This article is Part III in a series of articles regarding government spending. To read the other related pieces, go to my U.S. Federal Debt: Sources and Solutions page.
The Gripes and Wrath
Of all of the portions of the longstanding American dissonance over the U.S. Federal Budget, the king of all disagreements lies in taxation. It should not be a surprise then to understand that it is in taxation where the information regarding the Federal Budget is the most suspect due to all of the myriad political influences involved.
During the 2010 election cycle, the airwaves were filled with Tea Partiers railing against government spending and the need for lower taxes. We often heard of corporate taxes being too high and how they should be lowered. We heard of the economic benefits of reducing taxes. The Tea Party floated on a crimson tide of red ink into Washington D.C. and is now trying to drive the Republican agenda even further toward tax decreases, regardless of what happens with federal spending.
What is the current status of taxes in the United States? Who pays taxes in the U.S.? How do various taxes affect the population and job growth? We will investigate each of these questions in this article. These are rarely addressed in the news, despite the fact that the current budget battles are on the TV all of the time. We will address some of the political motivations of the Media that prevent them from accurately reporting issues of federal finance in a later article.
Tax Rates: The U.S. vs. the World
Considering the invective that can be overheard at any Tea Party rally, one would think that the people in the crowd are being taxed within an inch of their lives. The mere mention of the word ‘tax’ results in a bitter, emotional spew of slogans and booing – a visceral, angry reaction that is fueled by the rhetoric of Republican political candidates. It is one version of their five-minute hate. But is it realistic?
Figure 1 shows the 2006 rate of taxation in the U.S. relative to the world. This includes the total federal, state and local taxes or their equivalents in each case.
As you can see, the total tax rate is much lower than that of most other developed countries, and it is roughly half that of nations like Denmark and Sweden.
“Ah, that’s SOCIALISM!”shouts the Tea Partier. Yes, Denmark and Sweden do have socialist economies. But given that information, we should at least see whether there is a benefit. Below are lists of the top 10 nations in terms of Gross Domestic Product (GDP) per capita from the International Monetary Fund (IMF). Other lists can be found as well on Wikipedia.
|Rank||IMF (2010)||GDP per capita ($)|
|8.||United Arab Emirates||47,406|
Excepting Qatar and the United Arab Emirates which do not have income taxes due to the fact that those nations are run on revenues from their oil reserves, each of the countries with a higher GDP per capita has higher taxes than the United States.
In addition, as we will find, considering the higher tax rates, each of those countries has a lower Gini Coefficient, a measure of income inequality. World Gini Coeffficients are found in Figure 2.
Economies with higher Gini Coefficients can face instability and corruption in government as lower classes tend to be crowded out of the political process by wealthy and powerful individuals. Considering that the Gini Coefficient of the United States is actually worse than that of nations like Egypt, there should be no surprises that labor demonstrations are taking place in America.
The Purchasing Power Parity (PPP) index is a measure of the relative purchasing power of currencies around the world. This index is dependent on the development in an economy, the strength of the currency and also on the wages of the people. Nations with a higher Purchasing Power Parity are able to more easily afford a similar, pre-described “basket” of everyday goods (food, clothing, etc.) and services in countries with lower PPP indices. In essence, the PPP is one measure of the wealth of a country in slightly different way than GDP per capita. The GDP per capita describes how much money someone earns on average in a country where the PPP indicates how much one could do with that money.
Remember those countries whose citizens earn more than Americans? All of them – and even the Netherlands, which also has far higher tax rates than the U.S. – have higher PPP than the U.S. This can be seen in Figure 3. It essentially means that when someone travels from Norway to the U.S., they consider prices to be cheap in the way Americans find prices to be lower in Mexico.
There are several great reasons for this. Well, taxes actually raise incomes. Progressive radio host Thom Hartmann explains:
When I was in Denmark in 2008 doing my radio show for a week from the Danish Radio studios and interviewing many of that nation’s leading politicians, economists, energy experts, and newspaper publishers, one of my guests made a comment that dropped the scales from my eyes.
We’d been discussing taxes on the air and the fact that Denmark has an average 52 percent income-tax rate. I asked him why people didn’t revolt at such high taxes, and he smiled and pointed out to me that the average Dane is very well paid, with a minimum wage that equals roughly $18 per hour. Moreover, what Danes get for their taxes (that we don’t) is a free college education and free health care, not to mention four weeks of paid vacation each year and notoriety as the happiest nation on earth, according to a major study done by the University of Leicester in the United Kingdom.
But it was once we were off the air that he made the comment that I found so enlightening.
“You Americans are such suckers,” he said. “You think that the rules for taxes that apply to rich people also apply to working people, but they don’t. When working peoples’ taxes go up, their pay goes up. When their taxes go down, their pay goes down. It may take a year or two or three to all even out, but it always works this way—look at any country in Europe. And that rule on taxes is the opposite of how it works for rich people!”
My Danish guest was right. So before we get into the larger consequences of tax increases or tax cuts for the nation’s economic health, let’s parse this business about what tax increases or cuts mean for the rich and for the not-so-rich.
Why is this so? It is a matter of an economic phenomenon called tax incidence that essentially describes how the laws of supply and demand work with taxes on wages. If a government introduces a tax on worker salaries, it happens that those workers will need a little more money in order to be able to purchase food and supplies necessary for daily life. In the very short term this can be a slight problem, though after about a year it means that a number of workers who are taking new jobs would have negotiated higher wages than they would have without the tax increase. The increased wages they receive mean a higher demand for jobs, and that increases wages even more. When all is said and done after a year or two, wages more than make up the amount of money lost to the tax increase!
Companies in the United States understand this quite well – why else do you think that the “business-friendly” party, the Republicans continually asks for tax cuts? Not only does this help Republicans pretend they are on the side of workers, but it is one way of forcing labor prices lower for the wealthy while being able to retain more money for themselves.
But taxes are not fun to pay, you say. Well, then one would expect that people who live in countries with high tax burdens would be unhappy. Yet in 2011, Forbes reported a survey conducted by the Legatum Institute in which they asked citizens around the world about their happiness and standards of living and compiled these into a “Prosperity Index”. Their results were interesting. The United States fared alright at #10. But it was beaten by strong social democracies that each have higher taxes! Here is the top ten, with total tax rates listed just for fun:
|Rank||Legatum Prosperity Index Rank (2011)||Total Tax Rate (%)|
Sure, the United States did alright, but the odds are very low that every country ranked higher than the U.S. would have higher taxes by coincidence. In fact the U.S. is ranked more highly than it otherwise would be due to the fact that it holds the world’s reserve currency, which offers the U.S. a extra wealth that other countries do not have access to.
A Tea Party person might interject here once again: But the U.S. has FREEDOM! Let us take a look at that idea a little bit more carefully. What does freedom mean? Of course it can mean things like freedom of speech and freedom of assembly, but it can also mean upward mobility. After all, failing other freedoms, being wealthy can often result in a very different perception of a person by the government. How likely is it for a person in the lower classes to rise up to the higher classes? Two Social scientists, Dorling & Henning have done a study on the relative (im)mobility of citizens in a variety of nations, especially the U.S. and other countries that are listed in the lists above. Their results are in Figure 4, where it can be seen that
the countries that pay higher taxes all have greater ease in moving from the lower classes to the higher ones in economic status and this may be correlated with income disparity. The U.S. does shine here in terms of educational mobility, though this amazing feature of American society is currently under attack.
At this point, the recalcitrant Tea Partier mutters, “Well, you still have not talked very much about taxation.” This is largely true, though so far we have discussed some of the possible results of taxation when it is done right. We will discuss taxation itself and some more of the side-effects in the next section, in which we specifically look at the history of taxation in the United States.
Taxes in the American Economy
Another farce about taxes, yet it is a commonly held belief that taxes in the United States are high right now even when compared to historical rates. In a recent article, Richard Wolff shows a plot that displays the historical income tax rates in the highest and lowest tax brackets in the U.S. (Figure 5).
Taxes on the wealthy had been at recent lows just prior to the Great Depression, but one of the policies that the Roosevelt Administration pursued was to raise income taxes on the wealthiest Americans to 90%. “How draconian!” you may say, “How could he do that?” Roosevelt was quite wealthy himself but his relationship with organized money was quite different from that of President Obama’s. For example, on the eve of the 1936 election FDR gave a speech at Madison Square Gardens. Here is a quote:
For twelve years this Nation was afflicted with hear-nothing, see-nothing, do-nothing Government. The Nation looked to Government but the Government looked away. Nine mocking years with the golden calf and three long years of the scourge! Nine crazy years at the ticker and three long years in the breadlines! Nine mad years of mirage and three long years of despair! Powerful influences strive today to restore that kind of government with its doctrine that that Government is best which is most indifferent.
For nearly four years you have had an Administration which instead of twirling its thumbs has rolled up its sleeves. We will keep our sleeves rolled up.
We had to struggle with the old enemies of peace—business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering.
They had begun to consider the Government of the United States as a mere appendage to their own affairs. We know now that Government by organized money is just as dangerous as Government by organized mob.
Never before in all our history have these forces been so united against one candidate as they stand today. They are unanimous in their hate for me—and I welcome their hatred.
I should like to have it said of my first Administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said of my second Administration that in it these forces met their master.
(This speech is truly worth a listen as the mere words do not quite carry FDR’s oratory. He knew how to give a speech. Here is the link once again.)
Can you imagine President Obama saying something similar? During the week before an election?!! He had the perfect opportunity to do so when he was elected. Instead, he hired Timothy Geithner, one of the people who created the mess as his Secretary of Treasury and kept Ben Bernanke on at the Federal Reserve. The Tea Party may not believe so, but Obama is owned by Wall Street. Goldman-Sachs was one of his largest benefactors during his election.
The 90% tax rates on the wealthy by FDR were intended in part to break the political power of the most wealthy individuals in the country, whose unregulated financial speculation resulted in the Great Depression. (Sound familiar?) In part, the taxes were high in order to fund programs like Social Security and, yes, to redistribute wealth.
But wait a second! Redistributing wealth is bad for the economy, right? Well, let’s take a look. Figure 6 shows annual growth in U.S. GDP since 1929.
GDP growth rates in the United states were far higher during the times when the top income tax rates were REALLY high than they are today. In fact, the growth rates tend to be highest when top income tax rates are also highest. This is primarily due to two things.
First, the high tax rate created the Middle Class. With many more people able to purchase products that American companies produced, the economy boomed during the 40’s, 50’s and 60’s.
Second, it turns out that productivity increases during times when the top tax rate is highest. Higher taxes mean higher federal spending and higher spending boosts the economy.
Of course there is that caveat that one can not allow the federal debt to go too high, otherwise it is possible to create stagflation as I mentioned in Part II. Considering this, I was excited to see the correlation between National Debt and the income tax rate that Greg Hollingsworth put on his blog, shown in Figure 7.
Did you notice how as the top income tax rate drops, the U.S. Federal Debt skyrockets? Well, the top tax rate on the wealthy seems rather high, but recall that wealthy people only earn a portion of their money in the form of income. They also earn a lot of money through capital gains. Those taxes are rather low, too. But as you can see lowering taxes has had a profound effect on the American economy. Not only is it running less efficiently than it once had, but the national debt is going through the roof, too.
There is also a growing problem of the income disparity that we mentioned earlier. One problem with having a billionaire is that the billionaire does not invest all of his or her money into the economy. Rather, there is always a sizable portion of those assets that is rather illiquid, meaning that it does not circulate through the economy. This effectively reduces the money supply for everyone else and a BILLION is a very large number, so it represents a rather large loss of capital in the economy. The more billionaires, the greater this problem becomes and this is a motivating factor for the high tax rates on the highest income brackets. The wealthy are, after all, most able to afford the taxes and they have certainly benefitted from having been born and raised in the American economy, so it is a way of paying back to society.
Still, the income disparity is continually growing. In fact, thanks to tax loopholes that are available to the wealthy (but not the Middle Class), the world’s third richest man, Warren Buffet, famously complained that he pays a lower tax rate than his middle-class secretary. He has class, so he asked the Bush Administration and the Obama Administration after that to raise his taxes. He even argued that it would be good for the economy. He is still waiting for that to happen. In fact, the disparity in incomes in the U.S. is at its greatest size ever – bigger than the disparity at the beginning of the Great Depression, as is seen in Figure 8.
Right now 1% of the population earns more than 20% of all of the income in the country. Much of that money sits idle when it could be re-invested into the economy.
Figure 9 shows just how bad the situation is. The three bars in the plot show the Real, Estimated and Ideal fractions of income held by each quintile of the population according to a survey of the U.S. population by Michael Norton of Harvard Business School.
The results show that the actual income disparity is far worse than the perceived one, and very very far from the ideal held by the average American. In fact the American ideal has the top 20% of income earners only earning 30% of income! That is even more socialist than Denmark!!
People are beginning to realize this and they are beginning to wake up out of the hypnotized slumber they have felt since Ronald Reagan and they are getting angry about this. Especially when they take a look at the relative growth rates of each income bracket over time (Figure 10) But there is one more thing that REALLY makes people mad.
Something is still missing, though… Hmm…
…and that missing thing is the corporations. Now I know what a Tea Partier would say: “We can’t have high corporate taxes because companies will just move away.” Regulations could prevent that, and corporations should pay their share because they use and abuse our natural resources and national infrastructure all of the time.
If you were to ask the Heritage Foundation, they would show you this diagram (Figure 11):
Oh no! America’s corporate tax rates are among the highest in the world! America is doomed!! All the companies will move away!
Not so much… Those are the official tax rates, not the actual ones. There are lots of tax loopholes for companies. Rachel Maddow did a great piece in October, 2010 in which she mentioned that GE, Bank of America and Citigroup (the latter two playing a significant role in starting the Great Recession) paid $0 in corporate taxes. Yes, companies that earn billions of dollars per year pay less than you do in taxes and that is closer to the rule than the exception, though most small businesses do not share in those benefits. And yet, the Republicans keep asking for tax breaks for the rich and for corporations – out of fear that tax loopholes might be closed. It is possible for them to make the argument for lower taxes because the current tax rate is ostensibly so high. That is why the difference between the official tax rate has not been lowered so that it reflects reality.
There is more.
The pre-New York Times FiveThirtyEight blog posted an entry with a plot, Figure 12, that is the coup de grace.
Look at Figure 12. Look at the Corporate Tax Rate. Look at the Social Security Income & Retirement Tax Rate. The reason that corporations now pay very little in actual taxes now is that since the time of Eisenhower, the decrease in the corporate tax rate has been funded by the increase in taxes on entitlements as a direct result of Republican federal policy.
Corporations extract resources that are owned by the public. They make a profit for themselves from those resources and they do not repay the public. That is where tax policies are today. So when you see that the budget deficit has swelled and that the middle class is doing poorly, it is a direct result in the drop in high-income taxes and corporate taxes. The effect is so profound that wealthy industrialists like the Koch brothers will save money by spending hundreds of millions of dollars to corrupt the political process so that they can buy the policies that they would like. They get a free ride with billions of dollars in the bank, but you get to pay for their exploits with middle class wages. Isn’t it about time that we had a discussion with our Tea Party friends? I thought so.
References and Links