Modern Taxation Theory in the Faroe Islands

Faroese folk dancers, some of them in national costume

The economics community was rocked last night by the first publication of Modern Taxation Theory (MTT). MTT argues (really observes) that the way we all talk about taxes is wrong. When someone is paid $100 and receives $80 “after tax,” we say they were taxed $20. In fact, they were taxed $100 and the $80 they receive is a transfer payment made by the government. We see from this that all transactions are taxed at 100% and all disposable income is government transfer payments.

This theory has important insights about the question of how much disposable income people should receive, especially the rich. Right now, we ask things like “should we tax the rich more?” But in fact the rich, and everyone else, are already taxed at 100%. The question is whether the rich should receive fewer government transfer payments than they do now. I say yes. Others perhaps say no.

Every country practices MTT whether they realize it or not. MTT is a description of reality, not a prescriptive theory of what countries should and should not do.

With that said, there is one country that explicitly leans into the reality of MTT. It’s a country that gets relatively little global attention, but one at the forefront of how taxation really works. That country? The Faroe Islands.

An autonomous part of Denmark, the Faroe Islands has the most interesting approach to tax administration in the world (and I mean this genuinely).

In the Faroe Islands, employers do not “withhold tax” from their employees’ paychecks and then remit the remainder to them as disposable income. Instead, they pay their employees’ entire paycheck to a government-approved clearinghouse. That clearinghouse then applies the country’s tax rules to the sum and then pays each worker what they are owed “after tax” (to use the language of Ancient Taxation Theory).

Thus the Faroese tax administration system is literally to bring 100% of each worker’s pay into the government (or government-approved clearinghouse) and then make a separate payment to each worker based on an earnings-related formula. So, in a very tangible sense, the Faroe Islands have a 100% tax rate and all disposable income is transfer payments from the government.

To be clear, all taxation works like this. No country, no matter how they want to characterize what they are doing, can escape the raw reality that all transactions are taxed at 100% and all disposable income is government transfer payments. But the Faroe Islands nonetheless stand alone as a wonderful example of a country taking this lesson to heart and explicitly arranging their fiscal institutions around Modern Taxation Theory.