Taxation, American Style

Tuesday, April 17th, 2012

Contrary to common belief, the American tax system is more progressive than those of most industrialized democracies, Veronique de Rugy reports:

A comparison of France and the U.S. is revealing: The top marginal income tax rate in the U.S. is 35 percent and kicks in at $379,000. In France the top rate is 41 percent and kicks in at $96,000.

The U.S. federal government also relies much more heavily on the income tax, rather than the regressive consumption taxes — such as the value-added tax (VAT), retail sales taxes, and gasoline and tobacco taxes — favored by most OECD nations. European countries generally have lighter taxes on capital as well, another regressive feature.

Finally, the U.S. tax code allows large deductions and personal exemptions for low-income households, distributing social benefits in the form of policies such as the child tax credit and the earned income tax credit. These adjustments increase progressivity.

Judging solely from government outlays, it appears to be true that the United States has a smaller, more efficient government than the big welfare states of Europe. Relative to the size of GDP, U.S. government spending is about 16 percent smaller than the average for the European Union. But the difference is largely illusory. European governments tend to channel much less spending through their tax codes than the U.S. does. A November 2011 OECD paper titled “Is the European Welfare State Really More Expensive?” calculates the share of tax breaks used in OECD countries, separating out those used primarily for social purposes. The data show not only that the U.S. offers more tax breaks for social purposes as a share of GDP than any other country (almost 2 percent as opposed to the 0.5 percent OECD average) but that roughly two-thirds are tax breaks toward current private benefits (such as encouraging people to have children). These breaks, which total some $84 billion a year, are better thought of as welfare spending via the tax code.

Only by measuring tax breaks do you begin to see the true girth of the American welfare state. The chart at the top right shows social spending as a share of GDP in major countries, taking into account tax breaks for social purposes, direct taxation of benefit income, and indirect taxation of consumption by benefit recipients, all of which consume economic resources but do not show up in the budget or other measures of government spending as a share of GDP. According to these OECD data, net social welfare outlays in the U.S. consumed 27.5 percent of GDP in 2007 — above the OECD average of 23.3 percent.

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