Sweden's tax rates are among the highest in Europe, especially on marginal earnings. Accounting for the effect of direct and indirect taxes as well as income-dependent transfers, the marginal tax rate amounts to 75% for the average income earner. Dividing the economy into a taxed and an untaxed sector, this means that the value of the gross marginal product of labor in the taxed sector must be four times as high as the value of the (gross and net) marginal product of labor in the untaxed sector in order to give the same net remuneration for marginal labor time.

The high marginal taxes thus give a strong incentive for time allocation to untaxed activities such as home production and leisure. Moreover, there are strong incentives for tax avoidance that can be accomplished through payments in the form of fringe benefits and through excessive borrowing in order to obtain deductible interest expenditures. Finally, tax evasion carries a high premium due to the high tax rates.

For all these reasons, high marginal tax rates tend to produce a relatively small tax base and distortions in the allocation of resources. Some, but not all, of these factors tend to give a small observed economy as measured by national account statistics.

After many years of experience, most economists, politicians, and the mass media recognize these effects of high marginal taxes; yet their quantitative importance remains a matter of much debate. The four largest parties in Sweden, covering 95% of the seats in the parliament, consider the effects to be sufficiently severe to call for a reduction in the marginal tax rates.