconomic restructuring. The question is, rather, why microeconomic reform was not perceived as the appropriate response to Denmark’s economic problems. I have argued that an important reason was the marginal position of neoclassical tax economists in the Danish finance administration, which precluded the kind of bureaucratic reform advocacy seen elsewhere. As a result, ministers were not exposed to persistent arguments for efficiency-oriented tax policies and were able to maintain control over tax policy setting. During the 1990s, politicians of the left set a tax policy course that was centered on macroeconomic stability and the commitment to high and progressive taxation—at a time when many other governments were slashing tax rates. The political agenda would, however, change dramatically with the election of a right-wing government in 2001.

Grappling with the “Specter of Inequality” The victory of the Liberal-Conservative coalition in the 2001 elections brought a familiar figure to power. Anders Fogh Rasmussen, prime minister and strong man of the government, was easily the most market-liberal politician Denmark had ever seen. Fogh Rasmussen had orchestrated the failed supply-side coup in the late 1980s and had later published an ultraliberal pamphlet entitled From Social State to Minimal State (Fogh Rasmussen 1993). He was sympathetic to ideas about “starving the beast” and favored lower marginal taxes and a reduction of the tax burden (Asmussen 2007: 125). As leader of the Liberals from 1998, he had toned down this message and softened the party’s policy positions. But many were expecting Fogh Rasmussen to show his true colors once he got into office—especially given his strong parliamentary base. For the first time in modern Danish history the parties of the right did not need the support of the political center to pass laws. With the votes of the Danish People’s Party

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(Dansk Folkeparti)—a populist right party—the Liberal-Conservative coalition commanded a majority in parliament. And while the People’s Party pushed the Liberal-­Conservative coalition hard on immigration policy—the prime concern of the populist right—it provided stable support for the government on economic policy issues. In business circles, the expectations were high: It’s no secret that there were high expectations in the business community when the Liberal-Conservative government took over in 2001. Fogh Rasmussen was known to be very liberal, even if he had moved toward the center before the elections. We believed that he was lying or that he at least understood the economic arguments [for marginal tax cuts]. We believed something was going to happen in tax policy.26

But there was something haunting the Liberals, namely what one political advisor referred to as the “specter of inequality.”27 The failure to oust the Social Democrats in the 1998 elections by promising lower taxes had led to much soulsearching in the Liberal Party. Party leaders attributed the defeat to the salience of the issue of equality during the campaign: “The analysis of Fogh Rasmussen and Hjort Frederiksen [the party secretary] was that we are vulnerable when the economic debate is about distribution, whereas we win when the debate is about economic responsibility or value issues,” related a close political adviser. “And that gave rise to the strategy that we needed to neutralize the discussion about distribution.”28 Because proposals for cuts in top tax rates inevitably raised such debates, tax policy came to be seen as a losing issue. “You don’t win elections on tax policy changes,” asserted Thor Pedersen, the Liberals’ minister of finance. “That’s also the case with tax cuts. Danes won’t accept that some get bigger cuts than others. In public debate, that’s always portrayed as unfair.”29 The solution was to keep tax cuts off the agenda. In the 2001 election campaign the Liberals replaced their traditional proposals for tax cuts with the promise of a tax freeze—and won a landslide victory. In line with Fogh Rasmussen’s doctrine of “contract politics”—basically, of keeping his promises to voters—the government adopted the tax freeze (skattestoppet) immediately after taking office. The freeze implied that no tax could be increased either as a percentage or in absolute terms. The Social Democrats and the trade unions criticized what they saw as irresponsible fiscal policy. The Wise Men of the Economic Council also condemned the policy because the moratorium on tax changes stood in the way of necessary restructuring of the tax system (Danish Economic Council 2002). And the Ministry of Finance

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disliked the tax freeze, mainly because the failure to adjust taxes fixed in absolute amounts would lead to the erosion of revenues. In the Ministry of Finance, Keynesian macroeconomics had remained a dominant force. As one official observed, “We are very Keynesian in our culture in the Ministry of Finance. The neoclassical wave has come later and with less force than in Norway and Sweden.”30 In the ministry, tax economics was confined to a small office that counted only four people and sorted under the macroeconomic division. The institutional subordination of taxation to macroeconomic policy “led to greater attention to the macroeconomic aspects of taxation.”31 Finance officials saw tax policy as an “instrument to finance public expenditure”32 and were most concerned about fiscal sustainability and other macroeconomic issues. They were much less concerned about the effects of different taxes on economic behavior and the allocation of resources. To be sure, there were also tax economists in the Ministry of Taxation. Yet, this ministry served more practical and administrative functions and played only a secondary role in policy making. Despite the criticism from officials and independent experts, Fogh Rasmussen stayed his course. Under the Liberal-Conservative government, the power over economic policy had shifted from the finance minister to the prime minister (Jensen 2008: 505). With close allies in charge of the ministries of finance and taxation, Fogh Rasmussen effectively decided the government’s policies in the tax area from the prime minister’s office.33 Other actors—civil servants, the political opposition, the social partners, and academics—were put on the sidelines. In 2004 and 2007, the government made modest cuts in the taxes on belowaverage earners through the introduction of an in-work tax credit and a higher threshold for the middle bracket of the income tax.34 The labor movement was “strongly against” the cuts, but “was not heard” by the government.35 Business associations, on the other hand, criticized the government for not going far enough. On both occasions, employers had called for reductions in top marginal tax rates on labor (see Larsen and Andersen 2004: 192). And the Wise Men pointed out that a cut in the top tax rate on personal income would have had a stronger positive effect on labor supply (Danish Economic Councils 2007). But, consistent with the strategy of avoiding criticism on equity grounds, the Liberals targeted the cuts at people on low and medium incomes and left the top rate unchanged—to the “great disappointment” of employers.36 After six years

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of right-wing government the highest statutory tax rate stood unchanged at 63 percent. “Paradoxically this was the decade with the least movement in the highest marginal tax rate,” lamented a business representative. “The Liberals did less in the 2000s than the Social Democrats had done in the 1990s.”37

Market-Oriented Tax Reform at Last

The Liberals’ decision to set down an ad hoc commission on taxation after winning reelection in 2007 came as a surprise to almost everyone involved. Why Fogh Rasmussen finally abandoned the strategy of keeping tax reform off the agenda is a mystery—even his close advisors were puzzled by the decision. For sure, it was not a response to calls from the bureaucracy. The Ministry of Finance did not at any point express interest in tax reform (see the following discussion). Neither was it an answer to demands from business. The main employers’ association had asked for lower top rates but not for a tax commission and was “taken completely by surprise” when it was announced.38 One possible explanation is that the move was a reaction to pressures or invitations from other parties. The Social Democrats had called for a tax commission during the 2007 election campaign (Andersen 2011: 29), and the Conservatives were pressing for tax policy changes within the government. Yet Fogh Rasmussen had never paid much attention to the demands of other parties before. Another explanation—supported by close advisors to Fogh Rasmussen—is that the Liberals’ third consecutive election victory in 2007 changed the political calculations of the prime minister. The premier had decided to leave the Danish political scene to become secretary general of the North Atlantic Treaty Organization (NATO) and knew that he would not have to face voters again. As prime minister, Fogh Rasmussen had so far pursued a softer line in economic policy than his earlier writings would have suggested. The premier might therefore have seen this as the right moment to “realize some of his original political objectives”39—even if the electoral consequences were unsure. The mandate of the tax commission was to design a reform that involved a “marked reduction of taxes on labor income, in order to stimulate work and enterprise” (Skattekommissionen 2009: 7). This focus reflected the political goals of the government but also echoed the concerns about labor supply raised repeatedly by economists on the Economic Council (for example, Danish Economic Council 2006) and on previous expert commissions, as well as by CEPOS (Center for Politiske Studier), a free-market think tank with close links to the

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Liberal Party. Although the tax commission was chaired by a former Social Democratic minister, it was dominated by neoclassical economists and did not have other representatives from the political parties, interest groups, or the bureaucracy. However, the secretariat was composed of officials from the economic ministries. Although there were interactions between the commission and the Ministry of Finance, officials did not engage actively in the work of the group. “There was no strong agenda or attitude to the tax reform in the bureaucracy,” observed one economist on the commission.40 In line with its emphasis on fiscal responsibility, the ministry was most concerned about the revenue implications of a reform. “The most important issue for the Ministry of Finance was that the reform would be fully financed,” commented the commission chairman, “but that was something everyone agreed on.”41 The finance ministry thus played a very limited role in the discussions about tax reform. The commission’s final recommendations were guided by neoclassical economic principles. “Given that the commission was filled with economists who think in the same way, there wasn’t much disagreement about solutions,” remarked the chairman.42 In its report the group proposed across-the-board rate cuts—including a solid reduction of the top statutory rate—combined with a decrease in the value of the interest deduction and other base-broadening measures (Skattekommissionen 2009: 29). The report was well received by the Liberal-Conservative government and employers. The Social Democrats and the trade unions were also sympathetic to the combination of lower rates and broader bases but disliked the redistributive profile of the proposal. After the Social Democrats rejected a compromise, the government reached an agreement on reform with the Danish People’s Party. The final reform lowered the top statutory rate on labor from 63 to 56 percent and introduced a gradual reduction of the value of the interest deduction from 33.5 to 25.5 percent. The reform did not, however, extend to capital taxation, which meant that the high, uneven, and in some cases progressive rates on capital were left unchanged. Though it had a market-oriented profile, the Danish tax reform was thus more limited in scope than the reforms in New Zealand and Norway. Although the cuts in the top rate entailed a moderate increase in posttax income inequality,43 the reform did not constitute a decisive move away from the egalitarian model. Denmark remained one of the most equal economies in the OECD, with a level of inequality similar to its Scandinavian neighbors and far below the level in the Anglo-Saxon countries.

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To summarize, Danish tax policies from 2001 to 2010 were largely determined by the political agenda of the right-wing government. The moratorium on tax increases and the modest tax cuts targeted at low and middle incomes reflected the Liberals’ strategy of avoiding the sensitive issue of inequality. And the moderate market-oriented tax reform adopted in 2009 was primarily a product of the government’s long-deferred agenda of cutting marginal taxes. The reform also drew on the proposals of economic experts on the commission and in the Economic Council, that is, from economists outside the state. Civil servants, on the other hand, played a very limited role in the reform process. How do these findings square with the broader argument of the book? Recall that the book raises two central questions. The first question, which motivates the study, is which factors explain the adoption of market-conforming policies. I put primary emphasis on the role of economists within the state, though without arguing that this is a necessary condition for reform or excluding a causal role for other factors. The Danish tax reform of 2009 was, unlike the reforms in New Zealand and Norway, driven primarily by political factors. It thus lends support to the rival argument that emphasizes political parties as the primary agents of the turn toward the market in public policy. The Danish reform demonstrates that there are other paths to market-oriented policies than the “bureaucratic” path mainly explored in this book. Economic reform followed a “political” path similar to what Peter Hall observed in the UK under Margaret Thatcher, with politicians playing the main role and state actors being put on the sidelines (Hall 1993). The second question, which lies at the center of the theoretical argument, is how the position of economists within the state shapes the relationship between politicians and bureaucrats in policy making. I argue that the presence of neoclassical economists in the bureaucracy increased the influence of civil servants over politicians in tax policy making, through the mechanisms of expertise, ideas, and norms about administrative behavior and, conversely, that the absence of this kind of economists weakened the influence of the bureaucracy in tax policy formulation. The marginal role of neoclassical economists in the Danish Ministry of Finance and the very limited influence of ministry officials over tax policy making conform to these expectations. This does of course not prove that the two things were connected. There were several reasons why the Liberal-Conservative government was able to control policy setting, including the political leadership of Fogh Rasmussen. Yet, the evidence also suggests that

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the marginal role of tax economists in the finance bureaucracy played a role. Unlike their colleagues in Norway and New Zealand, Danish finance bureaucrats lacked the specific analytical expertise and policy ideas to set the agenda in tax policy. An example of this was that Finance officials did not engage actively in the 2009 tax reform process. This passive approach—striking if we consider the activism of finance bureaucrats in the reform processes in Norway and New Zealand—gave other actors great freedom to pursue their policy preferences.

Conclusion Why did Denmark resist market-conforming tax policies for so long? In this chapter, I have argued that the limited extent of market-oriented tax reform primarily was the result of the preferences of political parties but also had to do with the position of economic expertise within the civil service. The course of Danish tax policy in the 1990s and 2000s was defined by partisan agendas, first by the Social Democrats’ emphasis on macroeconomic management and redistribution and later by the Liberals’ strategy to keep the issue of inequality off the table. But when politicians were able to dominate tax policy formulation, I argue, this was due in part to the institutional and ideological fragmentation of economic expertise in the Danish state apparatus. Neoclassical ideas about taxation never took hold at the center of the economic bureaucracy, and this weakened the policy role of officials and impeded the adoption of marketconforming tax policies. How can this argument be reconciled with existing accounts of the role of economic experts in Denmark? In their comparative study of “knowledge regimes,” Campbell and Pedersen paint a rather different picture, highlighting the growing role of economic knowledge in Danish policy making. They point to the increasing necessity of backing up policy arguments with solid research and the growing use of expert commissions to investigate policy issues ( Campbell and Pedersen 2014: 201–203). However, whereas their argument is broadly construed, the argument presented in this chapter refers specifically to the field of taxation. Although there is little doubt that there has been a general movement in the direction indicated by Campbell and Pedersen, the evidence from tax policy adds nuance to this story. First, some of the tax measures adopted in Denmark—most notably the moratorium on tax increases—lacked any scientific basis whatsoever, indicating that policy making was not always constrained by what the empirical evidence showed. Second, the presence of economic ex-

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perts on ad hoc commissions did not always entail effective policy influence. The impact of experts rather appears to have been contingent on the structure of these commissions, especially on the links between commissions and the civil service. Whereas commissions that brought together academics and civil servants stimulated the flow of new economic thinking to the bureaucracy (as in Norway), the impact of Danish expert commissions on taxation was limited by the fact that they were largely cut off from the permanent bureaucracy. This difference also speaks to the broader theme of this chapter: Although economists undoubtedly played a role in Danish discussions about tax policy, it was arguably more as outside experts than as bureaucratic insiders.

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Chapter 7

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T

HIS story of market-oriented reform has not only featured the well-known faces of prime ministers, finance ministers, and party leaders; it has also cast little-known characters from within the government apparatus in leading roles. I have shown how market-conforming policies in the field of taxation to a large extent were driven by a group of professionals operating from within the state, who used their trusted position as providers of policy-relevant knowledge to pursue their own agenda. Based on analytical skills and a strong identification with professional ideas and norms, neoclassical economists in government bureaucracies were instrumental in persuading elected leaders to embrace a set of efficiency-oriented tax policies. To be sure, this was not the only driver of the turn toward the market: Political agendas, business interests, and structural economic factors also had an impact. Yet, state economists played a primary role as architects and advocates of this policy shift. The core argument of this book has been that the varying extent of market-­ conforming reform reflected differences in the institutionalization of economic knowledge within the state. Although the advent of Keynesian economic management brought economists into public bureaucracies, the position and authority granted to economic experts varied greatly across countries. These differences conditioned the impact of the later shift toward neoclassical economics, as the bureaucracies with the closest links to the international economics discipline were most susceptible to the new economic ideas, including new theories about taxation. I have argued that the penetration of tax economics in the bureaucracy not only shaped what policy solutions were on the table but also strengthened the ability and willingness of bureaucrats to exercise influence over elected leaders in policy formulation. This contributed to substantial variation in the extent to which countries embraced market-conforming policies. In this concluding chapter, I revisit the theoretical argument in light 161

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of the empirical findings, starting with the conceptualization of economic policy change.

Degrees of Market Orientation or National Adaptations to Market Ideology? This book has examined the varying extent of market-oriented reform across countries. But can the cases rather be understood as different national adaptations to market ideology? From this perspective, the turn toward the market is not so much a matter of more or less as a question of specific national “translations” or “edits” of the overarching ideology, in which ideas are adapted to different domestic political, institutional, and ideational settings (Kjær and Pedersen 2001; Ban and Blyth 2013). For instance, Cornel Ban and Mark Blyth argue that liberalization in the BRIC countries has been characterized by a “proliferation of institutional and ideational hybrids that bore the imprint of distinctive ‘edits’ of the original Washington Consensus to make them compatible with the domestic context” (Ban and Blyth 2013: 245). Rather than just reproducing the Washington Consensus, this process has given rise to different “hybrid” forms of economic management that blend this ideology with domestic ideas and institutional features. Seen through this lens, the cases examined in the present study could be interpreted as different national adaptations to the overarching market ideology, with Ireland as a case where “more market” ideas were translated into a focus on competitiveness in global markets and the Scandinavian countries as cases where a greater orientation toward the market was combined with a social-­ democratic commitment to redistribution. There is certainly some support for this interpretation. National institutional contexts and political concerns clearly shaped the specific character of tax reform in the four countries. And even if New Zealand and Norway embraced similar market-conforming policies, the reforms can be seen to have been part of different political-economic projects—in the former case a sweeping liberalization of the economy, in the latter case a “modernization” of the social-democratic model. Yet, analytically, speaking of “hybrids” or “translations” of market ideology obscures more than it illuminates in this set of cases. Even if we acknowledge that no country has gone free of the trend toward a greater reliance on markets, it does not mean that every policy should be understood as a different form of embracing the market. By doing so, we run the risk of lumping together phe-

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nomena that are fundamentally different and seeing market orientation where there is none. For instance, the very limited impact of efficiency-oriented thinking on the economic policies of Denmark and Ireland should warn us against concluding that these countries just pursued another form of market-oriented policies. Differences in economic reform were not so much the product of different national adaptations of the Washington Consensus as the result of the varying influence of this agenda in different political-administrative systems. And, as I have argued, this variation in influence was closely related to the varying entrenchment of economic experts in state institutions.

The Agents of Market-Oriented Reform The question of who drove market-oriented reform has been one of the central issues in this inquiry. Given that taxation often figures among the most salient issues in election campaigns and in political discussions more generally, one could expect politicians to play a preeminent role in the setting of tax policy. There is no doubt that politicians mattered for the introduction of market-­ conforming policies. The radical reforms in New Zealand would not have happened without the political entrepreneurship of Finance Minister Douglas; the policy changes introduced in Denmark in 2010 were driven primarily by the country’s Liberal-Conservative government; and, more generally, the attitudes of parties in power influenced the prospects for market-oriented reform. Yet, a strong partisan account finds little support in the cases examined here. There was, first of all, no systematic relationship between party color and market-conforming policies. Efficiency-oriented reforms were enacted by social-­democratic and conservative governments alike, and the same was true for policy changes that ran in the opposite direction. Contrary to the usual partisan account (see Boix 1998), the issue of market-oriented tax reform cut across the left–right cleavage. The left was split between those who saw lowrate, broad-base tax reform as necessary to fix economic imbalances and improve the fairness of the system and those who held on to high statutory tax rates as a shining symbol of social solidarity. The right was equally torn between the tempting promise of lower rates and the not-so-tempting prospect of losing generous tax breaks. One could of course object that this dynamic was specific to the tax domain. Yet, in many areas the appeal of efficiency-oriented reforms has failed to follow traditional party lines. For instance, parties of the left have introduced private sector principles in public management and restructured

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welfare benefits based on concerns about ensuring the continued legitimacy and sustainability of public services (for example, Klitgaard 2007). Second, and more crucial to my argument, the ideas and initiative for market-­oriented reform in most cases did not come from political parties but from economic experts in the bureaucracy. As documented in the previous chapters, elected leaders rarely produced the initial impulse for the introduction of market principles. (The Danish reform in 2009 constituted an important exception.) Instead, the substantive agenda for reform was set by strategically placed officials in government ministries based on professionally defined conceptions of what constituted “good tax policy.” This was the case in both New Zealand and Norway, where neoclassical economists inside the state were the principal architects of reform. In these cases, the evidence suggests that without the intellectual impulses from the bureaucracy, market-conforming policies would not have been adopted in the form that they were: Policy change would likely have taken a different course or would not have transpired at all. At the same time, a bureaucracy infused with neoclassical thinking was not a necessary condition for market-oriented policy change. This is clearly demonstrated by the Danish tax reform in 2009, which was initiated and conceived mainly by politicians without significant involvement from economic bureaucrats. The Danish reform illustrates that there were several paths to reform, not only the predominantly bureaucratic path followed in New Zealand and Norway but also a more political course that effectively circumvented the permanent administration (see Hall 1993). Beyond politicians and bureaucrats, what role did actors outside politicaladministrative institutions play? Contrary to the expectations from the varieties of capitalism (VoC) literature, the influence of business interests on marketoriented reform was for the most part modest. Their influence was strongest in Irish corporate taxation, where a coalition of state agencies and international companies successfully advocated a low single corporate rate. In New Zealand, business organizations played a supportive but secondary role to bureaucrats in the formulation of tax policy. And in Denmark and Norway, business associations had little direct influence on the introduction of market-conforming tax policies (in fact, Norwegian employers vehemently opposed key elements of reform). The preferences of firms did not vary systematically with the production regime either, as we would expect from the VoC literature. In the liberal market economies, business organizations in New Zealand supported a broad-

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based tax system without special incentives, whereas Irish businesses lobbied tirelessly for specific tax breaks. In the coordinated Scandinavian economies, employers were keen on tax reductions but (at least in Norway) opposed to the broadening of tax bases. Finally, some accounts of the turn toward the market highlight the role of experts outside the state. Campbell and Pedersen (2014) point to experts in policy research organizations as important producers and disseminators of knowledge and policy recommendations that influence policy making. To be sure, nonstate economists did play a role in the policy processes examined here. In Denmark, the “Wise Men” of the independent Economic Council played a significant role in public debate about tax policy and had some influence on the reform in 2010. In Norway, university economists provided academic inspiration and specific design solutions through their participation on ad hoc commissions. Yet, the role of external experts in this set of cases was modest compared to the influence of experts inside the state. Both in New Zealand and Norway, the impulse and the broad solutions for market-conforming policies came predominantly from economists in the bureaucracy, who carefully controlled the input of outsiders in policy making. Although state economists did not have a monopoly on expertise, their insider status put them in a favorable position to define which ideas and recommendations reached political leaders. This leads us directly to the next issue.

Politicians, Bureaucrats, and the Making of Economic Policy The central role of state experts as agents of market-oriented reform raises interesting questions about policy making: Why were bureaucrats able to influence politicians in some cases, but not in others? What kind of policy-making dynamics underpinned the decisions about economic reform? The relationship between politicians and bureaucrats in policy making has often been depicted as a clear-cut division of labor, where politicians formulate policy objectives and administrators select the policy instruments to achieve these goals (see Aber­bach, Putnam, and Rockman 1981 for a discussion). In a recent iteration of this model, Johannes Lindvall argues that the influence of expert ideas is “real but limited” because “expert ideas influence the methods governments use but not the goals they pursue” (Lindvall 2009: 707). One obvious problem with this model is the difficulty in distinguishing goals from means: For instance, is economic efficiency a goal or just an instrument to achieve

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higher goals? The neat distinction between politicians setting goals and experts finding means has also been dismissed in the public administration literature, which points to the variation in the policy role of bureaucratic experts (Campbell 1988; Carpenter 2001; Lee and Raadschelders 2008). The present study also reveals dramatic differences in the policy role of bureaucrats, ranging from economic experts in the New Zealand Treasury who influenced both the goals and means of economic policy to generalists in the Irish Department of Finance who influenced neither. One could of course attribute the differences in the leverage of bureaucratic experts to features of the political leadership. On one level, it is obvious that due to personality, ambition, or training, some ministers grant bureaucrats more influence than others. Yet, arguments about “political personality” are extremely difficult to specify and often border on the tautological (that is, politicians influence policy because they have a strong personality and are seen as strong personalities because they influence policy). Moreover, this book features plenty of strong political characters, some of whom dominated policy formulation and others who deferred to the bureaucracy on important issues. For instance, the case of Roger Douglas and the New Zealand Treasury suggests that the willingness to grant influence to administrative experts is based as much on an evaluation of the bureaucracy’s ability to present intellectually convincing and politically relevant advice as on personality. Another argument is that the policy role of bureaucratic experts depends on the economic context. In hard times, policy power shifts toward experts who can provide solutions to the economic woes; in good times, power shifts toward politicians who have more room for maneuver in economic policy. Indeed, many of the market-oriented reforms examined here were passed during or right after a period of economic crisis. Conversely, Irish politicians paid very little attention to bureaucrats during the “Celtic Tiger” boom. Yet, although the economic situation clearly did affect the policy-making relationship, the case studies show that economic crisis did not necessarily imply a greater policy role for bureaucrats. Both Denmark and Ireland experienced profound economic imbalances in the 1980s but did not rely heavily on experts in the ministries to solve these problems. The impact of economic crisis on policy making thus appears to depend on existing patterns of political-administrative interaction, reinforcing the role of bureaucrats where they are already potent rather than turning downtrodden servants into masters.

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In contrast to these accounts, I follow Daniel Carpenter in arguing that the policy influence of bureaucratic experts is based primarily on features of the relevant administrative organization (Carpenter 2001). Bureaucratic autonomy, as he conceptualizes it, lies in the ability of officials to change the agendas and preferences of politicians through a process of persuasion. Carpenter argues that this ability is based on organizational reputations for expertise and efficacy—­reputations that are grounded in actual organizational capacities and embedded in multiple networks and that provide bureaucratic agencies with political legitimacy. Although I subscribe to this notion of bureaucratic autonomy and its roots in the legitimacy of bureaucratic experts, my argument differs subtly but significantly from Carpenter’s. First of all, I locate the main source of legitimacy in the professional expertise of bureaucrats. This type of legitimacy is specifically rooted in the authority of professions external to the bureaucracy, both at the national and international level (Fourcade 2006). This implies that bureaucratic autonomy is not so much premised on having a good reputation with a wide variety of stakeholders as on possessing expertise that is validated by academic disciplines and recognized by political elites. The reputation that matters the most is the one bureaucratic experts establish vis-à-vis their political masters. (To be sure, different conceptions of whether broad support networks or specific political sponsors are most important to some extent reflect different political systems, as discussed later.) Furthermore, I have argued that bureaucratic autonomy is a question not only of legitimacy but also of the motivation and willingness of officials to actively pursue independent policy agendas. The professional identification of officials can provide them with the motivation and normative cover for seizing a more prominent role in the policy process. The comparative evidence suggests that the professional expertise of the bureaucracy was an important determinant of the leverage of civil servants in policy making in our cases. In Norway and New Zealand, the systematic buildup of economic expertise in the bureaucracy in the postwar period laid the foundations for a central role in the formulation of economic policy. From 1980 onwards, officials successfully used their analytical capacities and reputation for “competence” to convince politicians to pursue a more market-oriented course, barraging ministers with detailed economic analyses that spelled out the benefits of efficiency-enhancing tax reform. By contrast, the general lack of economic competences in the Irish finance ministry and the paucity of specific

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microeconomic expertise in the Danish ministry appears to have weakened the policy role of bureaucrats and contributed to the dominance of politicians in policy setting. There were, however, some notable exceptions to this pattern: The influence of the Irish industrial development agencies over corporate tax policy appears to have been based on their close links to multinational companies rather than on professional expertise, a finding that conforms closely to Carpenter’s argument about the importance of networks. And state economists in Norway were unable to convince politicians to reform the taxation of housing despite their analytical skills, indicating the limits of expertise as a source of policy power. But, overall, the evidence on the microlevel interactions between politicians and civil servants suggests that the professional knowledge of bureaucrats significantly increased their chances of being heard. Beyond expertise, the ideology of economists constituted a source of bureaucratic autonomy. Neoclassical economic theory equipped officials with a set of principles and ideals that often stood in stark contrast to the reality of economic policy (“neutrality” versus “discrimination,” “efficiency” versus “distortions,” and so on), and this discrepancy constituted a powerful motivation for active policy advocacy, as we saw in the cases of New Zealand and Norway. Where this ideology was absent, on the other hand, officials often took a more passive approach in policy making. The leverage of economists was also strengthened by professionally rooted norms about how to act in the policy process. Both in New Zealand and in Norway, the rise of neoclassical economists was accompanied by an explicit shift in the norms about administrative behavior—away from classic Weberian ideals about clear boundaries between political and administrative roles and toward a commitment to teaching politicians “what was right” according to professional principles. Underpinning this doctrine was a new self-understanding, according to which economic experts saw themselves less as the minister’s obedient servants and more as representatives of an independent intellectual community (cf. Markoff and Montecinos 1993). As a result, officials in these countries were in some cases willing to overstep traditional boundaries between the political and the administrative “in the interest of gaining a particular desired state of affairs.” Again, this stood in stark contrast to the lack of critical policy advice in the generalist Irish bureaucracy. To be sure, these findings only provide tentative insights about the relationship between economic expertise, ideas, and norms and the policy role of bureaucrats. Yet, they raise interesting questions for further research: Do

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economists systematically approach policy making differently than, say, lawyers, political scientists or sociologists, and do neoclassical economists differ in this regard from their Keynesian predecessors? How are professional identities attenuated or accentuated by the organizational context? And if neoclassical economists indeed expose particular attitudes to the policy process, how will their growing numbers in government ministries affect public policy making in general? Importantly, answers to these questions need to be anchored in an understanding of the historical role of the economics discipline in the state.

The Rise of Economists within the State Economics as a “technique of government” emerged in the wake of the Great Depression and World War II, as a result of the clash between new political ambitions for active economic management and an administrative system that was unprepared to take on the new tasks (cf. Fourcade 2006). Yet, although this conflict was manifest across the cases examined here, the role accorded to economic experts within the new enterprise of economic management varied greatly. I have argued that the uneven rise of economists reflected national differences in the three basic elements of this historic conflict, namely political, intellectual, and administrative factors. The ascent of economists within the Norwegian state was triggered by the combination of Labour hegemony and a sophisticated domestic economics profession and consolidated through the administrative concentration of economic expertise. The absence or weaker nature of these factors in Denmark helps explain the more fragmented role of economists within the Danish state. In Ireland, administrative structures were of primary importance, as a generalist civil service system effectively blocked the buildup of economic knowledge within the state—much as in the UK (Fourcade 2009: ch. 3). By contrast, more open administrative structures facilitated the influx of economic experts in New Zealand, which (unlike in Norway) was driven from inside the bureaucracy. These findings are broadly in line with Fourcade’s thesis about the importance of the “the organization and exercise of ‘government’” in shaping the role and practice of economists (Fourcade 2009: 247). The cases are good examples of how administrative institutions confer authority on certain professional projects while depriving others of recognition. Yet while Fourcade’s notion of relatively stable “administrative orders” that structure the enterprises of professions certainly is compelling, there is reason to be skeptical about the

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premise that complex administrative systems can be usefully subsumed under this kind of master headings. Public administrations are multidimensional and multilayered systems, which are made up of entities of different character and composed of sediments from different historical periods. Although some administrative orders are easy to pin down—such as Ireland’s British-style generalist state—others elude easy classification. This is not only a quibble about the possibility of abstracting from complex historical cases. The more important point is that the institutional position of professions is shaped not only by the overarching features of administrative systems but also by the characteristics of specific administrative organizations and the relationships between them, such as the integration versus splitting of a ministry or the central versus marginal position of a ministerial division. In other words, the position of economic knowledge cannot be “read off” the administrative order; it is rather the result of a contingent historical process involving a complex set of political, intellectual, and administrative factors. This conclusion also points toward interesting research opportunities at the intersection of administrative history, organization theory, and professional sociology.

The Diffusion of Neoclassical Economics One of the central claims of the book is that the formation of economic knowledge within the administrative system during the Keynesian era conditioned the later diffusion of neoclassical economic thinking. Arguments about diffusion start from the premise that policy processes at the national level are interdependent, in the sense that the ideas and policies adopted in one country are conditioned by the ideas and policies embraced in other countries. Although the possible connections are manifold, this book has focused on the question of why neoclassical economic ideas spread from the United States to some countries but not to others. The notion that policy ideas spread most easily to countries that are close in geographical or sociocultural terms—because these countries are more likely to interact, learn from, and imitate each other (see, for example, Simmons, Dobbin, and Garrett 2006: 798)—has found little support in this study. Neoclassical ideas were not adopted to a greater extent in the Anglo-Saxon countries than in the Scandinavian states. I have instead argued that more than the links between countries at the macrolevel, it was the ties between professionals at the microlevel that directed the diffusion of policy ideas in this set of cases.

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The empirical chapters have shown how the spread of neoclassical economic theory depended crucially on the entrenchment of the economics profession within the state. Neoclassical ideas broke through in the bureaucracies where economists had achieved a dominant position during the Keynesian era, whereas they failed to gain a foothold in the administrations where the role of economic expertise was weak or fragmented. This somewhat paradoxical pattern can be understood in light of the theoretical argument about how the links between professions and organizations condition the diffusion of new ideas. The spread of new economic ideas depended on the strength of the ties between the bureaucratic departments and the academic discipline and in particular on the links to the international economics discipline. Most important were recruitment ties: Ministries that pursued the “best and brightest” economics graduates and emphasized academic credentials when filling top-level posts were subject to an inflow of economists whose training reflected newer theoretical developments, including recent PhDs from top American economics departments. Both in Norway and New Zealand, these U.S.-trained experts were the main engineers of the shift from Keynesian to more market-based economic thinking in the bureaucracy. Similar processes did not take place in Denmark, where hiring to the finance ministry was more diverse, or under the Irish system of competition-based recruitment. Yet, why did the recruitment of economists with a wholly different view of the economy not generate more resistance or intraprofessional struggles in the bureaucracy? One significant reason was professional continuity: Neoclassical economists had not usurped their way into the ministries; they had been selected based on their professional credentials. Although the existing staff may have had reservations about the ideas of the newcomers, they had no doubts about their analytical competences. But generational dynamics were also crucial. As has been found in previous studies, the ideational shift toward neoclassical economics coincided with a generational shift among staff (Chwieroth 2009). The retirement of officials hired in the decades after the war opened the door to new cohorts of officials with different views about the economy. This was especially the case in Norway, where a generation of economists who were trained around World War II and believed strongly in regulation gave way to a younger generation of economists with a greater belief in the market. But in New Zealand as well, the younger cohorts of economists who entered the finance bureaucracy

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in the late 1970s and 1980s proved far more susceptible to neoclassical economic thinking. The diffusion of neoclassical thinking was also reinforced by other types of links between bureaucrats and outside academics and other experts. This included the interaction with the international economics discipline through officials sent abroad for further training, as in New Zealand. It also involved contact with international organizations such as the OECD and the IMF, which transmitted more applied policy advice. In Norway, finance officials also interacted regularly with domestic academics from more neoclassical economics departments. In particular, the interaction between academics and civil servants on various ad hoc commissions stimulated the flow of new economic knowledge to the bureaucracy. Expert commissions were used to investigate tax policy changes in all our four countries. Yet, the joint participation of academics and bureaucrats on commissions appears to have been the crucial element in facilitating the diffusion of new economic ideas. Whereas this comingling characterized tax commissions in Norway and the New Zealand Tax Working Group, Danish commissions and the Irish Commission on Taxation of the 1980s included plenty of experts but had more tenuous links to the regular administration. The dynamics of diffusion observed here challenge the conventional conception of the passage from Keynesian to neoclassical economics as a predominantly conflictual process. Although the rupture in terms of models and policy prescriptions was obvious, there was continuity in the emphasis on academic training and technical skills. Even if they disagreed on much, Keynesians and neoclassical economists were absolutely committed to the idea of “economic expertise.” And the institutionalized commitment to economic knowledge in recruitment and policy investigation practices turned out to be a key driver behind the adoption of the new economic paradigm. The findings also speak to the relationship between domestic intellectual traditions and U.S.-style economics. Fourcade has argued that stronger domestic intellectual traditions made developed countries less susceptible to the influx of U.S.-trained economists (Fourcade 2006: 174). Yet, in Norway, a strong national strand of economics appeared to represent a stepping-stone rather than a stumbling block for the later adoption of American neoclassical economics. The traditional prominence of the Oslo School conferred professional and institutional authority on the new generation of more market-oriented economists. Conversely, the lack

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of a significant homegrown economics tradition did not facilitate the spread of neoclassical economics to Denmark or Ireland, although one could argue that there were elements of this in New Zealand. The organizationally contingent diffusion of ideas found in this study resonates with the state-centered argument that the impact of new economic perspectives is contingent on the openness of state structures to experts and their ideas (Weir and Skocpol 1985; see also Hall 1989b). Weir and Skocpol’s contention that the adoption of economic innovations depends on “the normal mechanisms used by states to incorporate educated expertise” in policy- making (126) is confirmed by the crucial role of administrative recruitment and investigative commissions for the spread of ideas in our cases. However, this perspective has less to say about the professional dynamics at play. The relations between “old” and “new” economics, between the domestic and the international discipline, and between bureaucratic and academic economists all conditioned the process of diffusion (see Fourcade 2006). In other words, what mattered for the adoption of novel economic ideas was not only the openness of state structures in general but also the specific configuration of economic expertise inside the state and in society more broadly. This points us toward another model, proposed by Campbell and Pedersen (2011, 2014), which highlights the importance of “knowledge regimes” for the diffusion of economic ideologies. The spread of neoliberalism, they argue, was mediated by the “structure and practices of knowledge regimes,” that is, the national “field” of policy research organizations and institutions that produce and disseminate policy ideas (Campbell and Pedersen 2014: 6). Their notion that the varying organization of policy-relevant expertise in different countries matters for the diffusion of ideas is valuable and in line with the findings of this book. For instance, the greater concentration of economic expertise in the Norwegian knowledge regime than in the Danish one had major implications for the adoption of new economic thinking, and institutions like ad hoc commissions played a significant role in the policy process. However, the broad range of policy research organizations emphasized by Campbell and Pedersen—think tanks, political party foundations, parliamentary expert offices, and the like— had limited importance in our set of cases. Instead, administrative institutions turned out to be crucial for the shift to more market-oriented policies. In other words, some parts of the knowledge regime were far more important than others for the adoption on new policy ideas.

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Economists and Market-Oriented Reform beyond Small States Given that this book is based on a study of tax policy making in four small, culturally homogenous, advanced economies, the question of generalizability is a significant one. To what extent does the argument about economists and the adoption of market-conforming policies transcend this particular empirical setting? First of all, some would say that a technical area like taxation represents a particularly favorable setting for the influence of economists. I would object that as a policy field taxation is not only technical but also highly politicized. Taxation directly concerns the distribution of benefits and burdens in society and is often the subject of heated political debate. (As an example, one of the sticking points in the acrimonious negotiations over a third Greek loan program in 2015 was the seemingly mundane issue of reduced VAT rates on the Greek islands.) More obscure economic issues such as capital account liberalization or inflation targeting in monetary policy thus arguably represent easier cases for the argument about expert power than taxation. On the other hand, tax policy is a field where there appears to have been unusually strong agreement among neoclassical economists. As shown in the empirical chapters, there was broad consensus among neoclassical experts about the principles of low rates, broad bases, and neutral taxation (at least until the 2000s), even if there were disagreements on more specific issues of policy design. This study may therefore understate the extent of intraprofessional struggles in other areas of economic policy making, such as between “freshwater” and “saltwater” economists in macroeconomics. A bigger question concerns the relevance of the findings from this set of small states for bigger, more heterogeneous countries. Large and diverse states provide a setting for policy making that differs from that of small states in important respects. For one, they often have multiple economic advice institutions with independent bases of power. For instance, the United States has several such institutions, including the Treasury, the Congressional Budget Office, the Office of Management and Budget, and the Council of Economic Advisers. This makes the question of bureaucratic power in policy making more complicated because it is not only a question of influence vis-à-vis politicians but also a question of power with respect to other agencies. Among other things, politicians have greater opportunity to shop around for solutions in different agencies. This limits the kind of power derived from near-monopolies in the provision of expert knowledge that we found in Norway or New Zealand. How-

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ever, professional monopolies may persist even in the absence of institutional monopolies on expertise if all relevant agencies recruit staff with the same educational background. A second point is that larger and more heterogeneous polities often have more complex legislative institutions. Whereas the small countries examined here all had a strong capacity to produce political decisions, the political systems of larger democracies are often characterized by more complex interinstitutional politics and greater institutional gridlock. (To be sure, this is not always the case: France has a political system with strong centralized power, whereas Switzerland has a highly complex decision-making system.) A more complex political-institutional setting implies that the leverage of bureaucratic experts depends not only on the endorsement of a few strategically placed politicians but also on building broader institutional coalitions for reform (see Carpenter 2001). It also implies that there may be greater institutional hurdles to the policy influence of economic experts. In Italy, for instance, highly educated economists have enjoyed a prominent position in bodies such as the Bank of Italy and the ministries of finance and economy (Quaglia 2005). Although these experts have had influence at certain points in time, their ability to shape Italian policies has clearly been restricted by a political system plagued by inertia. These are reasons why the linkage between the role of economists within the state and the move to market-oriented policies are bound to be more complicated in larger polities. Finally, to what extent does the argument pertain to developing countries? The literature on the globalization of economic knowledge points out that developing countries differ from more advanced economies in their greater need to gain legitimacy within the international community. Because of the need to demonstrate to international financial institutions, multinational companies, and foreign countries that they are economically responsible, developed countries are more likely to promote U.S.-educated economists to higher bureaucratic and political offices (Markoff and Montecinos 1993; Babb 2004). The same argument has been made for the postcommunist countries (Markoff and Montecinos 1993; but see Bockman and Eyal 2002 for an alternative view). The complete absence of foreign-trained economists in top political positions in our small developed countries supports the idea that there are systematic differences in this kind of ceremonial use of economic expertise. The presence of professional economists in both political and bureaucratic positions in ­developing

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countries suggests a magnified role for economists in market-oriented reform. In this setting, the relation between politicians and top bureaucrats may turn into a close alliance built on shared professional perspectives, which may serve as a powerful engine for the adoption of market-conforming policies (see, for example, Babb 2004). Beyond these distinctions, it is worth emphasizing that the findings from our small, developed countries fit well with existing research about the ascent and influence of economists in other settings. Indeed, the capacity of neoclassical economists to prosper in settings as diverse as Pinochet Chile (Montecinos 1998), the Mexican one-party state (Centeno 1997; Babb 2004), social-­democratic Norway and Anglo-Saxon New Zealand is striking and worthy of close scholarly attention. What this book adds to the general story is an argument about why neoclassical economics emerged in some places and not in others and a consideration of the particular resources that allowed economists to exert influence in policy making. Although this study constitutes a first exploration of these relationships, more systematic comparative historical analyses and studies of policy processes are needed to understand what has become a highly influential professional group in contemporary society.

Whither the Power of Economists? Since the onslaught of the global financial and economic crisis, the power of economists has become the subject of public debate like never before. Mainstream economics has been blamed for contributing to the financial meltdown, for not having predicted the economic crisis, and for prolonging the crisis through the insistence on austerity policies (Blyth 2013). At the same time, neoliberalism has proven remarkably resilient in the face of mounting criticism (Schmidt and Thatcher 2013). What can our findings tell us about the future of market-conforming policies and the prospects for change? First and foremost, this study points to the institutionalization of neoclassical economic ideas as a major source of resilience. Although the “force of institutions” is often mentioned as an explanation for the persistence of neoliberalism (Schmidt and Thatcher 2013; Hall and Lamont 2013: 21), this study illustrates a specific way in which institutions sustain market-oriented thinking and disadvantage alternatives. The cases have shown how the impact of economic policy ideas depends to an important extent on their embeddedness within key bureaucratic institutions. And ideas, once embedded within organizational structures, are difficult

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to dislodge. This is especially true within stable, hierarchical organizations like ministerial bureaucracies. At the same time, the historical narratives of this book provide several examples of ideational ruptures that offer lessons about the prospects for change. One source of ideational change is structural organizational reform. In the past, the creation of new departments or divisions, the splitting of existing departments, or the transfer of tasks has altered the impact of professional ideas, by giving prominence to some types of knowledge and marginalizing others. This may still be a viable strategy in some cases. Yet, there are also barriers to this kind of action, including resistance from the bureaucracy itself and legitimate concerns about the independence of the civil service. And, as we have seen, structural changes do not always succeed in breaking professional monopolies if the underlying ideology remains the same. A subtler, but potentially consequential, source of ideational change is altered recruitment patterns. The hiring of staff with different professional backgrounds or with a different type of economics training can profoundly influence the way of thinking within an organization. For instance, Cornel Ban has shown how staff changes within the IMF altered the organization’s attitude to the use of fiscal stimulus packages (Ban 2015). Of course, the most definitive move away from the current emphasis on economic efficiency in public policies would go through ideational changes within the economics discipline itself. In the field of tax economics, academics such as Emmanuel Saez and Thomas Piketty have started to question some of the conventional assumptions about what tax policy should look like. And they have done so using highly sophisticated methods and drawing on the original interest of the optimal tax literature in equality—not only efficiency. Whether their ideas will take root within the mainstream remains to be seen. But they have at least raised questions that economists have not asked in a long time: Is it possible that the optimal tax rate on labor is much higher than we thought? Maybe progressive taxes on capital and wealth are a good idea after all?

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Reference Matter

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Appendix

List of Interviews

A

LL interviews were conducted by the author between 2009 and 2011. The interviews were semistructured and lasted on average a little more than an hour. Quotes from the interviews are presented in anonymous and nonattributable form, except when interviewees gave explicit consent to be quoted by name. Table A.1. List of interviews. New Zealand Roger Douglas, Minister of Finance, Labour Party, 1984–1988 Wellington Peter Dunne, Minister of Revenue, United Future Party, 2005–2013 Wellington Former economic advisor, Labour Party Wellington Graham Scott, head of the Treasury’s Economics II Division 1979–1981, Assistant Secretary 1981–1985, and Secretary to the Treasury 1986–1993 Wellington Ian Dickson, head of the Treasury’s section for indirect taxation, 1984–1986 Wellington Greg Dwyer, director of the Treasury’s tax policy division, 1985–1987 Wellington Norman Gemmell, Chief Economist and Principal Adviser (Tax) in the Treasury, 2007–2011 Wellington Steve Mack, tax policy official, Treasury Wellington Former senior official, Treasury Wellington Former official, Treasury Wellington Official, Treasury Wellington Robin Oliver, head of Inland Revenue Department (IRD) tax policy division Wellington Senior official, IRD Wellington Peter Conway, Secretary of New Zealand Council of Trade Unions Wellington Business representative Wellington Business representative Wellington John Shewan, partner PricewaterhouseCoopers (PwC) and member of Tax Working Group Wellington

February 15, 2011 March 3, 2011 February 23, 2011 February 8, 2011 February 9, 2011 March 1, 2011 February 15 and March 2, 2011 February 18, 2011 February 14, 2011 February 1, 2011 March 1, 2011 February 16, 2011 February 17, 2011 February 21, 2011 February 28, 2011 February 28, 2011 March 2, 2011

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Appendix

Table A.1. List of interviews (continued). New Zealand, continued Geof Nightingale, partner PwC and member of Tax Working Group Tax lawyer, member of Tax Working Group Accountant, member of Tax Review 2001 Ireland Alan Dukes, Minister for Finance, Fine Gael, 1982–1986 Former Minister for Finance, Labour Former senior official, Department of Finance Former senior official, Department of Finance Former senior official, Department of Finance and Revenue Commissioners Senior official, Department of Finance Senior official, Department of Finance Official, Department of Finance Official, Department of Finance Former senior official, Revenue Commissioners Senior official, Revenue Commissioners Former senior official, Department of Enterprise Member of Commission on Taxation 1980s Trade union representative Business representative Interest group representative Accountant, Irish Tax Institute Accountant, private sector Economist, Trinity College Dublin Economist, Trinity College Dublin Economist, University College Dublin (UCD) Economist, University College Dublin (UCD) Economist, Economic and Social Research Institute (ESRI) Political scientist, University College Dublin (UCD) Sociologist, University of Maynooth Norway Arne Skauge, Minister of Finance, Conservative Party, 1989–1990, and head of the Commission on Taxation, 2002–2003 Former Minister of Finance, Labour Party Former Minister of Finance, Conservative Party Trond Reinertsen, deputy director of the Ministry of Finance’s Economic Division, 1979–1980, and Undersecretary in the Ministry of Finance, Conservative Party, 1989–1990 Former Undersecretary in the Ministry of Finance, Labour Party

Wellington Wellington Telephone

February 24, 2011 February 22, 2011 March 23, 2011

Dublin May 4, 2010 Dublin May 4, 2010 Dublin April 23 and May 11, 2010 Dublin May 4, 2010 Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Dublin Telephone

April 30, 2010 April 21, 2010 April 27, 2010 April 27, 2010 April 27, 2010 April 28, 2010 April 29, 2010 April 26, 2010 April 19, 2010 April 26, 2010 May 5, 2010 May 12, 2010 April 28, 2010 May 11, 2010 April 19, 2010 April 15, 2010 April 16, 2010 April 20, 2010 May 12, 2010 May 7, 2010 May 27, 2010

Oslo Oslo Oslo

September 28, 2011 February 12, 2009 September 15, 2011

Telephone

February 2, 2009

Oslo

February 13, 2009

List of Interviews

183

Table A.1. List of interviews (continued). Norway, continued Former member of parliament, Labour Party Member of parliament, Conservative Party Former policy maker, Conservative Party Former senior official, Ministry of Finance

Oslo Oslo Oslo Oslo

February 7, 2009 September 14, 2011 September 6, 2011 January 13, 2011

Senior official, Ministry of Finance Senior official, Ministry of Finance Senior official, Ministry of Finance Former official, Ministry of Finance Official, Ministry of Finance Trade union representative, LO Business representative, NHO Member of Aarbakke commission

Oslo Oslo Oslo Telephone Oslo Oslo Oslo Oslo

January 4, 2011 February 2, 2009 September 8, 2011 January 21, 2011 September 8, 2011 September 6, 2011 September 2, 2011 September 14, 2011

Denmark Mogens Lykketoft, Minister of Finance, Social Democrats, 1993–2000 Ole Stavad, Minister of Taxation, Social Democrats, 1993–1994 and 1998–2000 Carsten Koch, Minister of Taxation, Social Democrats, 1994–1998, and leader of the Tax Commission, 2008–2009 Thor Pedersen, Minister of Finance, Liberal Party, 2001–2007 Member of parliament, Social Liberal Party Former political advisor, Liberal Party Political advisor, Liberal Party Former senior official, Ministry of Finance Former senior official, Ministry of Finance Former official, Ministry of Finance Official, Ministry of Finance Senior official, Ministry of Taxation Economist, Economic Council of the Labour Movement Business representative Economist, University of Copenhagen Economist, University of Copenhagen Political scientist, Copenhagen Business School

Copenhagen September 24, 2010 Telephone

September 15, 2010

Copenhagen Copenhagen Copenhagen Copenhagen Copenhagen Copenhagen Telephone Copenhagen Copenhagen Copenhagen Copenhagen Copenhagen Copenhagen Copenhagen Copenhagen

September 2, 2010 September 15, 2010 September 10, 2010 September 20, 2010 September 24, 2010 September 14, 2010 September 16, 2010 September 6, 2010 September 7, 2010 September 13, 2010 September 28, 2010 September 22, 2010 September 8, 2010 September 9, 2010 September 17, 2010

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Notes

Chapter 1 1. To avoid excessive repetition, the terms market-conforming and market-oriented are used interchangeably in the text. 2. Thomas Kuhn’s original notion of a “paradigm shift” was reserved for the natural sciences, which are typically governed by a single paradigm. But the term is often applied also to the social sciences, even if these disciplines are characterized by a greater diversity of approaches. When used about the social sciences, the term usually refers more loosely to major changes in the basic assumptions, ways of thinking, and methodology that are accepted by members of a scientific community. 3. I here understand “imposing a preference” as meaningfully changing the core policy goals or solutions that another actor wishes to pursue. Merely filling in the details of a politician’s incomplete policy view does not qualify as imposing a preference. To be identified as real bureaucratic influence, the views of politicians need to change significantly and meaningfully with respect to their initial preferences as a result of the advocacy of officials. Chapter 2 1. In Norway’s case, the standard measure of the tax share of GDP includes the large offshore petroleum sector. As such, it does not necessarily reflect the real level of taxation on economic activity on the mainland. However, removing the petroleum sector from the estimates does not change the picture dramatically: The oil-adjusted tax share of GDP is generally only one or two percentage points higher than the standard measure (Finansdepartementet 2001: 110–115). Chapter 3 1. Interview with Graham Scott, head of the Treasury’s Economics II Division from 1979 to 1981, Assistant Secretary from 1981 to 1985 and Secretary to the Treasury from 1986 to 1993, February 8, 2011. 2. Ibid. 3. Ibid.

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4. Interview with Ian Dickson, head of the Treasury’s section on indirect taxation in the mid-1980s, February 9, 2011. 5. Interviews with three members of the Treasury’s tax division in the 1980s, February 16, 2011; February 17, 2011; and March 1, 2011. 6. Interview with former Treasury official, February 17, 2011. 7. Interview with Greg Dwyer, director of the Treasury’s tax policy division from 1985 to 1987, March 1, 2011. 8. Interview with Roger Douglas, Minister of Finance (Labour Party) from 1984 to 1988, February 15, 2011. 9. Interview with Ian Dickson, February 9, 2011. 10. Ibid. 11. Interview with Graham Scott, February 8, 2011. 12. Interview with Roger Douglas, February 15, 2011. 13. Ibid. 14. Interview with former Treasury official, February 16, 2011. 15. Interview with Roger Douglas, February 15, 2011. 16. Interview with John Shewan, partner at PricewaterhouseCoopers (PwC), March 2, 2011. 17. As measured by the Gini coefficient, inequality in disposable income in New Zealand grew from 0.27 in the mid-1980s to 0.34 in the mid-1990s. Over the same period, inequality in the United Kingdom increased from 0.31 to 0.34 and in the United States from 0.34 to 0.36 (OECD 2011b: 47). 18. MMP is a personalized PR system under which some members of parliament are elected by plurality in single-member constituencies while other seats are distributed according to party totals to maintain overall proportionality. 19. Interview with Robin Oliver, head of the Inland Revenue Department’s (IRD) tax policy division, February 16, 2011. 20. Interview with Norman Gemmell, Chief Economist and Principal Adviser (Tax) in the Treasury from 2007 to 2011, March 2, 2011. 21. Interview with senior IRD official, February 16, 2011. 22. Interview with Steve Mack, tax policy official in the Treasury, February 18, 2011. 23. Interview with Norman Gemmell, February 15, 2011. 24. Interview with Norman Gemmell, March 2, 2011. 25. Interview with Steve Mack, February 18, 2011. 26. National had great leverage within the government, as the coalition was oversized and none of the three small parties by itself could block National’s proposals. The responsibility for tax policy was, however, divided between a finance minister from the National Party and a revenue minister from the centrist United Future Party, meaning that political power in the tax area was somewhat more dispersed than in the 1980s. 27. Interview with former senior Treasury official, February 14, 2011. 28. Interviews with Treasury officials, February 18, 2011, and March 1, 2011.

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29. Interview with Peter Dunne, Minister of Revenue (United Future Party) from 2005 to 2013, March 3, 2011. 30. Interview with Geof Nightingale, partner PwC, February 24, 2011. 31. Interview with Treasury official, March 1, 2011. 32. Interview with Peter Dunne, March 3, 2011. 33. Interview with senior IRD official, February 17, 2011, confirmed by other interviews. 34. Interview with business representative, February 28, 2011. 35. Interview with senior IRD official, February 16, 2011. 36. Interview with Geof Nightingale, February 24, 2011. 37. Interview with John Shewan, March 2, 2011. 38. Interview with Peter Conway, Secretary of New Zealand Council of Trade Unions, February 21, 2011. 39. Interviews with Geof Nightingale, February 24, 2011, and John Shewan, March 2, 2011. Both were members of the Tax Working Group. 40. Interview with Peter Dunne, March 3, 2011. 41. Interviews with senior IRD official, February 16, 2011, and John Shewan, March 2, 2011. Chapter 4 1. Interviews with member of the Commission on Taxation in the 1980s, April 19, 2010, and with an economist at Trinity College Dublin, April 15, 2010. 2. Interview with member of the Commission on Taxation in the 1980s, April 19, 2010. 3. Interviews with senior officials in the Department of Finance, April 21 and 23, 2010. 4. Interview with Alan Dukes, Minister for Finance (Fine Gael) from 1982 to 1986, May 4, 2010. 5. Ibid. 6. Interview with member of the Commission on Taxation in the 1980s, April 19, 2010. 7. Interview with former official in the Department of Finance, April 23, 2010. 8. Interview with former senior official with the Revenue Commissioners, April 28, 2010. 9. Interview with business representative, May 5, 2010. 10. Interview with former official in the Department of Finance, April 23, 2010. 11. Interview with senior official in the Department of Finance, April 21, 2010. 12. Interview with former official in the Department of Finance, April 23, 2010. 13. Interview with senior official in the Department of Finance, April 21, 2010. 14. Interview with business representative, May 5, 2010. 15. Interview with trade union representative, April 26, 2010. 16. Interview with business representative, May 5, 2010. 17. According to OECD data, the inequality in disposable income in Ireland (measured by the Gini coefficient) dropped from 0.32 in the mid-1990s to 0.29 in 2008. By comparison, income inequality in New Zealand edged down from 0.34 to 0.33 in this period,

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while in the UK it increased from 0.34 to 0.35 and in the United States from 0.36 to 0.38 (OECD 2011b: 47). Data from Irish researchers, however, indicate that inequality in household income was more or less stable throughout this period, with a Gini coefficient of between 0.31 and 0.32 (Callan et al. 2010). 18. From 2003, all senior posts in the Department of Finance were advertised publicly, but according to Finance officials there were few external applications, and most posts continued to be filled by career civil servants (interview, April 21, 2010). 19. Interview with economist at the Trinity College Dublin, April 19, 2010. 20. Interview with economist at the University College Dublin (UCD), April 16, 2010. 21. Interview with senior official in the Department of Finance, April 21, 2010. 22. Interview with economist at the UCD, April 20, 2010. 23. Interviews with senior officials in the Department of Finance, April 21 and 23, 2010. 24. Interview with economist at the Trinity College Dublin, April 19, 2010. 25. Interviews with senior officials in the Department of Finance, April 21 and 23, 2010. 26. Interview with former official in the Department of Finance, April 19, 2010. 27. Interview with senior official in the Department of Finance, April 21, 2010. 28. Interview with former senior official in the Department of Enterprise, April 26, 2010. 29. Interviews with former official in the Department of Finance, April 23, 2010, and former senior official in the Department of Enterprise, April 26, 2010. 30. Interview with former senior official in the Department of Finance and Revenue Commissioners, April 30, 2010. 31. It later emerged that companies like Apple and Google were using loopholes in the Irish corporate tax regime to erase most of the tax liabilities from their sales in Europe. In August 2016, the European Commission ruled that the tax breaks offered by Ireland to Apple constituted illegal state aid and ordered Apple to pay €13 billion in back taxes. 32. Interview with business representative, May 5, 2010. Chapter 5 1. All citations and quotes from Norwegian and Danish sources are translated by the author. 2. Interview with Trond Reinertsen, deputy director of the Ministry of Finance’s Economic Division in 1979–1980, and undersecretary in the Ministry of Finance (Conservative Party) in 1989–1990, February 4, 2009. 3. Interview with former senior official in the Ministry of Finance, January 13, 2011. 4. Ibid. 5. Interview with senior official in the Ministry of Finance, January 4, 2011. 6. Ibid. 7. Ibid. 8. Interview with senior official in the Ministry of Finance, February 2, 2009. 9. Interview with senior official in the Ministry of Finance, January 4, 2011. 10. Interview with Trond Reinertsen, February 4, 2009.

Notes to Chapter 5

189

11. Interview with senior official in the Ministry of Finance, January 4, 2011. 12. Interview with former senior official in the Ministry of Finance, January 13, 2011. 13. Interview with Trond Reinertsen, February 4, 2009. 14. Interview with former Labour Minister of Finance, February 12, 2009. 15. Interview with Trond Reinertsen, February 4, 2009. 16. Interview with senior official in the Ministry of Finance, January 4, 2011. 17. Interview with senior official in the Ministry of Finance, February 2, 2009. 18. In the Norwegian government, every minister has one or more undersecretaries. The undersecretary usually oversees the bureaucracy’s day-to-day policy work and often serves as a liaison between the minister and civil servants. 19. Interview with Trond Reinertsen, February 4, 2009. 20. Ibid. 21. Interview with trade union representative, September 6, 2011. 22. Ibid. 23. Interview with business representative, September 2, 2011. 24. Interview with member of the Aarbakke commission, September 14, 2011. 25. The income-splitting model divided the income of individuals who were selfemployed or active shareholders into a labor income component that was taxed under a progressive rate schedule and a capital income component that was taxed at a flat rate of 28 percent (see van den Noord 2000: 10). 26. Interview with Conservative policy maker, September 6, 2011. 27. Interview with senior official in the Ministry of Finance, January 4, 2011. 28. Interview with Conservative policy maker, September 6, 2011. 29. Interview with Arne Skauge, chairman of the Commission on Taxation, September 28, 2011. 30. Interview with Conservative policy maker, September 6, 2011. 31. Interview with Arne Skauge, September 28, 2011. 32. Ibid. 33. Interview with business representative, September 2, 2011. 34. Interview with official in the Ministry of Finance, September 8, 2011. 35. Interview with business representative, September 2, 2011. 36. Interview with Conservative policy maker, September 6, 2011. 37. The deregulation of cooperative housing in the 1980s made share owners very similar to regular owners (Stamsø 2009: 231). 38. An OECD comparison based on data from 2002 shows a home ownership rate of 77 percent in Norway and Ireland, compared to 65 percent in New Zealand and 51 percent in Denmark (OECD 2006b: 122). 39. For instance, a 2011 survey showed that the taxes on property were regarded as the most unfair taxes and that only about one in four approved of taxing housing in general. Whereas the two taxes on housing—municipal property tax and stamp duty—were seen as “very or rather fair” by respectively 26 percent and 11 percent of respondents, 71 percent saw the income tax as fair (Synovate 2011).

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Notes to Chapter 5

40. Interview with Conservative politician, September 14, 2011. 41. Interview with Arne Skauge, September 28, 2011. 42. Ibid. 43. The idea was that the fund would provide a stable flow of income to the economy even after the oil wells dried up. The budgetary rule was not formalized but was accepted by all parties except the Progress Party. 44. Interview with Conservative politician, September 14, 2011. 45. To be sure, we should be careful when comparing these two cases of revenue abundance because the source of the surpluses was different: natural resources in Norway and foreign direct investments (FDI) in Ireland. But although some tax breaks in Ireland were aimed at keeping the foreign investments flowing, many other incentive schemes and the hollowing out of the income tax had little to do with the FDI sector. Chapter 6 1. Whereas the Norwegian Labour Party governed alone with a majority from 1945 to 1961, the Danish Social Democrats were in opposition from 1945 to 1947 and from 1950 to 1953 and otherwise formed minority or coalition governments. 2. According to figures obtained from the Ministry of Finance, 40 percent of the ministry’s academic staff in 2010 (excluding leadership positions) had a political science degree, 40 percent had an economics degree, and 20 percent had other educational backgrounds (Finansministeriet 2010). 3. Interview with official in the Ministry of Finance, September 7, 2010. 4. Interview with former senior official in the Ministry of Finance, September 14, 2010. 5. Interview with Carsten Koch, Minister of Taxation (Social Democrats) from 1994 to 1998, and leader of the Tax Commission in 2008–2009, September 2, 2010. 6. Interview with former senior official in the Ministry of Finance, September 14, 2010. 7. The government did not strictly need the votes of the Social Democrats to pass reform but was eager to manufacture a broad political consensus (Ganghof 2006: 81). 8. Interview with Mogens Lykketoft, Minister of Finance (Social Democrats) from 1993 to 2000, September 24, 2010. 9. Interview with former senior official in the Ministry of Finance, September 16, 2010. 10. Interview with academic tax economist, September 8, 2010. 11. Ibid. 12. The Wise Men of the Economic Council, on the other hand, were clearly aware of the incentive effects of taxation. But they did not express a clear opinion about the proposals of the Personal Tax Commission and generally said very little about tax reform in their reports from 1992 and 1993 (see Danish Economic Council 1992, 1993). 13. Interview with Mogens Lykketoft, September 24, 2010. 14. Interview with Ole Stavad, Minister of Taxation (Social Democrats) in 1993–1994 and 1998–2000, September 15, 2010. 15. Ibid.

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16. For instance, both Poul Nyrup Rasmussen and Mogens Lykketoft, respectively Prime Minister and Minister of Finance for the Social Democrats in the 1990s, had spent decades as economists in the LO system. 17. Interview with member of parliament for the Social Liberal Party, September 10, 2010. 18. Interview with Ole Stavad, September 15, 2010. 19. Interview with senior official in the Ministry of Taxation, September 13, 2010. 20. Ibid. 21. Interview with former senior official in the Ministry of Finance, September 14, 2010. 22. Ibid. 23. Interviews with Mogens Lykketoft, September 24, 2010, and Ole Stavad, September 15, 2010. 24. Interview with Ole Stavad, September 15, 2010. 25. Ibid. 26. Interview with business representative, September 22, 2010. 27. Interview with former political advisor to the Liberal Party, September 20, 2010. 28. Interview with political advisor to the Liberal Party, September 24, 2010. 29. Interview with Thor Pedersen, Minister of Finance (Liberal Party) from 2001 to 2007, September 15, 2010. 30. Interview with official in the Ministry of Finance, September 7, 2010. 31. Interview with former senior official in the Ministry of Finance, September 16, 2010. 32. Interview with official in the Ministry of Finance, September 7, 2010. 33. Interview with former political advisors to the Liberal Party, September 20 and 24, 2010. 34. The government also gradually reduced the corporate tax rate from 30 percent in 2001 to 25 percent in 2007, based primarily on concerns about international competitiveness. 35. Interview with representative for the Economic Council of the Labor Movement (AE), September 28, 2010. 36. Interview with business representative, September 22, 2010. 37. Ibid. 38. Ibid. 39. Interview with political advisor to the Liberal Party, September 24, 2010. 40. Interview with academic tax economist, September 9, 2010. 41. Interview with Carsten Koch, September 2, 2010. 42. Ibid. 43. The Tax Commission projected posttax income inequality to rise with 0.7 point on the Gini index as a result of its proposals (Skattekommissionen 2009). The final reform was somewhat more unequal because it discarded some of the proposed base-broadening measures.

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Index

Aarhus University, 142 Abbott, Andrew, 13 administrative institutions. See state bureaucracies Anglo-Saxon countries, 2, 9, 24, 34, 91, 170 Auerbach, Alan, 74 Bakija, Jon, 7 Ban, Cornel, 162, 177 Blyth, Mark, 56, 162 Boix, Carles, 10 Boston, Jonathan, 66–67, 71, 72 Buckle, Bob, 76 de Buitléir, Donal, 87, 89 bureaucracy/bureaucrats. See state bureaucracies bureaucratic autonomy, 18–19, 21–22, 26, 104, 167–68 business interests, 10–11, 161, 164 Campbell, John L., 9, 15, 158, 165, 173 Carpenter, Daniel, 18–19, 167–68, 175 Chwieroth, Jeffrey M., 15, 25, 171 civil service. See state bureaucracies commissions, 15, 165, 172, 173 Cullen, Michael, 73 Denmark: business interests, 153, 154, 155; CEPOS, 155–56; civil service, 137; Commission on the Taxation of Interest, 144; Conservative Party, 144–45, 155; Danish Economic Council, 139, 141, 142, 143, 145, 151, 153, 154, 155, 157, 165, 190n12; Danish People’s Party, 152–53, 156; dual income tax, 144, 146; Economic Council of the Labor Movement (AE), 148; economic crisis, 141, 143–44, 145, 147; Economic Secretariat, 138–39; economics,

139–40, 141–43, 146, 150, 154; economists in state bureaucracy, 137, 138–43, 146, 154, 158–59; efficiency, 141, 146, 150, 151, 152; Keynesian economics, 137, 138, 140, 141, 142, 143, 148, 150, 154; lawyers in state bureaucracy, 137–38; Liberal Party, 137, 141, 144, 145, 151–58; LO (Landsorganisasjonen i Danmark), 148, 191n16; macroeconomics, 140, 141, 142, 143, 144, 146, 150, 151, 152, 154; marketconforming policies, 54, 135, 136, 137, 145, 149–50, 157, 158; microeconomics, 146, 150, 152, 168; Ministry of Finance, 137, 138, 140–41, 142–43, 144, 146–47, 149, 150, 153–54, 155, 156, 157, 168, 171; Ministry of Taxation, 140–41, 142–43, 154; Ministry of the Economy, 138, 140–41; neoclassical economics, 137, 141, 142, 143, 146, 150, 152, 154, 156, 157, 158; neutrality in taxation, 135, 144, 146, 150, 152; Personal Tax Commission, 145–46; political institutions, 136; redistribution, 136, 150, 153, 154, 156, 157, 158, 191n43; Social Democrats, 136, 137–38, 139, 144, 145, 147–48, 150, 153, 155, 156, 158, 190n1, 190n7; Social Liberal Party, 139, 147, 148, 149, 150; Tax Commission, 155–56; tax deductions, 144, 146, 147, 149, 151, 152, 156; tax freeze, 153–54; Tax Policy Secretariat, 142–43; tax reform of 1985, 144–45; tax reform of 1994, 147–50; tax reform of 1998, 151; tax reform of 2009, 155–57, 164; taxation of pensions/retirement savings, 52; think tanks, 155; trade unions, 148, 153, 156 deregulation, 4, 6 Diamond, Peter, 35–39, 117 diffusion, 8–9, 170; of economic ideas, 4, 5, 14–16, 17, 22, 24, 170–73; of economic

209

210

Index

diffusion (continued) ideas from the U.S., 4, 5, 8–9, 17, 24, 59, 61, 62, 113, 115, 117, 126, 134, 141, 170–71, 172 distortions. See taxation Douglas, Roger, 56, 64–70, 99–100, 163, 166 dual income tax. See taxation Dukes, Alan, 88 Dunne, Peter, 75 Easton, Brian, 60, 63 economic crisis, 166, 176 economic planning, 84, 110, 113, 137 economics, 3–6, 12–13, 16–17, 20–22, 24, 29, 35–40, 161, 167–73, 175–77; in Denmark, 139–40, 141–43, 146, 150, 154; diffusion of, 4, 5, 14–16, 17, 22, 24, 170–73; formalization of, 4–5, 35–36, 115; and Great Depression, 20, 109, 137, 164; in Ireland, 84, 85, 86, 87, 96–97, 100; Keynesian, 4, 5, 20, 21, 29, 34, 35, 40, 43, 54, 161, 170–72; macroeconomics, 4, 20, 174; microeconomics, 4, 20; neoclassical, 3, 4–5, 6, 12, 20, 21–23, 24, 26, 29, 37, 40, 161, 164, 168–73, 174, 176; in New Zealand, 58–62, 63, 65, 72–73, 74, 78, 79; in Norway, 107, 110–11, 112–16, 117–18, 119–20, 123, 125–26, 129, 134; profession, 4–5, 12–13, 16–18, 20–22, 39, 161, 164, 167–72, 174, 175–76; supply-side, 39–40, 63, 113, 118, 141–43, 145, 152; of taxation, 29, 35–40, 74, 118, 129, 146, 149–50, 154, 161, 177; transnational character of, 4, 16–17, 24, 175; and World War II, 16, 20, 84, 114, 137, 169 economists: in state bureaucracies, 3–4, 5–6, 12–23, 161, 164, 167–70, 171–73 efficiency, 2, 21, 165, 168; and taxation, 7, 29, 35–40, 50, 51, 54, 161, 163, 167, 177 European Union (EU), 1, 83, 101, 103; European Commission, 101–02, 188n31 expertise, 4, 13, 16, 19–20, 167–68, 172 Fanning, Ronan, 84 finance ministries: in Denmark, 137, 138, 140–41, 142–43, 144, 146–47, 149, 150, 153–54, 155, 156, 157, 168, 171; in Ireland, 81, 83, 84–86, 87–88, 91, 95–100, 102, 104; in New Zealand, 55, 57–68, 70, 71, 72–77, 78–79, 85–86, 118, 166; in Norway, 107, 109, 110–15, 116–18, 121, 123–24, 125, 128–30, 131, 134 Fourcade, Marion, 4–5, 16–17, 24, 36, 169–70, 172–73 France, 17, 175

Freidson, Eliot, 13–14, 20 Frisch, Ragnar, 110, 115 Gemmell, Norman, 74, 76–77 generalists: civil service model, 16, 57, 83–84, 170; in Ireland, 81, 83–86, 91, 96, 104, 168, 169, 170 Gjedrem, Svein, 115 Great Depression: and economics, 20, 109, 137, 164 Haavelmo, Trygve, 110, 115 Hagen, Kåre P., 122 Hall, Peter, 11, 13, 157 Heclo, Hugh, 20 Honohan, Patrick, 88, 100 ideational literature, 8–9, 12, 162, 173 ideology, 20–21, 168 inequality, economic. See redistribution influence, 5–6, 18, 19–21, 25–26, 167, 185n3 International Monetary Fund (IMF), 1, 5, 17, 58, 65, 81, 101, 172, 177 Ireland: business interests, 91, 92, 93, 94; Celtic Tiger, 1, 81, 91–92, 99; civil service, 83–84, 85–86, 95–96, 169; Commission on Taxation of 1980s, 87–88; Department of Enterprise, 101–104; Department of Finance, 81, 83, 84–86, 87–88, 91, 95–100, 102, 104; Economic and Social Research Institute (ESRI), 85, 95; economic crisis, 1, 81, 87, 88, 90, 95, 100, 101; Economic Development 84–85; economic openness, 82, 101–02; economics, 84, 85, 86, 87, 96–97; economists in state bureaucracy, 83, 84–86, 96–97, 100; efficiency, 83, 86, 90, 103; Fianna Fáil, 83, 84, 89, 91, 92, 93, 94; Fine Gael, 83, 88, 93, 94, 100; generalist civil service, 81, 83–86, 91, 96, 104, 168, 169, 170; IBEC, 93, 94; Industrial Development Agency (IDA), 101–02; Irish Congress of Trade Unions (ICTU), 93, 94; Irish Government Economic and Evaluation Service, 100; Keynesian economics, 84; Labour Party, 82, 88, 93, 94, 100; market-conforming policies, 81, 82, 83, 91, 100, 101, 103, 104; microeconomics, 86; National Economic and Social Council (NESC), 89–90, 94; neoclassical economics, 86, 87, 91, 92, 96, 98, 99, 103, 104; neutrality in taxation, 82; political institutions, 82–83, 95, 104; Progressive Democrats, 89, 91, 92; redistribution, 94–95, 187–88n17;

Index Social Partnership, 90, 94; tax deductions, 87, 90; tax distortions, 1, 48, 54, 82, 89; tax expenditures, 52, 93, 97, 99; tax incentives, 48, 52, 54, 82, 92, 93, 99; tax protests, 29, 86–87; taxation of construction industry, 1–2, 82, 93, 95, 98; taxation of corporations, 50, 81, 101–04; taxation of housing, 52, 93; taxation of pensions/retirement savings, 48, 52, 93; trade unions, 89–90, 91, 93, 94 Italy, 5, 175 Katzenstein, Peter, 24, 82 Kelly, Morgan, 95 Kerr, Roger, 68 Key, John, 75, 77–78 Keynesian economics. See economics knowledge. See expertise knowledge regimes, 9, 13, 158, 173 Laffer, Arthur, 39, 63, 113, 118, 141 Laffer curve, 39, 63, 118, 141 Lang, Henry, 58, 61, 85 Lange, David, 64, 69 Larson, Magali, 13–14, 19, 20 lawyers, 20, 169 Lie, Einar, 109–12, 114, 121, 125, 127 Lucas, Robert, 141 Lykketoft, Mogens, 135, 147–51 market-conforming policies, 2, 3, 6–8, 10–12, 22, 25, 27, 43, 53, 161, 162, 163–65, 174, 176; definition of, 3, 6–8; in Denmark, 54, 135, 136, 137, 145, 149–50, 157, 158; in Ireland, 81, 82, 83, 91, 100, 101, 103, 104; in New Zealand, 50, 55, 56, 70, 72, 73, 79, 80; in Norway, 50, 107, 109, 131, 133, 134 market-oriented policies. See market-conforming policies Markoff, John, 4, 21–22, 168, 175 McCreevy, Charlie, 91–94, 98, 99–100 McKinnon, Malcolm, 57–61, 65 Meade, James, 37 Mirrlees, James, 35–39, 117 Moe, Thorvald, 112–15 Montecinos, Verónica, 4, 21–22, 168, 175 Muldoon, Robert, 62, 63–64 Mundell, Robert, 39, 113 Murray, C.H., 85 neoclassical economics. See economics

211

neoliberalism, 6, 9, 61, 83, 142, 149, 173, 176 neutrality, in taxation. See taxation New Zealand: bureaucratic activism, 61, 65–66, 70, 79, 99; business interests, 68, 70, 76–77; civil service, 57, 58; deregulation, 55, 68, 71; diffusion of economic ideas, 61–62; economic crisis, 56, 58, 59, 60, 64, 69, 70, 78; Economic Management, 65; economics, 58–62, 63, 65, 72–73, 74, 78, 79; Economics II, 59–61, 62; economists in state bureaucracy, 56, 57–62, 72–74, 79–80; efficiency, 57, 62, 67, 73, 75; Goods and Services Tax (GST), 49, 69, 75, 77, 78; Inland Revenue Department (IRD), 71, 72–79; Keynesian economics, 57–58, 59; market-conforming policies, 50, 55, 56, 70, 72, 73, 79, 80; McCaw tax review, 63; microeconomics, 59–60, 62, 67, 70, 75; National Party, 55–56, 59, 62, 69, 70–71, 75, 77–78; neoclassical economics, 56, 59–62, 64, 70, 72, 74, 79; neutrality in taxation, 49, 51, 53, 64, 65, 67, 70, 73; New Zealand Business Roundtable, 68; New Zealand Labour Party, 55, 56, 57–58, 64–65, 67, 68, 69–70, 71, 73; political institutions, 56, 57, 69, 70, 71, 79; redistribution, 68, 71, 77, 79, 186n17; tax deductions, 2, 69; tax distortions, 60, 62–63, 66, 74; tax expenditures, 53, 62, 63; tax incentives, 2, 62, 66, 67, 68, 70, 72, 73, 77; tax reform of 2010, 74–79; tax reforms of 1984–90, 55, 56, 65–69; Tax Working Group, 76–79; taxation of pensions/retirement savings, 2, 47, 51, 66, 67, 73; think tanks, 68; trade unions, 68, 70, 77; Treasury, 55, 57–68, 70, 71, 72–77, 78–79, 85–86, 118, 166; United Future Party, 75, 186n26; value-added tax, 55, 65–67, 69, 70, 75, 78 norms about administrative behavior. See state bureaucracies Norway: Aarbakke group, 121–22, 123, 124, 132; Aune commission, 118–19, 120, 132; bureaucratic activism, 114–15, 121, 128–29; business interests, 122–23, 127, 128, 131; Central Bureau of Statistics, 111, 117; civil service, 109; Conservative Party, 119–20, 122–23, 125, 127, 128–29, 130, 132–33; dual income tax, 122, 125–26, 127; economic crisis, 108, 112, 120–21, 126; economics, 107, 110–11, 112–16, 117–18, 119–20, 123, 125–26, 129, 134; economists in state bureaucracy, 108–09, 110–18, 126, 134;

212

Index

Norway (continued) efficiency, 107, 108, 117–18, 119, 125, 127, 134; Keynesian economics, 108, 109, 110, 113–15, 134; Labour Party, 107, 108, 109–11, 112, 119, 120, 121, 122, 123–25, 127, 128, 131, 132, 139, 169; lawyers in state bureaucracy, 109, 111, 116–17, 121; LO (Landsorganisasjonen i Norge), 124; macroeconomics, 110, 113; market-conforming policies, 50, 107, 109, 131, 133, 134; microeconomics, 113; Ministry of Finance, 107, 109, 110–15, 116–18, 121, 123–24, 125, 128–30, 131, 134; neoclassical economics, 107, 113–16, 122, 123, 126, 131, 134; neutrality in taxation, 2, 53, 107, 108, 117, 119, 122, 125–26, 129, 130, 131, 132; NHO (Næringslivets Hovedorganisasjon), 124–25; oil/petroleum, 108, 112, 120, 126, 132, 133; Oslo School economics, 107, 110, 112, 115, 172; political institutions, 126; Progress Party, 131, 190n43; redistribution, 108, 116, 119, 120, 122, 127, 128; Skauge commission, 128–131, 132; social democracy, 107, 109–10, 112, 116, 134; tax deductions, 107, 108, 116, 117, 119–20, 122, 123, 125, 132; tax distortions, 118, 128, 130, 131; tax incentives, 116, 119; tax reform of 1992, 107, 108, 121–27; tax reform of 2006, 128–31; taxation of dividends, 107, 128, 130–31, 149; taxation of housing, 2, 52, 54, 107, 108, 116, 125, 128, 131, 132–34, 189n39; think tanks, 130; trade unions, 124, 128, 139 Norwegian School of Economics (Bergen), 114, 118, 121 Oliver, Hugh, 64–65 Oliver, Robin, 72 optimal taxation theory, 35–40, 117, 177 Organisation for Economic Co-Operation and Development (OECD), 17, 58, 118, 172 Øygard, Svein Harald, 124 paradigm shift, 4–5, 14, 22, 185n2 Pedersen, Ove Kai, 9, 15, 158, 165, 173 Pedersen, Thor, 153 Piketty, Thomas, 33, 39, 177 political institutions, 3, 11–12, 23, 175; in Denmark, 136; in Ireland, 82–83, 95, 104; in New Zealand, 56, 57, 69, 70, 71, 79; in Norway, 126 political parties, 3, 10, 24, 164 power. See influence Prasad, Monica, 7 process tracing, 25–27

production regimes. See varieties of capitalism professions, 3–4, 13–17, 19–23, 161, 167–69, 170–71, 175, 177. See also economics property. See housing Rasmussen, Anders Fogh, 141–42, 145, 152–55, 157 Rasmussen, Poul Nyrup, 148, 191n16 Reagan, Ronald, 3, 30, 40, 55 redistribution: and taxation, 8, 10, 29, 30, 35–36, 39, 42, 43, 162, 177 Reinertsen, Trond, 113–14, 123 Saez, Emmanuel, 37, 39, 177 Sandford, Cedric, 43, 87–88, 90, 91 Scandinavia/Scandinavian countries, 2, 9, 24, 34, 52, 162, 165, 170 Scott, Graham, 59–61, 62–63 Skauge, Arne, 123, 129 Skocpol, Theda, 13, 16, 18–19, 20–21, 173 Slemrod, Joel, 7 small states, 23–24, 82, 174–75 social democracy, 24, 107, 109–10, 112, 116, 134, 139, 162 Sørensen, Peter Birch, 126, 129 state bureaucracies: administrative orders, 5, 16, 169–70; bureaucratic activism, 18, 21, 158, 167–68; bureaucratic autonomy, 18–19, 21–22, 26, 104, 167–68; civil service models, 16–17, 24, 57, 83–84, 85–86, 95–96, 137–38, 169; economists in, 3–4, 5–6, 12–23, 161, 164, 167–70, 171–73; generational change in, 15, 61, 113–14, 115, 134, 171, 172; norms about administrative behavior, 6, 14, 18, 19, 21–22, 61, 66, 97, 99, 114–15, 129, 157–58, 161, 168; recruitment to, 14, 15, 57, 58–59, 61, 62, 72, 79, 83, 84, 85, 86, 96, 100, 104, 110–11, 114, 115–16, 140, 171, 172, 173, 175, 177; relationship politicians and bureaucrats, 18–20, 21, 55, 157, 165–68 Stavad, Ole, 147–49, 151 Steinmo, Sven, 8, 12, 29, 34 supply-side economics, 39–40, 63, 113, 118, 141–43, 145, 152 Swank, Duane, 10, 11 Sweden, 7, 122, 130, 140, 149 Tait, Alan, 65 tax reform, 2–3, 6–8, 10, 11, 30, 40–43, 54, 163; in Denmark, 144–45, 147–50, 151, 155–57, 164; low-rate, broad-base, 4, 7, 40, 163; move-

Index ment, 30, 40–43; in New Zealand, 55, 56, 65–69, 74–79; in Norway, 107, 108, 121–27, 128–31 taxation: average rates, 31; bases, 31; of capital, 33, 39, 50–52; of consumption, 31–33, 38, 48–50; of corporations, 33, 41, 50–51; deductions, 6, 7, 8, 10, 31, 34, 35, 38–39, 41, 47–48, 51, 52; distortions, 6, 7, 29, 36–40, 51, 54, 168; of dividends, 33, 50–51; dual income tax, 122, 125–26, 127, 144, 146; dynamic effects, 63, 118, 142, 147; economics of, 29, 35–40, 74, 118, 129, 146, 149–50, 154, 161, 177; effective rates, 31; and efficiency, 7, 29, 35–40, 50, 51, 54, 161, 163, 167, 177; excises, 32–33; expenditures, 31, 40, 97; of housing, 38, 50–52; incentives, 10, 29, 30, 34, 40; of labor, 31–32, 37–38, 39, 43–48; level of, 7, 11, 42, 52–53; marginal rates, 31; neutrality, 1, 8, 29, 36, 40, 50, 168, 174; of pensions/retirement savings, 33, 34, 41, 47–48, 51–52; of personal income, 31–32, 34, 40–41, 47; progressive, 29, 30, 31, 32, 33, 35, 38, 43, 177; rates, 31; and redistribution, 8, 10, 29, 30, 35–36, 39, 42, 43, 162, 177; regressive, 31, 32, 33; revenues, 7, 29, 30–31, 32, 33, 34–35, 42, 52–53; social security contributions, 31–32; statutory rates, 31; tax wedge, 29, 36, 46–47, 117; value-added tax, 32–33, 38, 42, 48–50, 174; and welfare state, 30, 33, 34, 35, 116, 136; and World War II, 33–34 Thatcher, Margaret, 3, 40, 43, 55, 157 think tanks, 9, 68, 130, 155, 173 trade unions: in Denmark, 148, 153, 156; in Ireland, 89–90, 91, 93, 94; in New Zealand, 68, 70, 77; in Norway, 124, 128, 139

213

United Kingdom: civil service, 16, 57, 83–84, 85, 95–96, 169; economics, 35, 117, 126; Government Economic Service, 81, 85, 100; Meade Report, 37–38, 63, 117; politics of reform, 157; tax reform, 3, 40, 42; taxation, 34, 37 United States: civil service, 16; Economic Recovery Tax Act of 1981, 7; diffusion of economic ideas from, 4, 5, 8–9, 17, 24, 59, 61, 62, 113, 115, 117, 126, 134, 141, 170–71, 172; economic advisory bodies, 174; economics in, 4, 17, 59, 113, 117, 141; economists trained in, 5, 17, 24, 59, 79, 113, 115, 116, 134, 171, 172, 175; political institutions, 23, 83; tax reform in, 3, 7, 30, 40, 43, 54, 55, 122, 127; Tax Reform Act of 1986, 7, 30, 40, 43, 55, 122, 127; taxation in, 32, 33, 34, 42; universities in, 4, 17, 59, 113; U.S. Treasury Report on Tax Reform, 63, 87 University of Copenhagen, 141, 142 University of Oslo, 110–11, 112–13, 114, 117 value-added tax. See taxation varieties of capitalism, 10–11, 164 veto player framework, 11–12 Victoria University of Wellington, 75–76 Washington consensus, 6, 162–63 Weber, Max, 19–20 welfare state, 24–25, 71, 110, 164; and taxation, 30, 33, 34, 35, 116, 136 Whitaker, T.K., 84–85 World War II: and economics, 16, 20, 84, 114, 137, 169; and taxation, 33–34