A. WHAT ABOUT TAXES?
By almost any standard, it is difficult to defend the position that the citizens of the United States are presently oppressed by excessive taxation. I offer several lines of argument to support my position:
(1) US taxes are also very low compared to other developed countries. Table IV-1 shows the total tax burden (combined State, local, and Federal taxes) of 20 developed countries around the world. As of 2006, the US tax burden amounted to 27.5% of US GDP compared to an average of 39.7% in the 15 core European Union countries and 36.4% and other developed countries.
TABLE IV -1
Tax Burden as % of GDP
| ||||||
Rank
|
Country
|
Tax Burden
|
Rank
|
Country
|
Tax Burden
| |
1
|
Denmark
|
50.8%
|
11
|
Germany
|
34.8%
| |
2
|
Sweden
|
49.5%
|
12
|
Spain
|
33.0%
| |
3
|
Belgium
|
44.7%
|
13
|
Canada
|
33.4%
| |
4
|
Finland
|
44.0%
|
14
|
Greece
|
31.4%
| |
5
|
France
|
43.9%
|
15
|
Australia
|
30.8%
| |
6
|
Norway
|
43.5%
|
16
|
Ireland
|
30.4%
| |
7
|
Italy
|
40.8%
|
17
|
Switzerland
|
29.2%
| |
8
|
Netherlands
|
38.5%
|
18
|
United States
|
27.5%
| |
9
|
United Kingdom
|
35.8%
|
19
|
Japan
|
27.4%
| |
10
|
Poland
|
34.9%
|
20
|
Korea
|
23.9%
| |
Source: Organization for Economic Cooperation and Development
(2) The perennial conservative mantra is that low taxes stimulate growth. However, if one looks at the relationship between taxes and economic growth it is difficult to discern such a relationship.
· In the US - Figure IV-1 plots tax revenues and GDP growth over the past sixty years. Revenues are represented by the pink line (plotted against the left axis) and spending by the dark blue line (plotted against, the right axis[1]). As we have already seen, revenues declined gradually over the past 60 years - there is a small spike during the Vietnam War, two declines resulting from the Reagan and Bush tax cuts, and a gradual increase during the Clinton administration. On the whole, however, year-to-year variations have been small. GDP growth on the other hand, has been all over the lot. The Pearson correlation coefficient between taxes and growth is .214. However, the correlation is positive meaning that higher taxes are associated with higher growth! This is not exactly what conservatives have been preaching (nor is it true, as I will discuss shortly).
FIGURE IV-1
Now it is reasonable to think that it might take time for changes in tax policy to have an effect on GDP. Accordingly, I tried calculating the correlation coefficients using lag times ranging from one to four years. A four-year lag, for example, correlates the taxation level for year N with GDP growth in year N+4. It turns out that the correlation of .214 - the strongest relationship of all - was obtained using a three year lag time. Smaller or larger lags produced smaller coefficients.
The actual strength of the relationship between two variables, however, is not the correlation coefficient; it is what statisticians call the coefficient of determination, which happens to be the square of the correlation coefficient. With a correlation of .214, the coefficient of determination is 0.04 (.214 * .214) indicating a negligible relationship.
Now I will be the first to admit that the foregoing analysis is simplistic and that the relationship between taxes and economic growth involves a host of additional variables along with many complex interaction effects. Nonetheless, when I look at Figure II-1 and I am inclined to believe “my own lying eyes”[2] rather than the economists, pundits, and politicians who argue that taxation kills jobs and inhibits economic growth.
· Internationally - Figure IV-2 plots the relationship between overall tax burden and economic productivity in 2007. Each data point represents the overall tax burden (vertical axis) and the level of economic productivity (horizontal axis) of each country relative to the United States. South Korea, for example has a tax burden of 23% of GDP and its productivity is 58% that of the US.
FIGURE IV - 2
TAX BURDEN AND PRODUCTIVITY
---------------------------------------------------------------------------------------------------------------------------------------------------
Source: Organization for Economic Cooperation and Development, (Administrative arm of the European Union)
Once again, the relationship between tax burden and economic activity is close to zero (Pearson r = .09, coefficient of determination = .0081) and the slope of the regression line (red) is again positive, meaning that whatever minuscule relationship there is between the two variables, it is the reverse of the supply side prediction. However, since the correlation is essentially zero, all we can really say is that these data show no relationship between productivity and tax burden.
In summary, the US taxpayer plays a 30% less in taxes than taxpayers in other developed countries (27.5% of GDP vs. 39.7% of GDP in the common market countries) and there is little evidence that increased taxes are associated with decreased economic growth.
B. OUR TAX DEFICIENCY
The US does not have a problem with excessive taxation. The truth is, the US is suffering from a serious tax deficiency.
Fact: Federal taxes for on-budget expenditures[3] were 15.8% of GDP when Eisenhower left office and 13.0% of GDP when George W. Bush left office on January 20, 2009. With 2008 GDP at 14,394 billion, this 2.8% decline in tax revenues amounted to $403 billion dollars in 2008 or 63% of the 2008 deficit of $643 billion. That’s right! Two thirds of our pre-recession deficit was the result of those reductions in tax revenues.
Fact: We are paying less in taxes than we did during the Eisenhower administration despite the fact that we have added Medicare, Medicaid since Ike was President. These two programs alone cost $599 billion in 2008 but I doubt that most Americans would consider them examples of runaway government spending.
Fact: Our overall tax burden is 25% lower than the average tax burden of OECD countries.
C. CONCLUSION
Our deficit problem is mostly a revenue problem. While spending has increased, those increases can be entirely accounted for by the added expenditures for Medicare and Medicaid. Spending in 1960 was 15.7% of GDP; in 2008 it was 17.4%, an increase equivalent to 1.7% of GDP or $245 billion in 2008 dollars. The cost of Medicare and Medicaid in 2008 was $599 billion. So we have added $599 billion in expenditures for two programs that I think few people would say are unnecessary while paying only $245 billion more in taxes. Sounds like a bargain to me!
Well, not exactly a bargain when you realize that we are paying far more per capita for health care than other developed countries without providing universal coverage as they do. The US spent 17.6% of its GDP on healthcare in 2009 compared to 11% in other developed countries. And it is not government sponsored health care that is the cause of the problem. The cost of privately obtained health insurance is actually rising at a faster pace than the costs of Medicare[4].
Quite simply, the American people have been misled by their political leaders into believing that we can have a huge military and an array of needed and necessary Federal services while paying far less in taxes than is necessary to cover those expenditures. What is it about paying their bills that is so hard for Americans to understand?
Of course, any tax increases needed to balance the budget should not be imposed until we dig our way out of the current recession. But once the recovery is underway, we need to face the music and pay the taxes necessary to finance the government services we demand.
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In Part V I will present my approach to eliminating the deficit.
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NOTE 1 - Wherever possible I have provided original source citations for data cited in this series. In addition to these citations, I have posted Excel workbooks containing the underlying data for Tables, Figures, and my calculations for derived numbers.
Workbook 1 - Budget 2008 to 2012.xls
Workbook 2 - Budget Historical Data.xls
Workbook 3 - CBO Projections Jan 2011.xls
The workbooks can be found at Google Docs at:
Each workbook contains an index with clickable hypelinks to the data sources for specified Tables and Figures. The hyperlinks do not work in Google.docs but will work if you download the document to your computer.
[1] The left and right axes have different numeric scales. This does not change the relationship between the two variables over time, but it does have the effect of bringing the two lines closer together in the graph making it easier for the reader to see the relationship.
[2] For trivia lovers, Richard Prior used these words in telling the story of how was caught red-handed by his wife in the act of having sex with another woman. Deciding to brazen it out, he jumps to his feet and shouts, “Who are you going to believe? Me or your own lying eyes!”
[3] On budget expenditures include basically everything except social security which, as I explained in Part I of this series, can be placed on a solid financial footing with some relatively painless and common sense remedies.
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