I spent most of today looking for data on taxes. I think it is clear that taxes are too low and we need a tax increase much more than we need spending reductions. I drafted the letter below for the president and my congressmen. I plan to add footnotes and references and generally clean it up, then send it this week.
They won't read it, but I feel better for having written it.
I hope this isn't too much content for a single post. I would apreciate any comments you might have.
If you like this and generally agree with the conclusions, feel free to use it as you see fit.
12/24/10 The final version is available: Tax policy analysis
I've incorporated a number of your comments. Thank you.
Mr. President, Senators and Representatives,
I have been very concerned recently about some of the decisions that have been made about taxes and spending and what appears to be a big battle coming up in 2011 about taxes and the deficit. To understand the issues a bit better, I spent some time looking at tax trends – mainly using reports from the OECD and IRS. I hope you will take a few minutes and study these charts and conclusions.
Executive Summary
Data from the IRS and OECD will be used to make an argument that:
• Taxes are too low, especially compared to rest of the world
• Low taxes do not promote economic growth or protect against recessions
• Social security taxes are too low
• The loss of tax revenue negatively affects federal deficits, child poverty rates, health insurance coverage, life expectancy, education and other quality of life issues
• Current tax rates are generally progressive but need to be adjusted at both the low and high ends of the income scale
• Tax increases need to be focused on the $100,000 - $150,000 income range (and all higher incomes to maintain a progressive profile)
Please review this information, do your own research and then work toward a comprehensive tax reform and tax increase in 2011-2012. Tax increases will not be popular – but you need to do your job and provide the leadership to explain these issues and make the right choices for the country.
How does the US tax burden look compared to other countries?
This chart shows the total tax burden for all types of taxes, as a percent of GDP. For many years (back at least to 1965) the taxes in US have been below the median rate for the OECD countries. Our taxes were essentially flat in the Ford and Reagan years while the rest of the world was increasing. Clinton raised our rates, but we were still well below the OECD median. Of course, Bush and Obama have both significantly reduced taxes to the point that the US tax burden in only 2/3 that of the OECD median.
We are in pretty good company – other countries with rates as low as ours include Mexico, Chile, Turkey and Korea.
In my opinion, we want to be a world class nation. We cannot do that without world class services, and that takes money. Our total taxes should be more like the 35% the rest of world pays. This may be personal income tax, corporate tax, consumption tax or some combination – but we need to start with an understanding that taxes have to go up.
TANSTAAFL. (Robert Heinlein – There Ain’t No Such Thing As A Free Lunch.)
Do low taxes promote growth?
This chart shows the relationship of GDP growth to tax rates for the 33 OECD countries. To look at pre-recession data, I used the average compound GDP growth rate from 2002 though 2008, and compared it to the average of the tax rates from 2000 and 2007. There is a weak negative relationship – higher taxes do correlate with lower growth. However, the relationship is very weak with only a 12% R-square. Clearly, there are many other factors with a bigger impact on GDP growth than tax rates.
There are many countries represented on this chart with higher tax rates and better growth than the US. I do not see any reason to believe that a tax increase will inhibit GDP growth.
Do low taxes protect against a recession?
This chart looks like the prior chart, but the GDP data is for the mostly recessionary decline in GDP from 2008 to 2009, and the tax rate is the 2008 tax rate. Once again, there is a weak negative correlation with a 12% R-square.
As with the prior chart, there are many countries with higher taxes and better economic performance in the recession. I don’t believe that low taxes helped out here, either.
What about social security contributions?
This chart is also from the OECD data. It shows the social security contribution as a percent of GDP for the US and for the median of 33 OECD countries.
From 1965 through 1985, contributions to social security were increasing in the US and worldwide. However, for the last 25 years the US contributions actually declined to 6.5% of GDP while the rest of the world saw contributions increase to almost 11%.
Even before the payroll tax holiday there has been concern that the social security trust fund is under-funded. Whether or not this is true, we clearly are not as serious about social security and retirement funding as the rest of the world. In my opinion, social security taxes are too low to fund this critical program.
What is the deficit impact of low taxes?
This chart shows federal revenue, spending and deficit as a percent of GDP. Back in 1965, we had essentially a balanced budget during the Johnson administration. Ford and Reagan both increased spending as a percent of GDP without a corresponding tax increase, resulting (obviously) in significant budget deficits. Clinton both reduced spending and increased taxes – there was a budget surplus in 2000. Bush and Obama have both lowered taxes and increased spending and deficits are again out of control.
Fiscal control requires addressing both revenue and spending. I am sure that federal spending can be cut – but I am equally sure that tax revenue can be, and in fact must be increased as well.
Republicans have proven to be "borrow and spend" politicians during the Ford, Reagan and both Bush administrations. Much less honest and more dangerous than any "tax and spend" policy, this has been devastating for the budget and the economy.
What have we gotten with our low tax base?
Child poverty rates among the highest in the world:
Health insurance – 0ne of only four countries that doesn’t cover everyone (along with Turkey, Mexico and the Slovak Republic):
Below average life expectancy:
Below average math skills:
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Just average science skills:
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Just average reading skills:
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Are taxes progressive?
This chart shows the top marginal tax rate in 30 OECD countries. The US has the 11th lowest top tax rate. It also shows the income level at which the top rate applies. In the US, this is 9.6x the average income level, whereas the OECD median is 2.3x. In other words, not only is the top US marginal rate lower than most, it also applies to higher relative incomes than most.
This chart shows effective tax rates for 2000 (before the Bush tax cuts) and 2008. The effective rate used is calculated from the IRS data by dividing total tax receipts for each income (AGI) range by the midpoint of the range. It is the effective average (not marginal) rate paid on all income (AGI) before deductions.
For the most part, taxes are progressive for incomes between $10,000 and $1,000,000. However, below $10,000 AGI it appears that the effective tax rate is actually higher at lower incomes. This was fixed somewhat in the Bush tax cuts. It also appears that effective tax rates decrease by about (3) percentage points at AGI levels over $1,000,000. This needs to be fixed as taxes are "reformed" in 2011 and 2012. The tax profile by income range was lowered across the board in the Bush tax cuts and does not appear to be appreciably more or less progressive than before.
The red line on the chart shows us "where the money is". This line represents total gross income in billions. Clearly, the "sweet spot" for raising taxes is in the $100,000 to $150,000 range – that’s where the bulk of the income is found. (For full disclosure – my income level is in this range.) If we are going to raise taxes, we have to look at this income level. There is also a fair amount of total income at the very high incomes that cannot be ignored, but it will not be the source of major revenue gains.
If taxes are in fact increased starting at $100,000, then taxes at all higher incomes will have to be increased as well to maintain the progressive nature of our current taxes structure.
Conclusions
My simple conclusions from this research is that taxes in the US are clearly too low. We cannot afford to do the things we need to do and come anywhere close to balancing the budget without a tax increase. If we want to keep (regain) our place as a modern nation and role model for the world, we need to fund social security, health care, education and other priorities. These require funding, which can only come from taxes.
Taxes need to be progressive. We need to fix the tails of the tax:income curve with lower taxes at the low end and higher taxes at the high end. In between, we specifically need to increase taxes in the $100,000 - $150,000 income level, since that is where the bulk of the nation’s AGI resides. To keep a progressive tax structure, all higher incomes must also participate in tax increases.
Mr. President, Senators and Representatives – please think about these issues and do your own research. The debates will be starting soon on spending levels and the federal debt ceiling. By all means, do your job relative to spending controls – but please, for all our sakes, do not neglect to also do your job on revenues and taxes. Tax increases will not be popular – but you need to do your job and provide the leadership to explain these issues and make the right choices for the country.
Sincerely,