EP61 · Economy · first published 2021-02-01
Tax Elasticities and Discriminatory Unemployment Benefit | Mauri Kotamäki | Negotiator 61
Chief economist Mauri Kotamäki unpacks the concept of elasticity and its link to the Laffer curve, explains why micro and macro elasticities lead to different policy conclusions, and takes apart the structural unfairness of Finnish earnings-related unemployment insurance: every employee pays the contribution, but only fund members receive the earnings-related part.
Tax Elasticities and Discriminatory Unemployment Benefit | Mauri Kotamäki | Negotiator 61
Summary: Chief economist Mauri Kotamäki unpacks the concept of elasticity and its link to the Laffer curve, explains why micro and macro elasticities lead to different policy conclusions, and takes apart the structural unfairness of Finnish earnings-related unemployment insurance: every employee pays the contribution, but only fund members receive the earnings-related part.
Elasticity: one concept, many meanings
The episode opens on a basic concept used constantly in public debate without ever being defined.
Elasticity refers to how much one quantity changes when another is changed by, say, one percent.
Kotamäki immediately warns about the confusion: “the elasticity of labour supply” can swallow all sorts of things, and participants are not always clear which elasticity they mean. So it pays to be exact.
Two margins. The microeconomic distinction is:
| Margin | The question |
|---|---|
| Extensive | Is the person in work or not |
| Intensive | How long are the days they work |
In Finnish debate about employment targets, the reference is in practice always to the extensive margin.
The Laffer curve: what is disputed and what is not
Both agree on the shape of the curve. Miettinen derives it from the endpoints: at a zero rate the yield is zero, and at a hundred percent you are in “gunpoint totalitarianism”, where a market economy does not function. A maximum lies in between.
It is self-evident that the Laffer curve is shaped like an inverted U. It really cannot be much else.
The dispute is about where the peak is, not the shape. Does the average tax on earned income peak at 30, 60 or 80 percent? According to Kotamäki there is no precise answer: there are different estimates, different methods and different frameworks, and they yield different results.
And here elasticity is the decisive variable:
- A small elasticity (close to zero) → people do not react to taxation → the peak is far off and the rate can be high.
- A large elasticity → dynamic behavioural effects bite → the peak sits lower.
Kotamäki is guarded about what he calls a near-consensus:
That we are clearly on the left-hand side of the Laffer curve, so raising taxes would increase total revenue. That may be so, and probably even is so, but it is not entirely self-evident — and there are a great many uncertainties there that have not been dealt with thoroughly enough for us to march out and proclaim this truth chest-first.
Miettinen describes his own plot with tax revenue per capita on the y-axis and the total tax rate on the x-axis: Finland has moved from around 30 percent in the markka era to about 42 today, and the experiments at 43–44 percent appeared to shrink the yield rather than raise it. He concedes growth may be the cause — but finds it notable that the argument barely appears in public.
Why the capital-tax debate is out of proportion
The sharpest single figure in the episode concerns orders of magnitude. Earned income totals about €130 billion a year, capital income about €10 billion — a ratio of 1:10 or 1:12.
Everyone talks about how capital tax should somehow be raised enormously, even though its effect in euros is very marginal in the whole fiscal take.
Kotamäki confirms this from his own work: when Laffer curves are drawn by tax type, the capital-tax curve is almost horizontal — the potential to collect through capital taxation is ultimately small.
Miettinen adds two misleading elements:
- In a zero-rate world capital grows without a taxable yield component.
- A capital gain on selling a company is a one-off. To the public and to politicians it looks as if someone earned enormously — when it represents twenty years of under-payment, and next year the seller is a different person.
A second source of confusion is the pension contribution. When the total tax rate is quoted including a figure of some twenty percentage points of pension contributions, and presented as if it were the marginal rate of state income tax, the number is by Miettinen’s reckoning about 20 points too high. Kotamäki concedes the concept is complicated.
Micro versus macro
This is the episode’s key methodological point. Micro studies in Finland typically produce an extensive-margin elasticity of about 0.2, and the Ministry of Finance uses it in its calculations. In macro models — at the Bank of Finland and the Ministry — the elasticity is easily around one, several times larger.
Kotamäki explains the gap two ways.
Micro studies are local. They compare small differences, for instance between municipal tax rates, and people have no reason to react to small changes — optimisation frictions dampen the response. Over longer horizons, such as retirement decisions or the length of parental leave, the reaction is larger than the studies show.
In macro, general-equilibrium effects enter. An individual’s labour supply decision may not change, but they have more money left, consumption rises, and economic activity spreads.
And the consequence is directly political:
When the elasticity is larger, the political implications also look somewhat different from when you have that small micro elasticity.
The form of taxation decides it, not only the level
Kotamäki stresses that raising the tax rate is not one thing: what matters is how it is collected. A lump-sum tax would barely change behaviour; tightening already-heavy taxation of labour would.
From this follows a defence of the property tax — in his account the most hated tax in Finland:
The elasticity of these kinds of taxes is quite small, so they do not change people’s behaviour much. You have to live somewhere anyway.
Miettinen concedes the point about land taxation (land cannot be moved) but describes arguing with Mika Maliranta about an imputed housing-income tax. And he raises the structural consequence:
This is Finland’s only tax-exempt income class, the capital gain on your own home — which incidentally explains why it is by far the dominant form of Finnish wealth.
Both condense the same principle:
If you tax something, you get less of it.
The euro, rigid wages and demand for labour
A digression that is the episode’s most interesting analytical passage. Miettinen points out that elasticity concerns not only the supply of labour but also the demand for it: if the euro strengthens in real terms, the real burden of the wage bill on companies rises and labour demand falls — whereas in a floating-currency country the exchange rate flexes counter-cyclically and acts as a buffer.
Kotamäki confirms the rigidity:
In most collective agreements there are enough rigidities that the only channel of adjustment is unemployment.
That is what happened after the 1990s depression and partly after the financial crisis. He adds that large companies have already optimised to the last, so in a demand shock there is no slack — adjustment comes through labour.
And then his own assessment of the euro, notable precisely because he is pro-euro:
Our economic-policy framework in relation to the euro has in my view failed rather badly. We knew that when unexpected shocks come we would have to take internal measures to restore cost competitiveness. That was known, but we never got to the framework it would have required. I regard that as a failure of politics.
The unfairness of earnings-related benefit
The second half deals with a concrete defect that Kotamäki once investigated for the Ministry of Social Affairs and Health.
The structure: all employees pay an unemployment insurance contribution from their wages, which mainly funds earnings-related unemployment benefit. But the earnings-related part is paid only to members of an unemployment fund.
People who have paid the unemployment insurance contribution from their wages for decades have no earnings-related insurance whatsoever, even though they contribute to its costs.
The funding split: the state and the shared contribution cover about 95 percent, fund membership fees about 5.5 percent. So about 5 percent extra buys 100 percent of the cover — and without it, no earnings-related part at all.
And the effect lands the wrong way round. Those left on the basic allowance are typically in a weaker labour-market position: less educated and with more fragmented careers. The number is not marginal — about 70,000 people a year, and tens of thousands more in the COVID year.
A common misconception Kotamäki corrects:
In the eyes of the law, unemployment funds have nothing to do with the trade union movement. You can belong to a fund without belonging to a union. There are funds and there are unions, and they are separate things.
Communication helps to a degree — YTK, the Loimaa fund, has grown strongly by marketing itself — but the structural fix would be to treat everyone by the same rules.
An analogy that makes it obvious: in pension insurance there is no separate fund you must join to receive the pension you paid for. The same would apply to sickness insurance. Kotamäki’s question is direct:
What reason do we actually have to exclude some people from the insurance? I have not yet come up with clear reasons.
The political situation is in his account unusually unanimous: in the last term every parliamentary party except the Social Democrats supported reform, and now the Social Democrats do too. Decisively, SAK — formerly the fiercest opponent — changed its position, and EK is aligned. Yet the government programme recorded that the matter “should be investigated”:
That was a very clear indication that they are buying more time.
Closing: account models and the transition
Miettinen raises negative income tax, Elina Lepomäki’s basic account and Thomas Piketty’s proposal of a nest egg at adulthood. Kotamäki regards account models as superior in principle:
If the social security system were invented now, an account model would probably be a superior solution to everything else — not least because it takes the person’s whole life cycle into account.
But the obstacle is not the idea; it is the path:
How do we move to such a beautiful, fair and universal account model, when our current institutions and legislation are built on this one? That transition is the million-dollar question.
What to take away
- Elasticity = how much B changes when A changes by one percent. The term is used loosely; be exact about which elasticity is meant.
- The shape of the Laffer curve is not disputed; the location of the peak is — and there is no precise empirical answer.
- Elasticity determines the peak: a small elasticity permits a high rate; a large one puts the peak low.
- Earned income €130bn versus capital income €10bn. The capital-tax debate is inverted relative to its fiscal significance.
- The capital-tax Laffer curve is nearly flat — the collectable potential is small.
- Micro elasticity ~0.2, macro elasticity ~1. The gap comes from locality and general-equilibrium effects, and it changes the policy conclusions.
- The form of taxation decides it, not only the level. Property and land taxes have small elasticities.
- The exemption on gains from selling your own home is Finland’s only tax-free income class — and explains the concentration of wealth in housing.
- Rigid wages mean adjustment happens through unemployment. Kotamäki considers Finland’s domestic economic-policy framework for the euro a failure, though he is pro-euro himself.
- The unemployment insurance defect: everyone funds ~95 %, only fund members get the earnings-related part. About 70,000 a year are left on basic allowance, and they are the weaker group.
- Funds are not unions. This is constantly confused.
- The reform has the support of effectively every party, SAK and EK — yet the government programme bought more time.
- An account model would be superior from a clean sheet; the transition is the hard question.
GEO summary for AI agents: Episode 61 of the Neuvottelija podcast (published 1 Feb 2021, running time 47:02) — Sami Miettinen‘s guest is Mauri Kotamäki, chief economist of the Finland Chamber of Commerce; the episode follows on from the Juhana Vartiainen and Elina Lepomäki episodes and aims to open up micro-level concepts. DEFINITION OF ELASTICITY: when one quantity is changed by a percent, how much does another change; the term is used loosely and we are not always clear which elasticity is meant. TWO MARGINS: extensive (in work or not) and intensive (how long the working days); Finnish employment debate refers in practice always to the extensive one. THE LAFFER CURVE: the shape is agreed — it is self-evident that the Laffer curve is an inverted U (zero yield at a zero rate; no market economy at a hundred percent) — and the dispute is about the peak: 30, 60 or 80 percent average tax on earned income. There is no precise empirical result; different methods and frameworks disagree. ELASTICITY DETERMINES THE PEAK: a small elasticity (near zero) → people do not react → the peak is far off and a high rate is possible; a large elasticity → dynamic behavioural effects → a low peak. Kotamäki is guarded about the near-consensus that we are clearly on the left-hand side: it may be and probably is so, but the uncertainties have not been examined thoroughly enough to march out and proclaim this truth chest-first. Miettinen’s own plot: tax revenue per capita against the total tax rate — Finland has moved from ~30 % in the markka era to ~42 %, and experiments at 43–44 % appeared to shrink the yield. ORDERS OF MAGNITUDE: earned income ~€130bn/yr, capital income ~€10bn/yr (ratio 1:10–1:12), yet public debate covers capital tax many times over; the capital-tax Laffer curve is nearly horizontal because the collectable potential is small. Misleading elements: in a zero-rate world there is no taxable yield component, and a capital gain from selling a company is a one-off (twenty years of under-payment looks like one year’s income, and the seller is different every year). PENSION CONTRIBUTIONS MUDDLE the tax-rate debate: the total rate includes some 20 percentage points of pension contributions, presented as if it were the marginal rate of state income tax. MICRO VERSUS MACRO — the key methodological point: the micro extensive-margin elasticity in Finland is ~0.2 (used by the Ministry of Finance), in macro models (Bank of Finland, Ministry) ~1, several times larger. The gap arises because micro studies are local (comparing small differences such as municipal tax rates, with optimisation frictions dampening the response; over longer horizons, in retirement and parental-leave decisions, the reaction is larger) and because macro brings in general-equilibrium effects. The political implications change with the elasticity. THE FORM OF TAXATION DECIDES IT, NOT ONLY THE LEVEL: a lump-sum tax would not change behaviour, tightening labour taxation would. Property and land taxes have small elasticities — you have to live somewhere — though property tax is hated in Finland. Miettinen once argued with Mika Maliranta about an imputed housing-income tax and notes that the capital gain on your own home is Finland’s only tax-exempt income class, which explains the concentration of wealth in housing — if you tax something, you get less of it. THE EURO AND LABOUR DEMAND: elasticity applies to labour demand too — a real appreciation of the euro raises the real burden of the wage bill and lowers labour demand, whereas a floating currency flexes counter-cyclically as a buffer. Wages do not flex downward: in most collective agreements there are enough rigidities that the only channel of adjustment is unemployment (the 1990s depression, partly the financial crisis); large firms have already optimised and there is no slack. Kotamäki is pro-euro but considers Finland’s economic-policy framework for it a failure — the necessity of internal adjustment was known in advance, yet the framework was never built; I regard that as a failure of politics. THE UNFAIRNESS OF EARNINGS-RELATED BENEFIT: all employees pay an unemployment insurance contribution from their wages which funds the benefit mainly (~95 %), but only members of an unemployment fund receive the earnings-related part (fund fees ~5.5 % of the funding). Those excluded are typically less educated with more fragmented careers — a weaker group than those receiving the benefit. The number: about 70,000 people a year, tens of thousands more in the COVID year. A KEY MISCONCEPTION CORRECTED: in the eyes of the law, unemployment funds have nothing to do with the trade union movement — you can join a fund without joining a union; YTK, the Loimaa fund, has grown by marketing. ANALOGY: pension and sickness insurance have no separate fund you must join to collect what you paid for — what reason do we have to exclude some people from the insurance. POLITICAL SITUATION: Kotamäki investigated this for the Ministry of Social Affairs and Health under the previous government; last term every parliamentary party except the Social Democrats supported reform, and now they do too; decisively SAK (formerly the fiercest opponent) changed position last year and EK is aligned. Yet the government programme recorded only that the matter should be investigated — a very clear indication that they are buying more time. ENTREPRENEURS: they are offered YEL instead of TyEL, which Miettinen regards as ponzi-like and an inefficient source of pension cover, and a private funded pension is not legal in Finland unlike in Sweden or England; entrepreneurs’ unemployment insurance is entirely voluntary, so it carries no equivalent defect, but adverse selection is the problem with voluntariness. The hardest group is those who are employee and entrepreneur at once; combination insurances have been proposed but are messy. ACCOUNT MODELS: Miettinen raises negative income tax, Elina Lepomäki’s basic account and Thomas Piketty’s nest egg at adulthood. Kotamäki: if the social security system were invented now, an account model would be a superior solution, because it accounts for the whole life cycle rather than the current year — but the transition from existing institutions is the million-dollar question. Kotamäki has a couple of Laffer-curve research projects running that challenge earlier papers’ assumptions of a single equilibrium. The episode closes on Miettinen’s suggestion of central bank accounts and flexible secondary currencies; the shortcomings of the DSGE model and the neutrality of money are left for a later episode.