Social Democratic America (12 page)

But these policies will help. Americans from less advantaged homes will have cognitive skills and noncognitive traits that give them a better shot at successfully entering and staying in the labor market and at having a long-lasting family relationship. Those who lose a job will have a stronger incentive to take another job even if it pays less, and they will have more help in finding one. Individuals unable to function effectively or continuously in the labor market, whether working age or elderly, will have a higher income. No one will have to fear lack of access to medical care, and fewer will face a massive out-of-pocket expense resulting from such care. Expanded provision of public goods and services will enhance economic security and take the edge off rising income inequality for those at the low end of the scale. A steady rise in the EITC will ensure that more of our economic growth reaches households in the middle and below.

How much will all this cost? That depends on the structure and generosity of the policies, and it isn't my aim to offer
recommendations at that level of specificity. As a ballpark estimate, I suggest we think in terms of 10 percent of GDP to cover the cost of new programs, the expansion of existing ones, and the rise in the cost of Social Security and Medicare that will come from population aging.

Can we afford it? Will this “social democratic” approach require sacrificing other elements of a good society? Are there attractive alternatives? Can these proposals get passed in our political system? I answer these questions in
chapters 4
and
5
.

SOME WILL SYMPATHIZE
with the ends I have laid out— improving economic security, expanding opportunity, and ensuring shared prosperity—but disagree with the means. One objection, common among those on the right side of the political spectrum, is that bigger government will lead to greater public debt, slower economic growth, less employment, restricted liberty, and diminished self-reliance, so we might do better to rely on private institutions such as families and communities. On the left, many favor stronger labor unions, promotion of manufacturing jobs, a higher wage floor, or perhaps a basic income grant. In this chapter I address these objections and alternatives along with a number of others.

Suppose we need, as I suggest in
chapter 3
, an additional 10 percent of GDP to fund new social programs, expansion of existing ones, and demography-imposed increases in the cost of Social Security and Medicare. Is that feasible? If so, what's the best way to do it?

Let's begin with feasibility. Is heavy taxation still possible in a world where firms, institutions, and wealthy individuals can move their money anywhere they like? The answer, at least so far, is
yes. Globalization has not induced a race to the bottom in taxation. Many rich nations have reduced their top statutory rates, but they've offset this by reducing tax exemptions and deductions. Effective tax rates have therefore changed little, and taxes as a share of GDP have not fallen.
¹

Indeed, the rich nations with big governments are no more likely than others to have large public deficits and debt. As
figure 4.1
shows, the social democratic Nordic countries have comparatively low levels of government debt. (Norway's oil resources account for its outlying position.) They spend a lot, but they generate enough tax revenues to pay for that spending.

How, then, should the United States go about taxing? Before answering, let me pause for a moment to define some basic terms. When those with high incomes pay a larger share of their income in taxes than those with low incomes, we call the tax system “progressive.” When the rich and poor pay a similar share of their incomes, the tax system is termed “proportional.” When the poor pay a larger share than the rich, the tax system is “regressive.”

FIGURE
4.1 Government spending and government debt

Higher on the vertical axis indicates larger debt. Government net debt: government financial liabilities minus government financial assets, measured as a share of GDP. The pattern is similar for gross debt (government financial liabilities). Government expenditures are measured as a share of GDP.
Data source
: OECD, stats.oecd.org. The correlation is –.25 (with Norway excluded). “Asl” is Australia; “Aus” is Austria.

The US tax system as a whole—taxes of all types and at all levels of government—is roughly proportional. The key measure is the effective tax rate, which is calculated as tax payments divided by pretax (and pre-government-transfer) income. According to the best data we have, the effective tax rate is about the same whether one's income is high, middle, or low.
²
Federal income taxes are progressive; the rich pay at a higher rate than the poor. But that progressivity is largely offset by regressive payroll taxes and sales taxes.

America is not unique in this. In all rich nations for which we have data, the tax system does little to alter the distribution of pretax income. In fact, if anything, our tax system is a bit less regressive than those of other affluent countries, because most of them have heavier consumption and payroll taxes than we do.
³

For the past generation, America's left has focused on the progressivity of federal income taxes, viewing taxes through a lens that emphasizes fairness and redistribution. But if your concern is income redistribution, your focus should be on transfers. It is transfers that do the bulk of the redistributive work in affluent countries.
⁴

Taxes matter mainly because they provide the funds for public goods, services, and transfers, and our tax system provides much less revenue than most other rich countries. This brings us back to the question of how to increase revenues in the United States.

As a candidate for president in 2008, Barack Obama pledged to not increase tax rates for the bottom 95 percent of American households, and as president he has held to this promise.
⁵
There is some sense in focusing on those at the top in the search for more revenue. The chief rationale for progressive taxation is that those with more income can afford to pay a larger share of that income than those with less.
⁶
The incomes of Americans in the middle and below have risen slowly over the past few decades. Meanwhile, the incomes of those at the top have soared, so they're now able to pay a larger share of those incomes.

FIGURE
4.2 Effective federal tax rate on the top 5 percent of incomes

Effective tax rate: tax payments as a share of pretax income. Federal taxes include personal income, corporate income, payroll, and excise. The chart has two estimates of the actual rate.
Data sources
: for the top line, Thomas Piketty and Emmanuel Saez, data set for “How Progressive Is the U.S. Federal Tax System?”
Journal of Economic Perspectives
, 2007, available at elsa.berkeley.edu/~saez; for the lower line, Congressional Budget Office, “Average Federal Tax Rates and Income, by Income Category, 1979–2007.” See the notes for calculation of the rate needed to increase tax revenues by 10 percent of GDP.

To get a
lot
more revenue, however, we have to go beyond the rich. Suppose we need an additional 10 percent of GDP, as I suggest in
chapter 3
.
Figure 4.2
shows the effective federal tax rate on the top 5 percent of households going back to 1960. This includes all types of federal taxes—personal income, corporate income, payroll, and excise. We have two estimates of this tax rate, one beginning in 1960 and the other in 1979. The dot for the year 2007 indicates what the effective tax rate on this group would need to have been in 2007 to increase tax revenues by 10 percent of GDP.
⁷
This is far above the actual rate at any point in the past half century. Whether desirable or not, an increase of this magnitude won't find favor among policy makers.

If getting the needed revenues solely from the rich is unlikely, where
can
we get it? To raise the 10 percent of GDP in additional tax revenues that we need, a multipronged approach is required.
Figure 4.3
shows one way to do it.

It begins with a national consumption tax. Limited use of consumption taxation is the main feature of the US tax system that separates us from other rich nations. Currently, we collect only about 5 percent of GDP in consumption taxes, almost entirely at the state and local levels. Most other affluent countries collect 10 percent or more.
⁸
A value-added tax (VAT) at a rate of 12 percent, with limited deductions, would likely bring in about 5 percent of GDP in revenue.
⁹

The idea of a large consumption tax has yet to be embraced by America's left, which objects to its regressivity. The degree of regressivity can be reduced by exempting more items from the tax;
¹⁰
but the greater the exemptions, the less revenue the tax will bring in. A better strategy is to offset the regressivity of a new consumption tax with other changes to the tax system, including some of those listed in
figure 4.3
.

The right tends to object to a VAT for fear it will become a “money machine”—a tax that can be steadily increased over time. But this fear is based on a misreading of the experience of other rich nations. Some countries have decreased their VAT rate, some have held it constant, and most of those that have increased it did so mainly in the 1970s and early 1980s, when high inflation made such increases less noticeable.
¹¹
Some argue that tax increases in rich countries since the 1960s have come mainly via VAT increases; in fact, they have come as much or more from increases in income and payroll taxes.
¹²

FIGURE
4.3 How to increase tax revenues by 10 percent of GDP

The numbers are percentages of GDP. They total 10 percent. All are estimates.

It may be a while yet before political leaders on America's left and right come to agreement that a VAT has considerable advantages and few drawbacks. But eventually it will happen.