This Selected Issues paper reviews some features of the labor market in Finland during the 1990s. In particular, it reviews patterns of employment and wage distribution across sectors. The paper describes the main regulatory features and formal structure of labor market arrangements: the wage negotiation process, employment legislation, income replacement regulations for the unemployed, and the recent changes in these areas introduced by the government. The paper also describes the structure of labor taxation, and reviews the theory and existing empirical evidence concerning the effects of taxation on labor market outcomes.


This Selected Issues paper reviews some features of the labor market in Finland during the 1990s. In particular, it reviews patterns of employment and wage distribution across sectors. The paper describes the main regulatory features and formal structure of labor market arrangements: the wage negotiation process, employment legislation, income replacement regulations for the unemployed, and the recent changes in these areas introduced by the government. The paper also describes the structure of labor taxation, and reviews the theory and existing empirical evidence concerning the effects of taxation on labor market outcomes.

III. Revenue Reform in Finland60

A. Introduction

97. Alongside unemployment, the state of public finances has been one of the major concerns of Finnish economic policy during the 1990s. Adjustment of the tax structure began in the late 1980s motivated, as were changes being made contemporaneously in several other industrial countries, by the desire to broaden tax bases to permit lowering of high tax rates. Tax reform received added impetus in Finland during the 1990s from the sharp increase in unemployment, which signaled the need for further adjustment. A related goal was the improvement of the economic efficiency of the tax system by introducing symmetric treatment of all types of income from capital. This involved reducing the degree to which housing capital was favored relative to other assets, improving the taxation of large and small companies, and rationalizing the treatment of interest income and expense.

98. One purpose of this chapter is to describe and assess these changes in the tax system over the last decade. However, the chapter also looks ahead at possible further reforms. Taxes and social security contributions that are levied on labor income remain high, and impede employment growth. Offsetting the revenue loss arising from cuts in labor taxes may require, together with expenditure cuts, some increases in other tax revenues. Thus a second purpose of this chapter is to discuss the scope for revenue-enhancing reforms in corporate and capital income taxation through base broadening, and through increased reliance on the property tax. Taxation of labor income is by far the major revenue source for municipal governments in Finland. In addition municipalities are assigned constitutionally major responsibilities in the area of social and welfare expenditure, and an elaborate system of grants from the central government have evolved to aid municipalities in meeting these responsibilities. Therefore, a reduction in the overall level of taxation and expenditure will require significant changes in the structure of local revenue and outlays. Thus, a third purpose of this chapter is to describe and assess the recent reforms in the system of grants to municipalities from the central government, particularly with regard to the incentives to increase the level of expenditure they present to municipalities.

99. The next section presents an overview of the evolution of the revenue structure in Finland in the last decade, and compares the current structure to the one that prevails in the EU. The following sections examine a number of selected issues in more detail, to assess the reforms and to identify directions for further reform. These comprise changes in the municipal revenue structure, as well as changes in the taxation of capital income, including the corporate income tax, the taxation of small business, and at the personal level the taxation of interest income and expense, and of housing. There are a number of public policies other than taxation that significantly affect the demand for and supply of housing, and these have during the 1990s worked, to some extent in the direction opposite to that of the tax changes. These other policies are also examined in this chapter. The effects of reducing the burden of taxation on labor income are examined in detail in Chapter 1.

B. Evolution of the Structure of General Government Revenue

100. Table 18 shows the evolution of government revenue in Finland over the period of reform, and compares the current state to the situation in the EU average. It compares the structure of taxation of general government in 1995 with what it was in 1985, before the reform, both in terms of shares of tax revenue and also in terms of shares of GDP. The first thing to notice is that the tax burden has continued to increase through the period of reform. The ratio of tax revenue to GDP rose 5 percentage points between 1985 and 1995, to 45.8 percent. This places Finland about three percentage points above the EU average (EU-15). Many of the EU-15 countries have also gone through fundamental tax reforms during the period, but the growth of revenues has not been as strong as in Finland; indeed the Finnish ratio and the EU-15 ratio were roughly equal in 1985 (40.3 percent for EU-15, compared to 40.8 percent for Finland).

Table 18.

Source of Tax Revenue in Finland and in the European Union

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Source: OECD: Revenue Statistics, 1996 Edition.

Sum for EU includes other taxes on income and profit.

101. A second relevant feature is that the reforms have shifted the burden of taxation to social security contributions and away from income and consumption taxes. As Table 18 indicates, in 1985 about 45 percent of revenue came from taxes on income and profit, while 17.4 percent came from social security taxes, and 34 percent from taxes on goods and services. By 1995, only about 40 percent of tax revenue came from taxes on income and profit, reflecting in particular the declining share of the personal income tax (PIT), and only about 30 percent from taxes on goods and services, while the share of social security contributions has increased by almost 10 percentage points. Indeed, the growth in tax revenue as a share of GDP in Finland is almost completely accounted for by the increase in social security contributions, as the right-hand section of Table 18 shows. The shift toward social security contributions reflects the pressure on social welfare expenditures arising from higher levels of unemployment, the aging of the population, and other social changes. Moreover Finland during the 1980s, in common with several other countries, increased the value of social security benefits, in particular the value of unemployment benefits relative to earnings, adding to the pressure.

102. A third feature is that, despite the reform, the PIT remains much more important in Finland than in EU-15, while corporate taxes, social security taxes and property taxes are less important. In particular, the relatively lower share of the corporate income tax reflects the fact that the effective corporate tax rates in Finland are among the lowest in the European union.

103. A fourth feature is that the reforms have kept the ratio of revenue from taxes on goods and services constant relative to GDP. Thus, an often-stated guiding principle of reform, to shift taxation away from income toward consumption, has not occurred. The major reform in indirect taxes in Finland was in bringing the form of the general sales tax closer to that of a VAT, and in broadening base, in particular by making services and construction taxable, while granting credits to businesses for tax paid on investments. This broadening of the VAT base kept the general sales tax ratio constant; increases in excise tax revenue also kept the relative importance of general and specific taxes constant. In other countries, there has been a tendency over the period for VAT revenue to become relatively more important than specific taxes.61

104. Together with significant changes in revenue shares the tax reforms also involved deep changes in the features of the most important taxes. The most profound changes affected the taxation of corporate and personal incomes. At the corporate level the tax base has been broadened and the tax rate reduced. Specifically, the system of deductions for deposits to earmarked reserves has been substantially abolished, a number of other incentive schemes have been limited or abolished, and depreciation has been brought more closely into line with economic depreciation. Between 1985 and 1995 the combined (central government plus municipal government) tax rate on corporations fell in a number of stages from a range of 57–63 percent to a single rate of 25 percent (28 percent beginning in 1996). As Table 18 shows, in terms of revenue the base broadening dominated, so that the share of total tax revenue raised from corporations increased slightly over the period, as did the ratio of corporate tax revenue to GDP.

105. As with other taxes, a major goal of the reform of the personal income tax was to broaden the base in order to lower tax rates. Another important goal was to reduce the uneven treatment of different types of capital income under the tax. The prereform tax system conferred a sizable preference to owner-occupied housing, and the tax deductibility of interest payments (for borrowing to buy assets yielding in principle taxable income, but also for purchases of housing, and even to some extent for current consumption expenditures) meant that the taxation of capital income at the personal level raised little or no net revenue. At the same time, corporate-source capital income was taxed twice, as dividends paid out of after tax corporate profits were taxed again at the personal level. The major reforms were the following:

  • to improve the taxation of capital, the comprehensive income principle was abandoned beginning in 1993 with the establishment of a separate scheduler tax on capital income, to which all types of capital income would in principle be subject. Capital income was made taxable at a flat uniform rate for all taxpayers, that was equal to the corporate tax rate, and lower than the marginal tax rate on labor income for most taxpayers. At the same time, the taxation of small business was reformed;

  • The double taxation of dividends was eliminated for domestic shareholders by the introduction of an imputation system;

  • The base for the taxation of labor income was broadened by eliminating certain deductions, including fringe benefits in the base to a greater degree, and restricting interest deductibility against labor income;

  • Marginal tax rates were reduced, as were the number of tax brackets. The top marginal tax rate was reduced by almost 12 percentage points, to 56.5 percent in 1995 (39 percent central, plus an average municipal tax rate of 17.5 percent). At the same time, the number of tax brackets at the central level was reduced from 11 to 6; increased personal exemptions and a wider zero-tax band reduced the average tax rate at the lower end of the income scale.

106. As indicated earlier, the net effect of the shift to a broader tax base with lower tax rates has been to keep PIT revenues approximately constant as a share of GDP. However, tax rates on labor income remain higher than in the European countries, while the maintenance of a number of preferences, including for investment in owner-occupied housing, capital gains and voluntary pension contributions, and the introduction of new preferences, including for bank deposits, have limited the growth of the base.

C. Municipal Fiscal Issues

107. The reform period has seen changes in the tax structure of municipalities and in the nature of their relations with the central government. This section describes briefly the nature of the changes made and the current structure of municipal tax revenue and of transfers from the central government.

108. In recent years overall fiscal performance of the municipal sector has been strong, reflecting a tradition of conservative management and the supportive nature of the state transfer program. However, beginning in the early 1990s, the sector was confronted by a number of challenges, including a surge in unemployment, which significantly increased demands on municipalities’ social welfare functions; and the central government fiscal consolidation program, which has resulted in lower transfers to municipalities. Local governments dealt with fiscal pressures through some tax increases, and through expenditure restraint, in particular on capital and wage expenditures. This combination of policies has enabled the sector to maintain modest overall budgetary surpluses during 1993–96 (Table 19). However, in part because of further reductions in state transfers to municipalities in 1997, the municipalities are expected to record a smaller aggregate budget surplus this year.

Table 19.

Finland: Municipalities’ Revenue and Expenditure,1993–961/

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Sources: Ministry of Finance, Economic Survey 1996; and data provided by the Finnish authorities

On a national accounts basis.

Imputed social insurance contributions and casualty insurance benefits.

Casualty insurance premiums, pension expenditure and interest.

Includes purchases of land and changes in inventories.

Municipal structure

109. Local self-government is guaranteed in the Finnish Constitution. The basic units of local government are the municipalities. Altogether there are 452 municipalities, ranging in size from a few hundred persons to about half a million. Municipal councils are elected every four years, in direct proportional elections. The practical administration of municipalities is carried out by executive boards elected by the councils. Local authorities are charged to provide basic services for community residents. They run comprehensive schools, upper secondary schools and vocational institutes. They provide adult education, libraries, cultural and leisure services, child day care, care for the elderly and disabled, socially targeted housing and income support. Local authorities also operate health centers that provide primary and secondary health care, and dental care services. In addition, they are responsible for street maintenance, water supply and sewerage, waste disposal and energy supply, and some environmental regulation. They also supervise land use and building activity within their areas.

110. There is no elected regional level of government. Instead, municipalities cooperate in the provision of certain services by establishing joint municipal boards. Some regional cooperation is required by law. For instance, hospitals are run by joint municipal boards that municipalities are required to belong to. Also, regional development and planning is required to be undertaken by joint boards called regional councils. Currently there are 270 joint municipal boards and 19 regional councils, in addition to the autonomous province of Aland. In addition to their statutory responsibilities, regional councils promote the interests of their regions and perform a broad variety of voluntary functions, such as the promotion of tourism and some cultural activities.

111. Municipal governments and joint municipal boards employ 400,000 people, which is about 20 percent of total employment in Finland. Over 80 percent of municipal employees are engaged in the provision of municipal services in the areas of education (30 percent of total employment), social welfare (26 percent) and health (29 percent). During 1990–93, the number of municipal employees fell by over 10,000 per year, but since 1994 there has been a small increase, on account of an increase in the number of part-time employees and those employed under employment subsidy schemes introduced by the central government. About 80 percent of municipal employees have permanent positions. With regard to salary determination, more than half of all municipal wage-earners fall within the sphere of the general national municipal collective agreement. Teachers, doctors, technical staff and employees paid by the hour have separate collective agreements.

112. Municipalities possess independent taxation rights. Since 1993, local authorities have raised between 50 and 60 percent of their annual revenue from own tax sources, and this ratio has been rising over time (Table 19). However, the proportion varies significantly across municipalities, from about 30 percent to over 75 percent. Government grants are the second major source of income for local authorities, accounting for 35–45 percent of total revenue since 1993, although the importance has been falling over time. Fees and sales revenue make up the final source of revenue for municipalities.

Municipal finance

113. Local authorities levy a municipal personal income tax and a real property tax. In addition, each municipality receives a share of the corporate tax revenue collected by the central government.

Municipal personal income tax

114. Municipal income tax, the dominant source of local own-tax revenue, is levied at flat rates on the earned income of individuals (thus excluding capital income) and the estates of persons deceased during the year. The base for the tax is determined by the central government, but the municipality has autonomy on the tax rate, within a certain range. Earned income includes salaries and wages, fringe benefits, pensions, the earned income share of business and agricultural income, and the earned income share of dividends of nonlisted companies, as well as scholarships and awards, forestry income, royalties and similar remuneration. There are a number of standard deductions, the most important of which is the earned income allowance that for 1997 allows a maximum deduction for annual earnings below about Fmk 35,000, and which declines gradually to zero, at an annual earnings level that exceeds Fmk 250,000. The tax rate is set annually in advance for the following year in each municipality by the municipal council. For 1997, the tax rate varies between 15 percent and 19.75 percent, with an average rate of 17.43 percent. The revenue raised from the final tax at source on interest income accrues entirely to the central government, and, correspondingly, interest expense and corporate income tax paid on dividend distributions is creditable only against central income tax.

Real property tax

115. A general tax on real property has been in force since 1993.62 The tax is levied on almost all real property, with important exemptions being forests and agricultural land. The tax due is determined by the taxable value of each property and by the tax rates set annually by each municipal council, within statutory limits. For the most part, value is determined by the value assessed for purposes of the central government’s wealth tax. The tax rate has an upper and lower limit prescribed by legislation. For 1997, the average tax rate based on the assessable value of property is 0.47 percent, the tax rate for permanent residential buildings is 0.22 percent, and the tax rate for second homes and related structures is 0.67 percent. Municipalities can also apply a higher real estate tax rate on power plants, with a ceiling of 1 percent on conventional power plants, and a ceiling of 1.8 percent on nuclear plants.

Other own-revenue

116. In addition, the revenue raised by the center from corporate income tax is distributed between the State (51.8 percent), the municipalities (44.8 percent) and the two main religious denominations. The municipalities’ share of corporate income tax is distributed among municipalities according to fixed shares, mainly based on the revenue received by municipalities from their own corporate income tax prior to the abolition of the municipal corporate income tax in the tax reform of 1992.

117. Local governments also derive revenue from charges and fees for managing local energy and water supplies. Local governments also operate other businesses such as ports, public transport, telecommunication and sewage networkers. These activities are sometimes handled via a majority holding in a limited company. Similar to the setting of local taxes, the governments have significant power in determining fees and charges.

Evaluation of own-revenue sources

118. The arrangements for sharing PIT revenues are well-designed. In particular, given the potential mobility of the tax base, the existing restrictions—the exclusion of capital income from the base, and the tax rate limits—have the desirable effect of limiting the degree of tax competition among localities.

119. However the share of revenue raised by the real property tax is modest by international comparison (Table 18). The normally recognized reasons for the attractiveness of property taxation at the local level include: (i) immobility of the tax base hampers evasion and permits variation of tax rates among jurisdictions; (ii) the tax is linked to benefits received; (iii) the tax is visible; (iv) the yield is predictable, and (v) it is relatively easy to administer. In the Finnish case the attractiveness of the tax is enhanced by the fact that the base is already being valued for purposes of the annual wealth tax.

120. The current distribution rule for municipal corporate income tax revenue is understandable as a transition rule, but lacks flexibility. In its current form, revenue from this tax is, from the point of view of a municipality, little different than a lump sum payment, that is unrelated to the current level of activity in the municipality. The fact that the municipality has no choice over the tax rate or the definition of the base limits tax competition and tax exporting. However, as the tax is, to some extent, a charge for services provided to companies by municipalities, other jurisdictions have adopted rules to match more closely a lower level government’s share of the revenue with its share of corporate activity. One possible solution, that has been adopted in a number of federal countries, ^involves the adoption of some form of the so-called formula apportionment system, that determines a jurisdiction’s share of the local tax paid by a company according to factors such as the share of the firm’s capital, payroll or sales accounted for by the jurisdiction.

Intergovernmental grants for current expenditures

121. Local authorities receive three types of direct subsidies out of central government funds: first to assist all municipalities in meeting current expenditures arising from major statutory duties, in particular in education, health and social welfare; second, to allow poorer municipalities to provide a reasonably comparable level of local expenditures without the necessity of levying municipal tax rates much higher than the average (commonly called “equalization” grants); and third to share the cost of approved municipal capital expenditures. In 1996, central government grants to local authorities totaled Fmk 34 billion (6 percent of GDP and 35 percent of total municipal revenue). Of the total, Fmk 1.6 billion represented capital transfers, and the remainder made up of grants for current expenditures and equalization.

122. The grants system has gone through two recent revisions, in 1993 and again in 1996–97. Prior to the first reform, a community’s grant for a specific category of current expenditure depended on that community’s actual expenditure in that category. The major change in the 1993 reform was a shift from this cost-based system of grants earmarked for specific purposes to a system of grants based on historical expenditure in the category averaged over all municipalities. In this way, the size of a municipality’s subsidy no longer depended on its actual expenditures. The 1996–97 reform introduced some further changes to the grants formulae for specific categories, and changed the basis for equalization grants. Prior to 1996 all municipalities were assigned to a number of “financial capacity” categories, on the basis of a number of factors, in particular on the size of the income tax base in the municipality. The size of a community’s grant was determined on the basis of its category. Under the new formula, a municipality’s per capita grant is determined by the magnitude of its tax base relative to the average per capita tax base of all municipalities, and the average of the tax rates over all municipalities. A novel aspect of this approach to equalization is that communities that possess higher than average per capita tax bases receive negative grants, so that the program represents to some extent a direct transfer of resources from richer to poorer municipalities.63

123. There are three main types of grants for current expenditure. These are: (i) the State subsidy for education and culture; (ii) the State subsidy for social welfare and health care; and (iii) the general State subsidy.64 The education and culture subsidy aims to cover 57 percent of municipal expenditures. Expenses are based on actual average national expenditures per student in 1993, for a number of different categories of students. In principle, the historical expenditures are to be updated annually by a system of index adjustments, that depend on increases in municipal wage costs and in consumer prices, but the central government decided in 1995 and 1996 to forego these adjustments. Adjustments will be made for 1997, and it is intended to also make the adjustment for 1998. The size of a municipality’s grant is then determined by the calculated per student expenses, the number of students in the jurisdiction, and the sharing ratio between the local governments and the central government.65

124. The formulae for state subsidies for social welfare (primarily day care and geriatric care) and health services (primary health care and hospital expenses) is of a similar form. Per member expenses in a category are based on actual expenditures in that category in 1993, increased by index adjustments. The categories are determined by age structure, and the municipality’s grant depends on the number of residents in that category. The central government’s sharing ratio is 25 percent for 1997.66 In calculating the grant for social welfare the municipality’s unemployment rate is also taken into account, and for the health care grant the municipality’s morbidity factor is also considered.67 In addition a number of special factors related to a municipality’s geographic location and the dispersion of population are taken into account.

125. The general State subsidy is the smallest of the three current expenditure grants to municipalities. It amalgamates subsidies for a large number of smaller municipal expenditures (e.g., fire and rescue services, traffic subsidies for large cities), and in addition takes account of special costs related to peripheral or archipelago location or bilingualism. As with the other subsidies, it is based on historical per capita cost, with an index adjustment.

Evaluation of the grants system

126. The reforms of the transfer system have improved the targeting of the transfers to the municipalities most in need, while significantly improving the incentive properties for municipalities in terms of both their tax rate choices and their expenditure decisions. The equalization system, by using national average tax rates rather than the community’s actual tax rate, ensures that a community does not loose equalization grant revenue when it increases its own tax rate. Thus the grant does not discourage tax effort on the part of municipalities, and the formula comes closer to compensating for differences in municipal tax capacity. With regard to grants related to particular expenditures, the grant is no longer a direct subsidy to local expenditure, so that municipalities now face a unit price for the service corresponding to the resource cost of provision.

127. A novel aspect of the Finnish equalization grant system is that it embodies negative grants for municipalities whose tax bases exceed the national average. As a consequence, the central government revenue system does not have to bear the total costs of ensuring that citizens in all communities have access to reasonably comparable levels of services at comparable tax rates.

128. The system is flexible enough to accommodate reductions in the level of transfers from the central government to the local governments. To the extent that local tax revenues will increase in response, the equalization formula will respond to offset disparities arising from differences in municipalities’ tax capacities.

129. At the same time, the potential allocative cost of the equalization of tax capacities must be appreciated. Equalization affects the distribution of economic activity and of residents across the municipalities in the nation. As a consequence, in certain circumstances, it may delay adjustment in regions that have suffered a permanent adverse shock to their economic base; and conversely it may make it harder for regions that have received a positive shock to attract additional resources and population.

D. Reform of the Taxation of Capital Income

130. The prereform tax system in Finland had been characterized by liberal rules for interest deductibility combined with favorable tax treatment of certain types of capital income, most notably the return to owner occupied housing. This differential treatment of types of saving led to intersectoral misallocation of capital, and, at the same time, yielded little or no net revenue.68 Corporate source income was taxed at high rates, and tended to be taxed twice, once at the level of the corporation, and again at the personal tax level as dividend distributions and/or capital gains on share sales. The reforms beginning in the late 1980s attempted to address these problems, to improve the allocation of investment, at the same time, shifting more of the burden within the personal income tax onto the taxation of capital incomes.

131. The most important of the early changes was the introduction of the imputation method for corporate dividend taxation, which had the effect of taxing corporate distributions to residents once, at the personal tax rate of the recipient. In addition, the corporate tax rate was reduced significantly, and the tax base was broadened by eliminating a number of deductions from income for deposits into a variety of earmarked reserve accounts. As noted in Section B, in 1993 personal income taxation moved toward a scheduler approach, the so-called “dual income tax,” by introducing separate tax schedules for earned income and for capital income, with all income within any category to be treated uniformly. Capital income was defined to include any yield from capital investment and included realized capital gains, interest dividends from stock exchange companies, rental income and the net yield from life insurance, but excluded the imputed rent from owner-occupied housing. In addition a formula-determined share of self-employed income and of dividends from small companies was deemed to be income from capital. Capital income was taxed only by the central government, without personal exemptions, and at a flat rate equal to the corporate tax rate. Interest expense was in principle to be deducted only when the debt had been incurred to acquire an asset yielding taxable income, and only against taxable capital income. In practice, interest expense in excess of capital income is deductible, within limits, from earned income.69 However, the form of the deduction that was adopted has had the effect of reducing the tax value of debt for most taxpayers, since the after-tax cost of borrowing is determined by the capital tax rate, and not by the taxpayer’s marginal tax rate on earned income. Realized capital gains on owner-occupied housing continue to receive preferential treatment under the new tax law.

132. On balance, the reforms reduced the marginal taxation on corporate income to residents while broadening the corporate tax base, lowered the tax rate on some previously highly taxed types of capital, and raised the effective tax rate on other previously favored types of capital. Reducing the rate at which interest could be deducted has probably had the effect of raising the average tax rate on capital income at the personal level. The reforms gave households an incentive to shift from real to financial savings and to adjust their balance sheets by selling off assets and amortizing debts. The evidence suggests that households in Finland adjusted accordingly, although the effects of the severe recession also played a role in determining their behavior in this regard.

133. In the rest of this section, certain aspects of the reforms are described in more detail, and possible drawbacks of the current system are identified.

Corporate tax reform

134. The reform of company taxation has taken place in several stages. Until 1990, companies paid both national and local income taxes of 33 percent and 14–20 percent respectively. In 1990, the tax rate was reduced and made uniform at 40 percent (23 percent central and 17 percent local). At the same time double taxation of distributed profits was abolished through the introduction of the imputation system. The tax rate was further reduced to 36 percent in 1992 (19 percent central plus 17 percent local), and reduced again to 25 percent in 1993, to match the flat rate of tax on capital income at the personal level.70 A separate local tax on corporate income was abolished at this time. Accompanying the lowering of the tax rate was a broadening of the base.71

135. With regard to depreciation, the current system is as follows. Industrial buildings, machinery and movable equipment normally must be written off using the declining balance method. The maximum depreciation rate for industrial buildings, shops and warehouses is 7 percent (4 percent for office and residential buildings). The’depreciation rates for machinery and equipment is 30 percent, allowed on a pooled basis. Assets with a useful life of less than three years may be expensed. Some assets (e.g., patents, copyrights, trademarks and other intangibles) may be depreciated over ten years, using the straight-line method. Nonfixed expenditures for research and development may be expensed, while laboratory and research-related structures can be written off at a 20 percent declining balance rate. Accelerated depreciation is allowed for investments in designated developing regions. In addition, companies continue to be able to avail themselves of replacement reserves. Normally taxable capital gains on the sale of depreciated assets can be deducted from the acquisition cost of depreciated assets purchased during the same tax year, or in many cases, during the following two years. This replacement reserve system has the effect on tax liabilities equivalent to allowing expensing of a portion of the cost of new assets, the portion limited by the size of the capital gain.

Evaluation of corporate taxation:

136. The elimination of the double taxation of dividends in 1990 made domestic share ownership more attractive for Finnish residents. There remains double taxation of retained profits through the taxation of capital gains on share sales, in common with the tax systems of many other countries. The expansion of the tax base, in particular through the elimination of the various reserve accounts, has allowed a significant reduction in the statutory tax rate. At 28 percent, Finland has, along with Sweden, the lowest corporate tax rate in the EU, and the lowest combined corporate and personal tax rate on profits distributed to residents. Despite a variety of incentives for investment in specific regions, the tax code is relatively free of special investment incentives. Thus the changes in the tax base have been consistent with improving the intersectoral allocation of investment. However, as a result of the lower overall tax rate, the tax continues to produce revenue that is significantly lower than the EU-15 average, as indicated in Section B above.

137. With regard to depreciation, the current system seems overly generous in two respects. First, the allowable 7 percent rate on industrial buildings is higher than the 4 percent normally given in Europe.72 Second, the replacement reserve system is a holdover from the old tax treatment of companies, and has the effect of providing significant accelerated depreciation where it applies.

The effects of the changes in the tax treatment of housing

138. Housing represents a significant share of the assets of households in Finland, as in other countries. Dwellings, including vacation homes and dwellings purchased for investment purposes constituted 78 percent of household assets in 1994, equivalent to about 1.5 times GDP for that year. Valuing and taxing the services rendered by owner-occupied housing constitutes one of the major obstacles to achieving equality of treatment in the taxation of the return to saving. In addition, home ownership tends to receive favorable treatment in a number of other respects, as a matter of public policy. These include light taxation or exemption from tax of capital gains on owner-occupied housing, and, in many countries, deductibility of mortgage interest against other income.73 Both these tax treatments characterized the income tax in Finland before the reform. The reform process has attempted to limit this favorable treatment, with partial success. While imputed rental income and capital gains on owner-occupied housing have remained essentially untaxed under the reforms, the possibility of deducting mortgage interest against other income has been reduced significantly since 1989.74 It has been estimated that the value to taxpayers of the exclusion of capital gains on owner-occupied housing totaled Fmk 2.6 billion (0.5 percent of GDP) in 1993. Similarly, the value of the exclusion of imputed rent was estimated to total Fmk 4.6 billion (1 percent of GDP; OECD (1996b)).

139. Prior to 1989, mortgage interest was deductible against taxable income at progressive marginal rates. The 1989 reform restricted the interest deductibility to 90 percent of the interest payable, up to a ceiling. While the limitation had only a small effect, it was widely understood that the government’s aim was to gradually further reduce the deductibility of interest expense against labor income. With the introduction of the dual income tax in 1993, interest expense became deductible without limit against taxable capital income. This had the effect of reducing the rate of subsidy to mortgage borrowing for most households, from 90 percent of the tax rate on labor income to the tax rate on capital income, at that time 25 percent. In addition, a tax credit was offered against earned income tax payable for any mortgage interest in excess of taxable capital income, at the rate of 25 percent of the interest expense, without limit. Thus, this reform had the effect of reducing the subsidy to mortgage borrowing significantly. The value of mortgage interest deductions has been estimated to have fallen to Fmk 2.5 billion in 1993, from Fmk 4.2 billion in 1992 (Table 20).75 The value of the deduction is estimated to have totaled Fmk 2.2 billion in 1996.

Table 20.

Finland: Central Government Support to the Housing Sector, 1990–19961/

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Source: Ministry of Finance data and estimates.

Excluding a number of preferences, including exemptions under indirection taxation, exemption of capital gains on owner-occupied housing, and exclusion of imputed rent on owner-occupied housing.


140. The combined impact of these measures was to significantly change the price structure in the housing market. Rental costs at the margin increased substantially and became essentially uniform across households. Thus, the tax changes presented households with an incentive to reduce their indebtedness and to reallocate their savings from housing to other assets yielding higher returns. As a consequence, the changes by themselves had the effect of reducing aggregate demand for housing; and, since the stock adjusts only slowly, this contributed to the sharp fall in prices and in new housing starts observed during the 1990s. The year 1989, just as the reforms began, marked the peak of house prices and of the rate of new construction. Nominal house prices, which had doubled between the end of 1984 and their peak in the second quarter of 1989, subsequently fell by 43 percent from that peak to the trough in 1993. There has been a moderate rise since then (about 8 percent over 1994–96, with a further increase in 1997).76 Accompanying the fall in prices during 1990–93 was a sharp decrease in the transactions volume in the secondary market.77 In addition, housing starts fell quickly to a low level after 1989. Starts began to recover in 1996, and further recovery is expected in 1997. For example, the number of housing starts was about 65,000 in 1989, and had fallen to only about 18,300 in 1995. In 1996 the number of starts rose to an estimated 24,000. However, only 5,000 units, or 21 percent of the total number of starts in 1996, represented starts that were not subsidized under one or more of a number of government programs introduced to stimulate activity in the construction sector (see below). For 1997, housing starts are expected to show a further significant increase to 30,000 units, with about 8,000 of these starts unsubsidized,

141. Apart from the provisions of the income tax code, housing supply and demand was also favored through a variety of central government programs. Benefits can be divided into five main categories. First are the housing allowances, paid directly from the central budget to favored groups, including the poor, pensioners, and students. These housing allowances increased rapidly during 1991–95, on account of the deterioration in the general employment situation, and have started to decrease in 1996. Second are the central government loans for social housing. These are financed by the Social Housing Fund, an extra budgetary fund established in 1995, and charged with financing new loans through securitization of the stock of housing loans previously held and managed by the government. The program has been modernized starting in 1997 with the replacement of loans to purchasers with subsidies to interest paid on loans made by private lenders. The third program involves interest subsidies on loans from private lenders, paid through the Social Housing Fund, for repairs to and new construction of social rental housing. The interest subsidy paid by the Social Housing Fund under the program is about 3 percent on loans made in 1997. The fourth program involves direct grants from the central budget for housing repairs, targeted mainly to allow the elderly and handicapped to live independently. The grants are equal to 10 percent of approved renovation costs. Fifth, the Supplementary budget proposal of February 1996 involved the creation of a government guarantee fund for private mortgage loans. According to the program, the state guarantees up to 20 percent of the loan, up to a maximum of Fmk 150,000.

142. Table 20 presents a partial accounting of the favorable treatment of housing in Finland. In 1996, the total direct and imputed interest cost of state loans and direct interest subsidies totaled Fmk 3.2 billion (0.6 percent of GDP), of which Fmk 2.4 billion were to corporations, mainly for rental housing, and Fmk 0.8 billion to households. Repair and other types of grants totaled Fmk 0.6 billion. These programs have had a large effect on the volume of new construction activity, as well as on the level of renovation on existing structures.

Evaluation of the treatment of housing:

143. The reform of the 1990s significantly lowered the incentives to invest in housing. This lead to a decline in the demand and a fall in prices. As the reforms were introduced gradually, the adjustment period was correspondingly long. The increases in housing prices observed in the last several years, and particularly in 1997, suggest that this adjustment period has been completed and prospects for the housing market have improved. While the reform of the early 1990s were wide ranging, a significant income tax benefit to home ownership remains, through nontaxation of imputed rent or realized capital gains, and interest deductibility.78 In other countries, some portion of the return to housing in these forms has been brought into the tax net,79

144. Housing and home ownership continue to benefit from a number of nontax programs. Some of these programs were introduced during the recession, as policies to stimulate economic activity and employment. In particular a large stimulus to construction and renovation was introduced during 1996. The level of direct and imputed subsidy was about Fmk 3.8 billion (0.7 percent of GDP) in 1996. As autonomous activity increases in the sector with the improvement in the economy and in households’ balance sheets, reducing the level of subsidy could effectively avoid the risk of overheating and bottlenecks.

Taxation of interest

145. Prior to reform, the putative taxation of capital income at the personal level likely yielded little or no net revenue to the government, primarily on account of the opportunity to deduct interest costs of borrowing against highly taxed labor income. Some small restrictions on interest deductibility were introduced in the 1989 reform. The introduction of the dual income tax in 1993 was motivated in large part by the desire to control the erosion of the income tax base through interest deductions. Currently, interest payments are in principle deductible only when the borrowing is used to finance assets producing taxable capital income, and the value of the deduction is uniform across all taxpayers and equal to the rate at which the capital income is taxed. Since this rate is lower than the marginal tax rate on labor for most taxpayers, the effect of the change was to increase the after-tax cost of borrowing even if there remains slippage in the taxation of the capital income, as in the case of the imputed rent on owner-occupied housing. When interest expense exceeds interest income, 28 percent of the excess is creditable against earned income tax due, within limits.80

146. A number of deviations from the symmetric treatment of interest remain. Two important ones arise from special provisions that deviate from the principle underlying the dual income tax. First, the interest on some bank deposits and certain bonds have been declared tax free. Currently, for new accounts, the interest paid cannot exceed 2 percent for the income on the deposit to be tax free. Thus, the exemption primarily involves checking accounts, for which interest is generally below 2 percent. Tax free treatment extends to certain 10-year government bonds and bonds of mortgage banks issues between 1989 and 1992, and carrying an interest rate less than the base rate of the Bank of Finland.

147. Second, the opportunity exists to elect to have some savings receive consumption-tax treatment, through earned-income tax deductibility of voluntary contributions to private pension insurance plans, up to Fmk 50,000. Under these plans, the return to the plan is taxed only when it is paid out as pension income after retirement. This tax treatment of the earnings, when coupled with the deductibility of the contribution, implies that the saving in these vehicles earns the before-tax rate of interest, that is, the return is untaxed.

Evaluation of interest taxation

148. The treatment of interest income and expense under the dual income tax has improved the operation of personal taxation. However a number of asymmetries remain. First, the existence of tax-free deposits introduces a distortion in the treatment of different types of savings, and opens up the opportunity for tax arbitrage. Second, the existence of tax deductible voluntary contributions to private pension plans opens up the possibility of interest deductibility of borrowing along with consumption tax treatment of the return to that borrowing. Preventing this is administratively difficult as long as a hybrid approach to capital income taxation is adopted.

Arbitrage between labor and capital income

149. Under the current dual income tax structure capital income is taxed at a lower marginal rate than labor income. While capital income is taxed at a rate of 28 percent, labor income is taxed at a top rate of 38 percent at the central level plus an average of almost 17.5 percent at the municipal level, in addition to employer and employee contributions for pensions and social welfare. This creates the incentive for tax avoidance through the transformation of labor income into capital income. The extent of the arbitrage that results depends on the possibilities to arrange transactions in such a manner as to effectively convert labor income into capital income for tax purposes (for example into dividend income or capital gains income), and the possibilities for deducting expenses undertaken to earn capital income against labor income. The problem is particularly acute in the case of the income of the self-employed and the income of the active owners of small corporations. This problem is dealt with in the Finnish tax system in a rough- and-ready way, applying a few rules of thumb that split income into a labor income component and a capital income component. This approach is motivated primarily by observability considerations. Under the law, a dividend distribution receives capital income tax treatment only to a limit of 15 percent of the company’s asset value as stated on the balance sheet. The amount of any distribution greater than this limit is taxed as earned income. The amount of any distribution less than the 15 percent limit cannot be carried back or forward.81 The tax treatment of the self-employed is similar. The investment income share of the profits of the business is calculated annually on the basis of the net wealth of the enterprise and is at most 15 percent of the net wealth.

Evaluation of tax treatment of small business

150. Distinguishing capital from labor income is a major problem in the dual income tax. Addressing it creates considerable administrative and compliance difficulties. The solution adopted in the Finnish tax system is rough-and-ready, and while administrable, distortions exist. First, a uniform imputed rate of return may not be appropriate in all cases, in particular because it fails to recognize differences in risk premia. Second, net wealth, the basis for determining the share that will be lightly taxed, can be increased over time by retaining labor income as profit within the enterprise. Thus active shareholders would tend to be undertaxed on their labor income under this approach. This tendency to undertaxation is reinforced by the fact that capital gains are treated in their entirety as capital income when realized. Third, the lack of carryover and carry back in the annual allowed investment share creates an incentive to withdraw the maximum as investment income in each year, even when retention within the enterprise may be economically more desirable.82 A simple solution to the problem is not available, but the incentive effect of the simple rules could be lessened by reducing the gap between the tax rates on labor and capital income, in particular by lowering the tax burden on labor.

APPENDIX III: III. Employment and Taxation in Finland: Empirical Estimation

1. The aim of this appendix is to estimate the impact of labor taxation, as measured by the real tax wedge (see Section D) on labor market equilibrium in Finland, and to compare the results with those reported in the studies by Tyrväinen (1995 b, c). While the model is similar to Tyrväinen (1995 b, c), the sample period was extended to the most recent years, so as to evaluate possible changes in the parameters that might have occurred since the beginning of the nineties. The appendix is organized as follows: the first part describes the theoretical model of labor market behavior; the second part describes the data set and variables used in the estimations; the third part presents the econometric techniques in the estimation, and, the final section presents and interprets the econometric results.

Theoretical model

2. Following Tyrväinen (1995 a, 1995 b), imperfect competition is assumed in the goods markets. The labor market is also assumed to be imperfectly competitive and the level of wages is the outcome of a bargaining process between employers and employees. Producers will maximize profits while facing a downward sloping demand curve, so that labor demand will depend on real producer wages and employer taxes, given a production function and the level of output. Workers will maximize utility given the net after tax real wage and the real unemployment benefits received as unemployed; labor supply will then depend on real consumer wages, employees’ taxes, and unemployment benefits. The wage setting schedule depends on the relative bargaining power of workers and firms and will be generally expressed as a function of total labor taxation, labor productivity and the unionization rate. Finally the level of employment will be determined given the level of real wages and output.

3. Specifically, the system will be described by (1) the profit maximizing behavior of firms and (2) the welfare maximizing behavior of workers. Firms are assumed to have a production function Q=Af(N), where A is the average productivity and N employment, and to face a downward sloping separable output demand function, Qd=P/[P^Z]where Z is a parameter describing the position of that demand curve faced by the firm, P is the general level of prices of the competing producers and p^ is the (endogenous) producer product price. The profit maximizing function will be:


where W(1+s) represents gross producer wages and s employers’ social security contribution rate.

Workers will maximize utility, given net labor income and unemployment benefits, so that the total welfare of the latter will be:


where W(1+τ)/Pc represents net consumer wages, with τ workers’ income tax rate and Pc the consumer price index.

The long run solution for the wage schedule will depend on factors influencing both firms and workers:


where u represents unions’ power and UB the level of unemployment benefits.

Employment would be jointly determined in the market as a function of real wages and the level of output.

Data set

4. The data used for the estimations were taken from the OECD databases and Statistics Finland publications. The data set comprised the quarterly series 1975.Q1–1995.Q4 for the average level of nominal wages (W), employment (N), real gross domestic product (Y), producer prices (P), consumer prices (CPI), and employers’(s) and employees’ average tax rates (t) on labor income, included in the regressions as the tax wedge (wdg),33 and a productivity index (PR). Finally a dummy was included to control for changes in the rates of income taxation.

5. Employers’ and employees’ tax rates were calculated given the total amount of paid wages and tax revenues from employers and employees social security contributions, as well as the total personal income taxes. Therefore, s, was calculated as the average rate of social security contributions to total wages paid, and t the average direct tax rate for the employee, inclusive of income and social security contributions, to total wages received. This way of calculating tax rates may lead to significantly different series than those obtained by using official marginal tax rates for the average income level, or by using the average marginal tax bracket. The differences in the ways of calculating the wedge may explain, in many cases, the differences observed in the econometric estimations when comparing similar studies.

6. Unfortunately time series for marginal tax rates, unemployment benefits or to proxy union power were not available, so that there is a possibility that some of the estimated coefficients are biased because of omitted variables. In particular, union power can have a strong effect on how workers and employers share the burden of taxation.

Estimation methods

7. Initial tests for nonstationarity were performed. All variables included in the model appeared to be nonstationary according to the ADF unit root tests. Next, a full VAR with the five variables was estimated.34 The rank tests according to Johansen’s procedure suggested that two long run relationships existed in the system. Then, the system was reduced to include only wages and employment as endogenous variables and an Error Correction Model (ECM) was estimated from the VAR formulation. Finally, the system was specified following equations 1 and 2 to allow for the estimation of the long term impact of the variables and estimated using FILM. Following Tyrväinen (1995 b), the dependent variable was chosen to be real gross producer wages, defined as W(1+s)/P. The specified equations for the ECM were:

ΔNt=δ0+γ0, wΔW(1+s)/Pt1+γ0,NΔNt1+.....+γ3,NΔNt3αN[βNNt1+βWW(1+s)/Pt1+βYYt1].

where W(1+s)/P are real producer wages, N employment, Pr productivity level, wdg the real wedge, and Y real GDP.

8. To check for the consistency of the results, a set of estimations was also performed including GDP among the endogenous variables in the system.

9. As the severe macroeconomic shock that occurred in 1990 may have brought some changes in the behavior of many economic variables. The estimations were initially performed only up to 1990. The sample was subsequently extended to end 1995, to include the most recent available data. To control for the recession period, output was included as an additional explanatory variable in the wage determination schedule.

Econometric results

10. The size of the long term impact of the wedge on wages (Table III-1 eq 1 and 1*) is similar to that reported by Tyrväinen (1995, a and b), and remains so when the sample is extended to include more recent data (Table III-1 eq 2 and 2*). The more striking result is the increase in the size of the pass-through of the wedge from wages to unemployment. While in the earlier sample estimations the elasticity of employment to changes in wages is around 0.2 (Table III-1 eq 1 and 1*), when the sample is extended the estimated elasticity more than doubles, ranging around 0.5 (Table III-1 eq 2 and 2*). Finally, the elasticity of employment to output ranges around 0.3 as expected.

Table III-1.

Finland: Wage Model Results 1/2/

(All coefficients refer to long term parameters)

article image
Source: Staff calculations.

Variable definitions: W = real producer wages, N = employment, wedge = real tax wedge Prod = Productivity index, GDP = real output.

Asterisk (*) refers to estimations where GDP was considered endogenous (and Prod was excluded)

In the longer period estimations, GDP had to be included to control for the recession period but, since correlation with Prod is very high, it was impossible to estimate the two parameters independently. The reported coefficient refers to GDP.

Figure III-1.
Figure III-1.

Finland: Simulation of a One Percent Cut in the Tax Wedge 1/

(In percent)

Citation: IMF Staff Country Reports 1997, 060; 10.5089/9781451813135.002.A003

1/ X axis represents years.

11. The dynamic adjustment process to changes in the exogenous variables is described by a set of short term coefficients which are for simplicity not reported. However, in order to gain some insight in the length of the adjustment period, Figure III-1 reports the effects on employment and wages of a 1 percent cut in the tax wedge. The effects are quite slow to materialize: while in the long run (seven years) employment would increase by 0.3 percent, only 30 percent of this total increase would materialize withing three years.

12. To conclude, the estimated increase in the elasticity of employment to wages suggests that the structural changes that took place in the economy in response to the adverse 1990–92 shock have been accompanied by an increase in the size of the impact on employment of changes in the real tax wedge.


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The real tax wedge is defined by (1+s)/(1-t)Pc/P, where s is the employers social security contribution rate, the tax rate on income, Pc the consumer price index and P the producer price index. The wedge represents the ratio of real gross labor costs to real after tax take-home pay of the employee.


The variables included were, real producer wages, employment, output, real wedge and productivity.


Prepared by Russell Krelove.


In EU-15, general consumption tax revenue rose by about 1 percent of GDP since 1985, while specific consumption tax revenue fell marginally as a share of GDP.


The tax replaced a number of more specific and complex property-type and other taxes.


Specifically, municipal income tax, real estate tax and the municipal shares of corporate tax are equalized. For each municipality and for each tax base, the average tax rate over all communities is applied to the municipality’s measured tax base. If the per capita revenue from this calculation is less than 90 percent of the realized average per capita revenue from that source over all municipalities, the community is entitled to a grant on account of this tax base to bring it up to the 90 percent level. When the per capita revenue from the calculation exceeds 90 percent of the average realized per capita revenue, the municipality’s overall subsidy is reduced by an amount that is 40 percent of the amount exceeding the equalization limit, up to a ceiling of 15 percent of the municipality’s calculated tax revenue.


Current transfers totaled Fmk 32.5 billion in 1996. The breakdown was Fmk 11.8 billion for education and culture, Fmk 16.1 billion for social welfare and health services, and Fmk 4.6 billion for others, including general subsidy and equalization.


State subsidies for education are paid to organizations maintaining private educational institutions, as well as to municipalities and joint municipal boards. In addition, bilingual education needs of municipalities are recognized in the grants paid where appropriate.


The central government share will be reduced to 24 percent in 1998. This sharing is achieved by defining a per capita local contribution amount that municipalities are expected to cover, which is subtracted from the total calculated per capita expenditure in all categories.


Specifically, for social welfare, approximately 93 percent of calculated expenditure is based on the age structure, while the unemployment factor (based in a nonintuitive manner partly on the municipal unemployment rate and its relation to the national rate, partly on the relative municipal and national employment rates, and partly on the number of unemployed in the municipality) receives approximately 7 percent weight. For the health care grant, the age structure is weighted approximately 75 percent, and the morbidity factor by about 25 percent, determined using a “sickness factor.”


In fact, calculations for several countries with similar tax treatment have indicated that there was a net revenue loss from the taxation of capital income. See Sorensen (1994).


Some such treatment was necessary because most domestic taxable interest income is subject to final withholding at source.


As already noted, the rate was raised to 28 percent in 1996.


In the 1993 reform in particular, the system of tax-deductible transfers to reserves was substantially abolished, subject to some transitional measures. At the same time the share of entertainment expenditures that could be deducted was reduced from 100 percent to 50 percent, and restrictions were placed on deductibility of voluntary contributions to pension plans. Losses were allowed to be carried forward for ten years, without interest, but could not be carried backwards. This provision created an asymmetry in the treatment of profits and losses.


See Farrar and Pointon (1996). Farrar and Pointon calculate that, under certain assumptions, the required before-tax rate of return on investment is the lowest in Finland among eleven European countries. For plant and machinery the required rate of return was calculated to be 13.3 percent in Finland, compared to an average of 17 percent; for industrial buildings the required rate in Finland is 14 percent, compared to an average of 19 percent; and for commercial buildings the required rate of return in Finland is 14 percent, compared to an average of 20 percent. In general in the calculations of Farrar and Pointon, Luxembourg, Finland and Greece have low effective corporate tax rates, whereas the Netherlands and Germany have higher rates. The magnitudes of the required returns, but not the thrust of the argument, needs to be modified on account of the increase in the tax rate to 28 percent in 1996. Note that the calculations show that there is no strong bias toward a particular asset category in the current system in Finland.


Since nominal interest is usually deductible, the interaction of this tax provision with inflation can have a significant effect on the after tax cost of borrowing. Even for moderate rates of inflation, the after-tax cost can become negative for those facing higher marginal tax rates.


The capital gain on a dwelling is, tax free if the taxpayer has simultaneously lived in and owned the dwelling continuously for at least two years.


At the same time some special additional tax reliefs were introduced for those households having difficulty with mortgage payments and those with negative equity, and extra tax credit for interest was granted for those who purchased their first house. The revenue cost of these and similar additional measures was Fmk 1.6 billion in 1993, and had fallen to an estimated Fmk 0.5 billion by 1996 (Table 20).


The increases in the effective VAT tax rate on new construction enacted in 1993 and 1994 would be expected to make existing (untaxed) housing relatively more attractive and have a positive impact on prices.


The fall in volume may be associated with a lock-in effect for existing owners arising from negative equity, as well as because of a lack of demand on account of expectations of further price decreases.


As indicated, the revenue cost qf the deduction of mortgage interest payments was estimated to be Fmk 2.2 billion (0.4 percent of GDP) in 1996. In addition, the cost of the exclusion of imputed rent and of capital gains on owner-occupied housing is estimated to have totaled Fmk 7.2 billion (1.5 percent of GDP) in 1993 (OECD (1996b)).


Of course, as the proportion of the return to housing that is made taxable is increased, nondistortionary treatment requires that a corresponding proportion of mortgage interest expense be allowed as a deduction.


In principle, the credit against earned income tax is limited to Fmk 8,000–12,000 (i.e., approximately Fmk 28,600–42,900 in interest expense), depending on the number of dependents of the taxpayer, but there are a number of qualifications and transition provisions that increase the ceiling (Finland, Ministry of Finance, 1995, pp. 23–24). Any excess interest expense can be carried forward for up to ten years.


This tax treatment applies to both active and passive shareholders in closely held companies.


For further discussion, see Lodin (1993) and Sorensen (1994).