Tax incentives – a solution to Finland’s shortage of skilled labor?

The Finnish Startup Community recently published a report on tax incentives. In this blog article, I present some key results from the report. The goal of the tax report was to respond to the Finnish Startup Community’s governmental program goals, which state that “Finland needs to study tax incentives to attract international companies and experts.”

The tax report is divided into two parts. The first part examines how immigrants react to tax incentives and what kind of tax incentives are available for highly skilled immigrants in different countries. The second part examines what tax incentive models are used to attract businesses to different countries.

Tax incentives have a positive effect on the immigration of special groups.

In the tax report, my most important policy recommendation is that the current taxation of key employees should be made more attractive so that Finland could increase the level of immigration of top professionals. Economic research literature suggests that the immigration of high-income individuals responds to the taxation of earned income. Carefully conducted research results can be found, for example, in Denmark [1] and the United States [2].

Studies have shown that lowering the top marginal tax rates led to increased immigration of top innovators and that tax incentives targeted at high-income immigrant professionals increased their immigration levels. Top innovators refer to inventors with the highest number of patents and their citations.

Taxation does not appear to have a strong effect on emigration

While taxation may impact immigration, it does not necessarily have the same effect on emigration. According to a study conducted in Finland, even individuals with high incomes do not exhibit a significant response to domestic earned income taxation when deciding to emigrate [3]. Therefore, I advise against implementing broader earned income tax cuts in Finland, as it may not be necessary to prevent the loss of skilled labor.

Based on the research literature, tax incentives are an effective way to attract high-level expertise, but in fears of large emigration, tax rate reductions or progressive tax cuts for the entire population should not be made.

High taxation also has also positive aspects

Tax revenues fund public services that can increase the attractiveness of the country. Such services include, for example, free daycare, basic education, and security. I am convinced that effective public service production matters when migrant labor considers staying in the country for a longer period. I believe that tax incentives can attract skilled labor, but high-quality services and good quality of life will keep them in Finland.

Why should Finland attract special groups with tax incentives?

The presence of top innovators and researchers is often associated with the emergence of research and production facilities, and sometimes even new industry clusters. Economic research has documented the contribution of top researchers to the creation of biotechnology clusters [4] and semiconductor, information technology, and nanotechnology clusters in the United States [5]. Finland needs new innovative and growing industries to increase its productivity and close the public sector deficit.

Moreover, Finland will significantly invest in research and development (R&D) by 2030. The amount of R&D investments planned by the parliamentary R&D working group would mean billions of euros added to annual R&D investments. Over half of the R&D expenditures are wages, which means a massive demand spike for employees who are able to do R&D work. Often these individuals are highly educated and high-skilled labor. Those are the people that Finland should attract from abroad.

Based on research literature, I suggest three statements:

1. Top innovators and highly skilled labor play a crucial role in enhancing the productivity of companies and driving the emergence of new industries.
2. The groups mentioned above are responsive to tax incentives when deciding to immigrate.
3. Domestic labor emigration is not significantly impacted by tight income taxation.

If points 1-3 are true, I believe it is justified to present aggressive income tax incentives to attract foreign special groups, even though there is no justification to make tax cuts for the rest of the population.

On the way to eroding the tax base?

If Finland starts competing with more aggressive tax incentives for skilled labor and top innovators, will this ultimately lead to immigrants not paying income tax anywhere? In principle, there is a risk that the tax base will slowly erode as individual countries outbid each other by offering increasingly attractive tax incentives.

If we look at, for example, attracting top talent and companies from Finland’s perspective only in the short term, I think it would be justified to introduce stronger tax incentives than currently in place. However, if we consider this issue in the longer term, the risk of eroding the tax base exists. The solution to this problem could be inter-country coordination or agreements that jointly agree on minimum tax rates.

Nevertheless, I do not see that tax incentives offered to a limited special group would be an immediate route to eroding the tax base, but in the bigger picture, continuous large-scale tax competition can be harmful.

Read the full tax report here (in Finnish)

References

[1] Kleven, H., Landais, C., Saez, E., Schultz, E. (2014)., Migration and Wage Effects of Taxing Top Earners: Evidence from the Foreigners’ Tax Scheme in Denmark, The Quarterly Journal of Economics, Volume 129, Issue 1, 333–378.

[2]Akcigit, U., Baslandze, S. & Stantcheva, S. (2016), Taxation and the international mobility of inventors, American Economic Review 106(10), 2930-81.

[3] Kalin, S., Kauppinen, I., Kotakorpi, K., & Pirttilä, J. (2022). Migration and tax policy: Evidence from Finnish full population data.

[4] Zucker, L. G., Darby, M. R., & Brewer, M. B. (1998). Intellectual human capital and the birth of US biotechnology enterprises. The American Economic Review, 88(1), 290.

[5] Zucker, L. G., & Darby, M. R. (2006). Movement of star scientists and engineers and high-tech firm entry.