TAX AND SPEND?
Democracies raise money through taxation. The overall tax revenues (taking together all levels of government) in the United States in 2017 was just 27 percent of GDP. This is seven points lower than the average in the OECD.
The United States was tied with South Korea, and only four other countries in the OECD have lower tax revenues (Mexico, Ireland, Turkey, and Chile).1Any significant public policy effort would require more funding. Even if the United States raises its taxes on the rich to match Denmark’s, the overall tax revenue as a share of US GDP will still be much lower than what it was in 2017 in Denmark (46 percent), France (46 percent), Belgium (45 percent), Sweden (44 percent), and Finland (43 percent). One reason is that if US tax rates were raised to those levels, it is possible top incomes would go down a lot because companies would move away from paying astronomical salaries; this might be desirable in itself but would defeat the purpose of raising revenue. In other words, although it might be desirable in terms of limiting inequality, the current proposal to raise income tax rates above 70 percent is unlikely to deliver so much new money to the state.
A wealth tax would raise more revenue as long as steps were taken to reduce evasion. Saez and Zucman estimate that a 2 percent wealth tax on Americans with assets above $50 million (this would affect about seventy-five thousand people), as well as a 3 percent wealth tax on those who have more than $1 billion would raise $2.75 trillion over ten years, or 1 percent of GDP.2 As we saw, 2 percent wealth tax for those worth more than $50 million is actually more popular than an increase in the marginal income tax rate.3 But even at the proposed level, it still raises just 1 percent of GDP.
Even in the European countries with high top rates and a wealth tax, the majority of the government’s revenues come from taxes on average earners.
In other words, the dream of a tax reform that leaves “99 percent of the taxpayers with a lower tax bill” would guarantee that the United States continues to be unable to redistribute much to those falling behind. Tax reform needs to apply not solely to the ultra-rich, but also the merely rich and even the middle class.As things stand, this is a no-fly zone for US politicians on the left and the right. Proposing to raise taxes on (almost) everyone is not popular. In our survey, 48 percent of respondents thought small business owners paid too much in taxes, and less than 5 percent thought they paid too little. The same was true for salaried workers.4 The hardest part may be to persuade the average taxpayer in the United States to pay more and get more public services. We suspect economists are partly responsible for people’s reluctance to pay taxes, in more than one way.
First, many prominent economists have raised the specter that people will stop working if taxes go up. For example, Milton Friedman, who famously declared: “I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.”5 They maintain that high taxes kill initiative and stop growth, even in the face of data that says nothing of the sort. We have already seen that the rich do not stop working when taxes go up. How about the other 99 percent though? Would they retire to the countryside? There is also a voluminous economic literature on the subject that makes it clear they won’t.6
One of the best examples is from Switzerland. In the late 1990s and early 2000s, Switzerland converted from a system where people paid taxes on the previous two years of income to a more standard “pay as you earn” system. In the old system, taxes due in 1997 and 1998 were based on income earned in 1995 and 1996, taxes due in 1999 and 2000 were based on income earned in 1997 and 1998, and so on. The new system works like that of the United States: estimated taxes due, say, for 2000 are collected throughout the year, then in early 2001 the taxpayer fills out an income tax return and the tax liability is adjusted.
To transition to the new system in Switzerland, there had to be a tax holiday. The canton of Thurgau transitioned in 1999. In 1997 and in 1998, taxpayers paid taxes on the income earned in 1995 and 1996. In 1999, they started paying taxes based on income in 1999. To avoid taxing people twice, no taxes were ever levied on the income earned in 1997 and 1998: those were the tax holiday years. Swiss cantons transitioned in different years between 1999 and 2001, so different people got their tax holidays in different years, depending on where they lived. The rebate was temporary and widely known in advance. So while people decided whether (and how much) to work for the year, they already knew they would pay no taxes. This was a perfect opportunity to see whether lowering tax rates made a difference to people’s willingness to work; we can just compare labor supply before, during, and after the tax holiday. The answer is it changed not at all. There was absolutely no impact on whether people decided to work or not, and no effect on hours worked either.7While the Swiss example is particularly stark, the result is more general. Taxes do not seem to discourage people from working.8 However, voters may still oppose taxation if they think others would stop working if taxes went up. In our survey we asked some of the respondents whether they would stop working, or work less, if taxes were higher. Seventy-two percent said they would absolutely not stop working, and 60 percent said they would work just as much as before. This is very consistent with the data. We also asked the other respondents how they thought the average person in the middle class would respond. In that case, only 35 percent of respondents believed the average middle-class person would work as much as before, and 50 percent believed they would stop working.9 Thus, when judging themselves, Americans are about right, but when they anticipate the behavior of their friends and neighbors, they are much too pessimistic.