Read Social Democratic America Online
Authors: Lane Kenworthy
Second, we should return to the pre-Bush income tax rates for everyone. This would increase revenues by about 2 percent of GDP.
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Third, we can raise income tax rates for those in the top 1 percent a bit more.
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Increasing the average effective tax rate for this group by 4.5 percentage points would generate about .7 percent of GDP. The 2012 tax deal will return the effective tax rate on the top 1 percent to around its pre-Bush level of 33 percent. An increase of four to five percentage points, to a 37â38 percent effective rate, would hardly be confiscatory.
Fourth, we can get rid of the tax deduction for interest paid on mortgage loans. This would increase revenues by about .6 percent of GDP. The aim of the mortgage interest deduction is to boost home ownership, but other affluent nations, such as Australia and Canada, have homeownership rates comparable to ours or higher without a tax incentive. Moreover, most of this deduction goes to households in the top fifth of incomes.
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Few in the middle or below benefit from it.
Fifth, we need a carbon tax. This would generate about .7 percent of GDP in revenues. We should have a carbon tax regardless of its impact on government revenue, to shift resources away from activities that contribute to climate change.
Sixth, we could impose a modest tax on financial transactions, such as purchases of stock shares, which would bring in about .5 percent of GDP. Opponents warn that it might cause trading to flee to other financial centers that don't have such a tax, but the United Kingdom has long had a financial transactions tax without any apparent damage.
Seventh, we can increase the cap on earnings that are subject to the Social Security payroll tax. A person's earnings above $114,000 are not subject to the tax (as of 2013). Because a growing share of
total earnings in the US economy has gone to those at the top in recent decades, a growing share has been exempt from the tax. In the early 1980s, about 90 percent of earnings was subject to the Social Security payroll tax; as of 2012 this had dropped to 84 percent.
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Raising the cap to get back to 90 percent would increase tax revenues by about .2 percent of GDP.
Finally, to get an additional .3 percent of GDP, bringing the total to 10 percent, we could increase the payroll tax by one percentage point (half a percentage point on employees and half a point on employers).
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This would leave the payroll tax rate well below what it is in many European countries, and almost certainly below the level at which it would be a significant deterrent to employment.
Figure 4.3
offers only one way to increase tax revenues. There are other options. The point is that the technical details of getting an additional 10 percent of GDP are not difficult.
Let's return now to progressivity and redistribution. Some egalitarian readers may be incredulous. Why would I say that America's tax system currently is not very progressive and then recommend changes that might make it even less so?
Keep in mind that the principal objectives of government social programs are to enhance economic security and opportunity and to ensure rising living standards. Redistribution of income is not the chief aim. And yet, in doing these things, social policy does achieve a good bit of redistribution. Let me spell out how this works.
Figure 4.4
shows a hypothetical distribution of tax payments and receipt of government goods, services, and transfers. Households are separated into quintiles based on their pretax income. The light bars in the chart show the share of dollars paid in taxes by households in each quintile. The tax system in this illustration is proportional; households pay the same effective tax rate regardless of their pretax income. Although everyone has the same tax
rate
, those with higher pretax income pay more in tax
dollars
because their pretax income is higher. The richest fifth of households get 56 percent of all pretax income, so they pay 56 percent of the tax dollars in this illustration.
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The poorest fifth of households get 4 percent of the pretax income, so they pay 4 percent of the tax dollars.
FIGURE
4.4 Tax payments and receipt of public goods, services, and transfers by income quintile
These shares are hypothetical. They assume all households pay the same effective tax rate (proportional tax system). And they assume all households receive or use the same quantity (dollar value) of public goods, services, and transfers.
The dark bars in the chart show the estimated value of the government goods, services, and transfers received and used by households in each group. I assume this value to be equal for all groups; in other words, households at each point on the income ladder get about the same amount of services, public goods, and cash and near-cash transfers. This is fairly close to the truth for public goods such as roads and parks and for public services such as schooling and healthcare. It's less likely to be true for transfers. But let's suppose, for this illustration, that it's accurate for the total of services, goods, and transfers doled out by the government.
What we see in the chart is that even with a tax system that is proportional rather than progressive, government social programs are fairly heavily redistributive. Those with high pretax incomes pay far more in tax dollars than they receive in government goods, services, and transfers. Those with low pretax incomes receive much more than they pay in taxes. Although redistribution is not the chief aim, it is a result nonetheless.
Much of this redistributive impact is hidden. We can't see it in income statistics. A lot of government social expenditure is on public services and goods, and their value isn't included in household income measures. But that doesn't mean it isn't real.
One final point: while increasing tax revenues by 10 percent of GDP would be a significant change, it isn't unprecedented. Over the course of the twentieth century, revenues' share of our GDP rose by about twenty-five percentage points. And an increase of 10 percent would put the United States merely in the middle of the packânot at the frontâamong the world's rich countries.
The bottom line: we
can
pay for bigger government.
If our government gets bigger, will our economy suffer? It's easy to understand why some think so. After all, an increase in taxes reduces the financial incentive to work harder or longer, invest in acquiring more skills, start a new company, or expand an existing one. And when governments provide goods and services, they inevitably waste some resources, particularly when they face no competition.
But that's too simplistic.
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The incentive effect of higher taxes can also work in the other direction; if tax rates go up, I may work more in order to end up with the same after-tax income I had before. Moreover, some of what government does helps the economy.
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When government protects people's safety and property and enforces contracts, it facilitates business activity. Enforcement of antitrust rules enhances competition. Schools boost human capital. Roads, bridges, and other infrastructure grease the wheels of business activity. Limited liability and bankruptcy provisions encourage risk taking. Affordable high-quality childcare increases parental employment and boosts the capabilities of less advantaged kids. Access to medical care improves health and reduces anxiety. Child labor restrictions,
antidiscrimination laws, minimum wages, job safety regulations, consumer safety protections, unemployment insurance, and a host of other policies help to ensure social peace.
There surely is a tipping point at which government taxing and spending begins to harm the economy. But where are we in relation to that point? We have the experiences of the world's rich countries to draw upon in answering this question. This evidence doesn't give us a full and final answer, but it strongly suggests that America hasn't reached the tipping point. Indeed, we might be far below it.
A useful measure of the size of government is government revenues as a share of GDP. Data for the United States are available going back to the early 1900s. These data include the federal government and state and local governments. Most of the revenues, though not all, are from taxes. The chart on the left in
figure 4.5
shows that revenues rose from the 1910s through the 1990s and then leveled off. All told, government revenues increased by approximately twenty-five percentage points, from less than 10 percent of GDP to around 35 percent.
The chart on the right in
figure 4.5
shows GDP per capita all the way back to 1890. I display the data in log form in order to focus on the rate of growth. The straight line represents what the data would look like if the economic growth rate had been perfectly constant. The actual data points hug this line. In other words, despite occasional slowdowns and speedups, the rate of per capita GDP growth in the United States has essentially been constant for the past 120 years.
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We've gone from being a country with a relatively small government to one with a medium-size government, and in doing so we've suffered no slowdown in economic growth.
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Now let's look at two big-government countries: Denmark and Sweden.
Figure 4.6
shows trends in government revenues and in economic growth for these two nations. In both, government revenues jumped sharply, especially in the decades after World War II. Revenues stopped rising around 1990, flattening out in Denmark and falling back a bit in Sweden. Like the United States, these two countries have had a nearly constant rate of economic growth since the late 1800s. A very large increase in the size of government didn't knock either country off its growth path.
FIGURE
4.5 Government revenues and economic growth in the United States Government revenues: Government revenues as a share of GDP. Includes all levels of government: federal, state, and local. The line is a loess curve.
Data sources
: for 1960â2007, OECD, stats.oecd.org; for 1946â55,
Economic Report of the President
2011, tables B-79, B-86; for 1913â25, Vito Tanzi
Government versus Markets
, Cambridge University Press, 2011,
pp. 9
,
92
, with a minor adjustment. GDP per capita: Natural log of inflation-adjusted GDP per capita. A log scale is used to focus on rates of change. The vertical axis does not begin at zero. The line is a linear regression line; it represents a constant rate of economic growth.
Data source
: Angus Maddison,
www.ggdc.net/maddison/historical_statistics/vertical-file_02-2010.xls
.
A possible exception is what happened in Sweden around 1990. At the end of the 1980s, government revenues in Sweden reached 65 percent of GDP. Shortly thereafter, the country experienced a severe economic downturn. By 1995, revenues dropped to 60 percent of GDP, and the economy returned to its long-run growth path. The onset of the early-1990s crisis stemmed mainly from the deregulation of Swedish financial markets and the government's pursuit of fiscal austerity during the downturn. Given that the economic downturn coincided with a high point in government revenues, it could be argued that government taxing and spending at 65 percent of GDP is too high. Maybe that's correct. If we follow that logic, however, then we must conclude that 60 percent of GDP, the level of government revenues when the Swedish economy returned to solid growth, is not too high.