Gregory A. Fossedal, Direct Democracy in Switzerland, 2002.12
Taxes>In no country on earth do the people think taxes are too low or too simple, or the burden imposed by the authorities to enforce them too light. Switzerland is no exception to this rule. "The taxes on capital and investment," says Hans Bar, the former chairman of Julius Bar, a respected investment bank in Zurich, "are too high." Edwin Somm, the former chairman of Asea-Brown-Boveri, the giant Swiss engineering firm, agrees. "There are a number of changes that must be made in the tax code to ensure competitiveness," he argues -- and then pulls out a series of charts that detail, Ross-Perot-like, what sectors suffer from the rates that are too high, and which ones have allowances too wide or too narrow. George, affable, six-foot-five porter at the front desk of the Bellevue Hotel in Bern, agrees. "The Swiss tax system is not that great," George offers. He pauses. "What are you comparing it to?"
The question illustrates the fact that if the Swiss are unhappy with their taxes, they are probably less unhappy than in most other countries. Asked if there are things they would like to change about their tax code, most people in Switzerland answer yes. Asked if they would trade their tax laws for the tax laws of Germany, Japan, or the United States, most Swiss quickly answer no.
Certainly a part of the reason for this is the simple fact that Swiss tax rates are somewhat lower than in many Western countries. Their value-added tax is the lowest in Europe, a cause of some friction vis-a-vis the rest of Europe and apprehension among the Swiss, who fear they may have to choose between integration and their low-tax traditions. Swiss income tax rates are among the lowest in the industrial world, as Table 12.1 illustrates.
Similarly, the Swiss value-added tax is about half that of the rest of Europe. (The United States had no value-added tax at the turn of the century, though one was occasionally proposed. The U.S. does, however, have sales taxes; the Swiss do not.) Taxes on corporate and investment income are on the one hand slightly lower than the average for other countries -- but the differential for these is much smaller than in the personal income codes.
Although these low rates are an important part of the code's relatively high acceptance by the Swiss people, they are by no means the only factor. Another is the relative simplicity of the code and of the reporting of income. In the cantons of Ticino, Geneva, and Aargau, officials allowed me to see the basic forms that taxpayers use to pay their income tax. The resulting documents looked like one of those postcard returns designed by various U.S. politicians to show how easy taxes would be if their "super simple reform tax code" were adopted. The simplicity of the forms becomes a metaphor, not only that the process is not complicated but that there is a rough, simple fairness to it -- and that the government, at least by appearance and in the Swiss case in reality, is not itself extravagant. Swiss who have lived abroad in France, Germany, or the United States generally compare the process of paying taxes in Switzerland favorably with that in these other countries.
Another cause of the relative acceptance of taxes in Switzerland is the balance of the code between different types of income. Many national tax codes are built upon the idea, whether stated or not, that certain types of activity are "good," and some bad -- or at least, not as good as the favored activity. Accordingly, they may tax various activities at very different levels. This introduces an element of seeming unfairness into taxation, and encourages envy and divisiveness politically, as some groups seek to expand their privileges still farther, while others strive simply to gain equal treatment.
Thus some codes tax foreigners heavily (the Arab states, for instance) while others (Russia, much of the former Soviet Empire) literally tax their own people more.1 Some codes tax corporate income higher than personal income, feeling that large enterprises need to be controlled or that they have more money and can therefore afford to pay more. Others tax companies (Europe, the United States) at much lower rates than people, in the thought that "investment" is good and creates jobs, while people having those jobs spending money on things is "consumption" and is not as good for the economy. Treatment of income by capital gains also varies widely. Some countries tax such gains more heavily than wages; others, such as the U.S. and Europe, more lightly; others have no capital gains tax at all; while in some countries, capital gains are simply treated the same as rents, wages, profits, or other incomes. Switzerland has no federal capital gains tax as such; the rate is zero. And many of the cantons treat capital gains the same as regular income in applying income tax rates, which are applied locally. Many cantons tax real estate sales, while gains on the disposition of other personal property is tax exempt. Business capital gains and income are all taxed -- and at rates as high as 50 percent.
The distortions that result from such differential taxation can appear comical to the outsider. In Britain in the 1970s, for example, the rate of corporate automobile ownership exceeded the rate of personal automobile ownership for a time. The combination of high tax rates and generous write-offs for "business transportation" made it much more economical for companies to provide transportation to many of their employees than to pay them wages, taxed at high rates, so they could buy cars of their own. But to the citizens of a country, such exceptions and imbalances can be infuriating. In the United States, so-called "flat" tax systems were proposed which in fact taxed wages at rates of 20 percent and more, while taxing capital gains at 0 percent.
The Swiss code has its share of these elements, particularly when it comes to farming activities. On the whole, however, rates are balanced. Wage income, capital gains, and corporate income are all taxed -- none at more than 40 percent, few at less than 10 percent. This attribute has been called "longitudinal fairness" -- a fairness of taxing not merely the rich and the poor at fair rates, but at taxing different types of activity at a reasonably even rate.
The Swiss tax on total net assets -- a wealth tax -- broadens the base still further, and enables a somewhat lesser penalty on the production of wealth to be traded off for a low-rate tax on static wealth. This is a tax with many attractive elements (if, of course, it is not simply layered on other high tax rates). Of course, one can argue whether such designs are, in fact, the most fair. The Swiss seem to regard this approach as acceptable. It is worth noting that a tax on wealth, or accumulated riches, may have a very different impact on the incentive to take risks, add value, and create jobs, than a tax on profits, gains, or income.
By other measurements of fairness the code performs reasonably well. The richest Swiss do not appear to pay as high a percentage of the national income tax as in the United States, Japan, or Germany. The actual rate that applies to their income is even lower, comparably, than in those countries: In the United States, the federal tax rate goes from 0 percent to 38.5 percent, and in such populous states as California and New York, from 0 percent to more than 10 percent.
From a redistributive point of view, then, the code is "less fair." This does not appear to bother the Swiss for several reasons, the first of which is they are not especially focused on comparisons of wealth, and in particular, have little desire to achieve economic equality through government redistribution. If a wealthy Swiss were to engage in great displays of wealth, he would be thought rude, and would be shunned by most of the society; but this social "tax" on the rich is thought, in part, to obviate efforts to seize property through the tax code or other means. In Switzerland, even today, one finds relatively lesser extremes of wealth in fact than in the United States, Britain, France, or even Germany. And there is almost no display. Corporate salaries in the multimillions of dollars, as seen in the United States and Europe, are less common, though no longer unheard of.
The Swiss comfort themselves in the fact that if the rich do not face extreme rates of taxation on paper, neither can they arm themselves with an array of loopholes to escape paying any taxation in fact. Nor are the most productive and creative members of society driven overseas by confiscatory schemes. A young police officer who discussed taxes with me at a coffee shop in Zurich commented that "what matters is that everybody pays some fair amount." Unlike many of their European and American counterparts, the Swiss do not have the nagging sense that while, in theory, the rich are paying half or more of their income in taxes, in practice, there are some who pay no taxes at all. Nor do they have much desire to tax others at such rates, even if it could be achieved.
To some extent, the tax code causes and reinforces these attitudes. To some extent, the society's condition of few extremes causes this tax code to be acceptable. In societies with greater disparities of wealth, and greater envy, it might not be.
Switzerland's size and position contribute to the country's determination to keep tax rates under control, indeed low by developed-country standards. Always dependent on trade and economic competitiveness, the Swiss are economic internationalists. They have a keen eye for the importance their own "domestic" tax or monetary policy will in fact have on their position in the world economy. A factory worker in Baden who talked to me at the train station had a relatively extensive knowledge of the different cantonal tax systems, praising Zug for its extremely low personal income tax rates. He had some knowledge, though not as detailed, of foreign systems. For example, while he could not quote personal income tax rates, he knew that they were higher in nearly all the surrounding countries. He also appeared to have a detailed sense of how the different rules for value-added taxes affected his wife's shopping habits when the family goes shopping in Germany.
Even so," there is reason for concern that the combination of various income taxes, social insurance rates, and the assets tax have begun to scare away some of Switzerland's most talented and productive members. This was especially acute in the 1980s when the United States and a number of other countries in the Americas slashed their tax rates while Europe cut rates, but not as much; and the Swiss, while starting from a very low-tax base, endured mild increases, later followed by the imposition of the value-added tax.
Where there is redistribution, the Swiss prefer to carry it out in a positive way than in a punitive one. For example, the educational system has a leveling impact, but does so more by lifting up and empowering the working class than by limiting the rich or the productive. Similarly the social welfare system carries out assistance, and needs no large base of revenue because the number of cases where it must be used is relatively small.
Swiss government spending tends to be concentrated not in transfer payments, such as public assistance, but in education, public works projects such as tunnels and roads, and other investments and value-added activities. These tend to help the middle class, rich, and poor alike, but surely they help the poor the most by expanding the base of potential production, spurring employment opportunities. They also yield a visible result, products and public goods -- parks, bridges, buildings -- that give the taxpayer some tangible return for his payments.
The result is a sense not so much of equality, as of community. There is a difference between feeling that everyone contributes, and feeling that every-one contributes the same, or contributes enough. The Swiss do not necessarily enjoy the latter sensations, but they are perhaps less focused on these. They do share a sense that for the most part everyone contributes something and everyone enjoys some benefits, from the state and, thus, from the money it collects in taxes. They sense, economically, that their tax code is sufficient, and this in itself is a relative rarity in modern societies.
Politics play a role in the tax code's acceptance in Switzerland. It is remarkable, in fact, that with all the turmoil over taxes in most countries, the interconnection between the tax code and political institutions is seldom considered. In Russia, for example, political corruption and slack tax revenues are discussed in isolation, when by all appearances the country's onerous tax code helps generate black market activity, both economic and political. In the United States, frustration with the tax code is seldom addressed in its political dimension. This is not to say that Switzerland structured its political system with the intent of smoothing over the difficulty of tax collection common to Western societies. The political system does, however, have an impact. There appear to be two political structures in Switzerland that substantially ameliorate the classic tension of taxation.
First, of course, is the system of direct democracy at the federal and still more so the cantonal and communal levels. In one way, the ability to challenge any federal tax increase by means of the facultative referendum has proven a powerful tool for keeping tax rates down. And this is an important element; it is, however, only the most superficial result of the Swiss populism. The voters have the same power, indeed greater power, to limit taxes at the cantonal and local levels -- yet they have proven more willing to approve new and higher taxes at those levels than the voters in perhaps any other country in the world.
As Tocqueville observed in the nineteenth century, "it is the cantons and the communes that provide things to the people" -- services and goods, schools and roads. Although the Swiss polity is somewhat more centralized today than when he made those remarks (1848), it is nevertheless still one of the most decentralized systems in the world. And local government is highly popular -- in large part because of the extreme degree of popular participation in it. Almost no tax may be increased without a popular vote -- in many cases, at a direct popular assembly, where the electorate may confront the politicians or other voters who propose the new burdens face to face, "looking them in the eye," as the Swiss like to say.
The phenomenon can perhaps be best understood if we compare the process by which taxes might be raised in Switzerland to that of other countries that have representative -- but not direct -- democracy. In the United States or Europe, most tax changes or increases are passed by a legislature, typically by narrow margins, and with much political agitation. The agitation must be greater, not lesser, because of the fact that everyone seeking to influence the decision knows there is no ultimate check by the people. The political message of the electorate, everyone realizes, is filtered before it reaches the few dozen elites who will make the decision -- and accordingly, all concerned seek to turn up the volume in order to get their message across. Voters, who do not enjoy the privilege of acting as legislators themselves, pay less attention to the merits and details of such issues than they would as quasi-legislators -- they must spend a proportionately greater amount of their time contriving ways to make their voice heard by the system. Likewise, their leaders, of whatever party, spend proportionately greater energy and time trying to stir up the passions of voters, and alert them to their direct interest on an issue, than in educating the electorate toward what all know will be the ultimate decision -- a vote by the people.
As a result, not only is the process less educational, for leaders and the people alike, but it results in the feeling that the popular wisdom has been cheated. How many of the major tax votes in the United States, for instance -- 1981, 1986, 1990, and 1993 -- were passed by narrow margins, with many of the decisive votes determined by lobbying and other pressures having little to do with the overall merits of the change? How much was the electorate stirred up and urged by both sides to contact their representatives -- but, in the end, without any direct voice in the outcome? The elitism of this process renders the legislative process more vulnerable to manipulation at the same time that it creates the appearance of a rigged game and alienates the voter from the result.
As a review of the initiative and referendum process suggests, it is more difficult to raise taxes in Switzerland than in perhaps any other country. Yet, taxes are raised and altered from time to time. And when they are, there is less resentment than elsewhere, because the burdens are self-imposed.
The resulting feeling of self-responsibility and accountability by voters is perhaps analogous to the findings of doctors who have studied medication by patients in U.S. hospitals. For many years, the common practice among doctors was to oversee the administration of painkillers closely. Wise physicians, of course, consulted closely with their patients regarding the amounts and timing of the doses. But it was generally thought that the doctor must make the detailed decisions -- their objectivity, and more so their expertise, meant that their judgment would be far superior to that of the patients, who would naturally tend to overdo the doses of such medication in order to relieve their pain.
In studies in the early 1990s, however, doctors decided to give some patients control over the administration of their own painkillers. (The patients were of course monitored to make sure they did not go outside of a certain band of safety; but within that very wide band, they applied the medication to themselves). The result, perhaps not surprising, was that they complained much less about pain than they had when the doctors were administering the medicine -- the complaints dropped to less than one-third of the previous level. Perhaps more surprising, the amount of painkiller used by the patients plummeted. On average, use of the medications fell by more than 40 percent. And in only 10 percent of the cases did use of the painkiller exceed what would have been prescribed by the doctor -- and then, generally, by only small amounts.
Even if a giant computer or highly sophisticated doctor could have somehow determined what patients would have chosen to take and when, the result would not have been the same. It was the feeling and reality of control that enabled patients to ration use of the painkiller in their own. There was no need to complain to the doctor, because each patient knew that in duress, if he or she felt a need for a sudden increase of dose, it was available. While the Swiss do not have the privilege of setting their own tax rates individually, they do enjoy, as a people, a degree of control over the process seen in few other political systems. As a result, tax rates are lower -- but they also arouse less resentment when they go up.
There's a second reason for the relative lack of turmoil over taxes in Switzerland: the high degree of variation in tax rates among the cantons. In the U.S. and most of Europe, the fact that income taxes are largely and in some cases wholly the province of the central government leads to a situation in which there is little variety in tax rates. This can best be understood if we compare tax rate variation in Switzerland to that of another country, such as the United States.
In the United States, a person living in New Hampshire, Florida, or Texas -- three states with no income tax and thus the lowest possible combined rates in the country -- a worker still winds up paying approximately 45 percent of her or his income in taxes.2 If the same person lived in New York or California, which with personal income tax rates close to 10 percent are among the highest tax states, state tax rates (deductible against the federal tax) might push the combined rate up by five or six points in the highest bracket -- for a combined total of a little more or less than 50 percent in the top bracket. All other states fall somewhere in between. Thus, the spectrum of possibility for a high-income earner in the U.S. would be a lowest possible tax rate of 45 percent, and a top possible combined rate of 50 percent. That's not a lot of difference, and it provides little in the way of choice for different people with different preferences. Someone living in New York who really hates high tax rates could move to New Hampshire, but would only be a few percentage points better off. On the other hand, someone living in Texas who misses the high level of social and other services in Massachusetts or California and doesn't mind paying for them can indeed move there. But they may find the milieu less satisfactory than they hoped for, because the uniformity of income tax codes and other revenue sources, a product of both higher federal rates and deductibility of state income taxes has made for a relatively similar picture on the revenue and spending side of most state budgets.
In Switzerland, the combined rate of income tax ranges from as low as 24 percent (Zug) and 26 percent (Schwyz) in some of the older, central cantons to as high as 43 percent (Zurich) and even 46 percent (Geneva) in the largest cities. Not surprisingly, such cantons as Luzern (35 percent), Glarus (35 percent), and Fribourg (36 percent) fall in the middle. The combined spectrum of possible tax rates thus moves up and down by 22 percentage points, or about 90 percent, expressed using the 24 percent lowest top rate as a baseline. (Note: Tax rates mentioned here are rounded off).
This variation contributes, like many other aspects of Swiss federalism, to a subtle and ongoing social peace. Citizens who strongly dislike taxes and prefer the more dynamic but less protective environment of a small local government tend to congregate in the cantons that fit that model. Those who prefer a larger economic role for the state, and don't object to the costs, tend towards Geneva, Zurich, and the cities.
A third important reason for Switzerland's relative calm over taxes is local administrative control of tax payment and enforcement. The Swiss have no equivalent of the U.S. Internal Revenue Service -- a federal agency charged with vast powers to gather information and enforce penalties. There is, in fact, no Swiss "IRS" concerning the income tax at all, and the small tax enforcement office that does exist handles mainly customs issues. The Swiss have a handful of officials that help ensure accurate payment of the value-added tax, but this compares to agencies in Japan, France, and Germany that employ agents into the thousands.
Income taxes are paid to the community, which reports and divides income with the canton; the canton in turn reports and directs income to the federal government. Even at the community level, means of enforcement are few. When asked what they would do if someone were not paying their taxes, or how it would even be discovered, the town council members in Hittnau shrugged. "People would not want to do that in their own community," one of the council members speculated. "It doesn't seem to be a problem -- people not paying their taxes." Indeed, international surveys of corruption and tax problems generally place Switzerland near the bottom of countries with substantial tax avoidance. By contrast, countries with large and powerful tax enforcement administrations, such as the United States, often report significant tax evasion. This problem appears to be acute in countries such as Russia and Nigeria, which have high rates of taxation.
This does not mean, of course, that if other countries were to eliminate their tax collection agencies, a sudden surge of payments would result. The opposite might be the case, unless other aspects of the system were adopted, not to mention the Swiss political culture of what can only be called a kind of local communism. The Swiss insistence on privacy is such that neither federal nor local authorities have access to banking records, even in cases of suspected tax evasion -- which in Switzerland is a civil offense but not a criminal matter, much less a felony. Nor are such matters commonly discussed even in close circles. Asked why such matters do not, for example, get leaked to the press, Ivan Pictet, a respected private investment banker in Geneva, explains that "there is such respect for privacy that one doesn't see that happening." The Swiss appreciate the protections they enjoy, and the fact that their government is constrained -- and so, sensing that to abuse these privileges would be to lose them, they respect the system voluntarily. "People do not want to see a system they like challenged by irresponsible behavior," Pictet continues. He was talking not simply about tax privacy, but privacy in general; and yet, to hear a taxpayer from a Western country describing the tax code as a system the people like is somewhat arresting.
Nearly all income tax systems rely to some degree, usually a large one, on voluntary compliance. The Swiss system, unconsciously, is well suited to this. Unlike consumption taxes or customs, the income tax is an unusually intimate tax, one that touches nearly everyone in society. Yet unlike consumption or property or other taxes it does not deal in the realm of tangibles, of purely physical goods more easily seen and rationalized. For this very reason it is perhaps most suited to the kind of sensitive, intimate treatment as in Switzerland is afforded by the fact of strong, generally popular local government.
One does not want to overdo the tired metaphor that government and community are "like a family," but among the Swiss, there is something to this metaphor. This is particularly so since the level of government that is most active and most real in the life of the average Swiss is that which is smallest and most intimate. The Swiss commune is capable, in scale, activity, and psychology, of acting somewhat like a family.
To recreate these results, one would have to recreate not only Switzerland's minimalist enforcement bureaucracy, but much of the whole society. This would include Swiss federalism, with its weak center and (more important) strong communities. It would also include the system of direct democracy -- and the feeling of popular empowerment that accompanies all these formal institutions. That the Swiss tax code can even function, given the degree to which it relies on the voluntary patriotism of its people is, however, evidence of the inadvertent genius of Switzerland's political arrangements.
Notes 1. The statistics and examples that follow are taken from a survey of world tax codes excerpted in Gregory Fossedal, "What the Tax Reformers are Missing," Wall Street Journal, 7 November 1997.
2. This is the top federal rate of 38.5 percent plus Social Security plus zero rate for state and local income. On paper. Social Security taxes are paid half by the employer, half by the employee, but however they are accounted for, they represent a "wedge" between what the employer pays and what the worker receives.