Combating Inequality May Require Broader Tax
The New York Times
By: Eduardo Porter
November 27, 2012
Rarely have we experienced such a confluence of arguments in favor of raising taxes on the rich. After a hard-won re-election fought mainly over taxes and spending, President Obama arguably has a mandate from voters to tap the wealthy to address our budget woes.
What's more, raising more money from the wealthy might go a long way toward righting our lopsided economy -- which delivered 93 percent of our income growth in the first two years of the economic recovery to the richest 1 percent of families, and only 7 percent to the rest of us.
Yet while raising more taxes from the winners in the globalized economy is a start, and may help us dig out of our immediate fiscal hole, it is unlikely to be enough to address our long-term needs. The experience of many other developed countries suggests that paying for a government that could help the poor and the middle class cope in our brave new globalized world will require more money from the middle class itself.
Many Americans may find this hard to believe, but the United States already has one of the most progressive tax systems in the developed world, according to several studies, raising proportionately more revenue from the wealthy than other advanced countries do. Taxes on American households do more to redistribute resources and reduce inequality than the tax codes of most other rich nations.
But taxation provides only half the picture of public finance. Despite the progressivity of our taxes, according to a study of public finances across the industrial countries in the Organization for Economic Cooperation and Development, we also have one of the least effective governments at combating income inequality. There is one main reason: our tax code does not raise enough money.
This paradox underscores two crucial lessons we could learn from the experience of our peers around the globe. The first is that the government's success at combating income inequality is determined less by the progressivity of either the tax code or the benefits than by the amount of tax revenue that the government can spend on programs that benefit the middle class and the poor.
The second is that very progressive tax codes are not very effective at raising money. The corollary -- suggested by Peter Lindert of the University of California, Davis in his 2004 book "Growing Public" -- is that insisting on highly progressive taxes that draw most revenue from the rich may result in more inequality than if we relied on a flatter, more "regressive" tax schedule to raise money from everybody and pay for a government that could help every American family attain a decent standard of living.
Consider government aid for families. According to the O.E.C.D. study, our Temporary Assistance for Needy Families is the most progressive program of cash benefits for families among 22 advanced countries, accurately targeted to serve the poor.
But American family cash benefits are the least effective at reducing inequality. The reason is that they are so meager. The entire budget for cash assistance for families in the United States amounts to one-tenth of 1 percent of the nation's economic output. The average across the O.E.C.D. nations is 11 times bigger. Even including tax breaks and direct government services, we spend a much smaller share of our economic output on family assistance than almost any other advanced nation.
The same pattern can be found across a range of government programs. The reason is always the same: their relatively small size. Over all, government cash benefits in the United States -- including pensions, disability, unemployment insurance and the like -- contribute about 10 percent to household income, on average, according to the study. The average across industrial nations is twice that.
Our budget reveals a core philosophical difference with other advanced countries. In the big-government social democracies like those of Western Europe, government is expected to guarantee a set of universal public services -- from health care to child care to pensions -- that are considered basic rights of citizenry. To pay for this minimum welfare package, everybody is expected to contribute proportionately into the pot.
Government in the United States has a different goal. Benefits are narrower. Social Security and Medicare follow a universal service template, but only for older Americans. Other social spending is aimed carefully to benefit the poor. Financed through a more progressive tax code, it looks more like charity than a universal right. On top of that, our philosophical stance virtually ensures a small government.
Progressive taxes make it hard to raise money because they distort people's behavior. They encourage taxpayers to reduce their tax liability rather than to increase their pretax income. High corporate taxes encourage companies to avoid them. High taxes on capital income also encourage avoidance and capital flight. High income tax rates on top earners can discourage work and investment, too. So trying to raise a lot of money with our progressive tax code would probably not achieve the goal and could damage economic growth.
Big-government social democracies, by contrast, rely on flatter taxes to finance their public spending, like gas taxes and value-added taxes on consumption. The Nordic countries, for instance, have very low tax rates on capital income relative to income from work. And they have relatively high taxes on consumption. In Denmark, consumption tax revenue amounts to about 11 percent of the nation's economy. In the United States, sales taxes and excise taxes on cigarettes and other items amount to roughly 4 percent.
Liberal Democrats have long opposed them because they fall much more heavily on the poor, who spend a larger share of their incomes than the rich. But these taxes have one big positive feature: they are difficult to avoid and produce fewer disincentives to work or invest. That means they can be used to raise much more revenue.
Public finances are under strain today on both sides of the Atlantic, as governments struggle to cope with our long global recession and the aging of the baby boom generation. In Southern Europe, the pressure to pare back universal welfare systems is intense. In the United States, political leaders on both sides of the partisan divide have realized that even our relatively meager package of social goods cannot be sustained with our slim tax take.
But the United States has one option that most of Europe's flailing economies do not. Its tax revenue is so low, comparatively, that it has more space to raise it. A more efficient, flatter tax schedule would allow us to do so without hindering economic activity.
Bruce Bartlett, a tax expert who served in the administrations of Ronald Reagan and George H. W. Bush, told me last week that he thought federal tax revenue could increase to 22 percent of the nation's economic output, well above its historical average of 18.5 percent, without causing economic harm. If President Obama tries to go down this road, however, he may have to build a flatter tax code.
"We should reform the tax system, no question," William Gale, a tax policy expert at the Brookings Institution and co-director of the nonpartisan Tax Policy Center, wrote in an e-mail. "We are going to need to move beyond the current set of tax instruments to raise the needed revenues -- a VAT and or a carbon tax seem like the obvious ways to go." And Mr. Bartlett, who writes a column for The New York Times's Economix blog, also pointed out: "We can't get all the revenue we need from the rich. Eventually, everyone will have to pay more."
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