Wednesday, December 1, 2010

Who Pays for Big Government?

Copyright, The New York Times Company

President Obama’s bipartisan National Commission on Fiscal Responsibility and Reform meets today and is expected to release its final recommendations soon on balancing the federal budget.

Progressives hope that the federal government will raise revenue mainly, if not exclusively, by levying taxes on wealthy Americans. But a comparison of France and the United States suggests that raising tax revenue will ultimately involve increasing tax rates on the poor much more than they would be increased on the wealthy.

Because the federal individual income tax is “progressive” — the tax is collected at higher rates from higher-earning groups — it is easy to assume that big government involves high tax rates on wealthy taxpayers without commensurately high tax rates on poorer taxpayers.

However, the individual income tax brings in only a minority of government revenue. According to the Organization for Economic Cooperation and Development, most taxpayers in Western European countries — countries known for their relatively generous welfare states — pay a smaller fraction of their income in individual income tax than Americans do (to view the O.E.C.D. data, click here, then on the “tax” pull-down menu, click on the second item, “Of individuals”).

Because the individual income tax is one of the few truly progressive taxes, and other taxes are regressive, the overall tax systems in Western Europe may not be as progressive as you might think.

For a specific example, consider France, where taxes are 43 percent of gross domestic product, compared with 26 percent in the United States (as I noted in last week’s post, I look at 2005 and exclude "miscellaneous" taxes and fees collected by state and local government, but include all other taxes such as payroll taxes, state sales taxes, property taxes, and state income taxes). The chart below shows my estimates of the income shares paid in taxes across French income deciles (blue) and across income deciles in the United States (red).

For example, France’s bottom decile (the 10 percent of French households with the lowest incomes) paid more than half of their income in various taxes, compared with less than 20 percent paid by America’s bottom decile.

France’s top decile is taxed at a rate that looks more like the rate in the United States — less than 40 percent.

The chart suggests that if the United States were to move to a French-style tax system, low-income Americans would see their tax rates more than double. High-income Americans would see their rates go up, too, but proportionally less.

To derive these results, I used calculations from the Congressional Budget Office for individual income and payroll taxes and rescaled them for France to reflect the differential importance of those taxes to collect revenue in the two countries. For state and local taxes in the United States, I used the calculations of the late Joseph Pechman (discussed in last week’s post). For the French value-added tax, I assumed that the income incidence was the same as Professor Pechman calculated for the state and local sales taxes.

I assumed that capital taxes in both countries are ultimately shifted to workers and consumers, and therefore have the same incidence as sales taxes (as I discussed last week).

It’s difficult to know the exact results for either the American or French tax systems, but it is clear that the two countries have very different tax mixes, with the French mix heavily skewed away from the kinds of taxes that might be progressive.

France’s individual income taxes, which are progressive like ours, bring in less than 4 percent of its G.D.P. to public treasuries, compared with 10 percent for individual income taxes in the United States.

The regressive payroll tax is France’s biggest tax, bringing in more than 17 percent of G.D.P. (plus another 4 percent from its flat-rate “contribution sociale généralisée”), compared with the 6 percent of G.D.P. the United States gets from its payroll tax. Customs, excise and sales taxes amount to 11 percent of G.D.P. in France, but only 4 percent in the United States.

With three of France’s regressive and flat-rate taxes amounting to a combined third of French G.D.P, not to mention the other taxes, it seems that low-income French have to be paying close to half of their income in various taxes, much more than low-income Americans do.

For these reasons, I am not the first to conclude that the taxes used by big governments are less progressive, and perhaps even regressive.

In a study published in 2005 that focused on the top-income decile (and unfortunately was limited only to the federal direct taxes), Professors Thomas Piketty and Emmanuel Saez noted that “countries in which government spending is a fairly high share of G.D.P. have always relied on a mix of taxes” with less progressivity.

Another study by Professors Monica Prasad and Yingying Deng, who used a different methodology, found the United States tax system to be the most progressive out of a sample of 13 countries.

Big government is no free lunch, even for the poor.


Anonymous said...

As government gets bigger, it has to tax every group of people at near the laffer limit for those people.

Obviously the laffer limit is higher for the poor than the rich, since the rich have more options to evade, to flee, or to goof off and give up.

So if it is taxing at the laffer limit, it is the poor more than the rich.

Nameless said...

20% effective tax rate in the lowest decile in the U.S.? No way. Double check your numbers. A household at the 20th percentile makes on the order of $20,000 a year (pre-recession). With this income, they'd pay zero in federal taxes, in fact, they'd get a refund of as much as 5% of income. State taxes tend to be similarly progressive as well. Even after payroll taxes and sales taxes, the effective tax rate should not climb above 10%.

Furthermore, if you're going to count taxes, you should subtract welfare spending (particularly, food stamps) and social security / medicare.

With everything accounted for, I'd expect to see bell-shaped curves in both countries. In the US, most households below the 40th percentile should be getting a free ride, with zero or negative net taxes paid into the system.

This is not to dispute the assertion that the US system is more progressive than the French system, which may very well be true.