This is part 2 of a two-part series on comparing the tax systems of the social democracies with that of the United States. I was motivated to write on this topic because it has become very fashionable for conservatives to point out that the social democracies tax regressively in order to "debunk" American fans of social democracy--since people who support social democracy tend to also support progressive taxation. Critics use the supposed regressivity of the tax systems in the social democracies to argue that progressive taxation and social democracy are incompatible.
This is wrong for two reasons, and that was the focus of the first post. First, the social democratic system is for the most part very progressive; the confusion stems from the fact that most experts on the American tax system assume that the social democratic system is basically the same as the American social welfare system, only more generous. But that's not true--the social democratic system is a different system entirely.
Second, the social democratic tax system actually is regressive for the richest 1%, who pay a lower tax rate than most of the poorest 99%. Many conservatives would like the conclusion to be that raising taxes on the richest 1% is therefore incompatible with social democracy. However, the richest 1% of the social democracies accounts for under 10% of national income, whereas the richest 1% in the United States accounts for nearly a quarter of national income. If the richest 1% has lower tax rates in the social democracies than the poorest 99%, the welfare state can still be funded because the richest 1% accounts for under 10% of all national income. But in the Untied States, a robust welfare state could not be funded without taxing the richest 1% higher than the social democracies do; they simply control too much of the national income.
I picked on Kyle Pomerleau of the Tax Policy blog not because he was a particularly ill-informed example, but because he was a particularly competent example. Most analysis of the differences of tax systems in the social democracies is so hopelessly muddled that there's nothing to criticize; it's simply all wrong. Pomerleau got a lot of the technical details correct about the social democratic tax system, so lets turn now to that topic.
To begin, Pomerleau notes that taxes and marginal tax rates are higher in the social democracies. True. And the highest tax rates kick in at much lower income levels:
However, the rates are not necessarily the most important feature of the Scandinavian income tax systems. In fact, the United States’ top marginal income tax rate is higher than Norway’s and only 18 percent lower than Sweden’s, yet raises 40 percent less income and payroll tax revenue than Norway and 50 percent less than Sweden.
The top marginal tax rate of 60 percent in Denmark applies to all income over 1.2 times the average income in Denmark. From the American perspective, this means that all income over $60,000 (1.2 times the average income of about $50,000 in the United States) would be taxed at 60 percent...Sweden’s top marginal tax rate of 56.9 percent applies to all income over 1.5 times the average income in Sweden. Norway’s top marginal tax rate of 39 percent applies to all income over 1.6 times the average Norwegian income.
Compare this to The United States. The top marginal tax rate of 46.8 percent (state average and federal combined rates) kicks in at 8.5 times the average U.S. income (around $400,000). Comparatively, few taxpayers in the United States face the top marginal rate.That last paragraph needs a little more perspective. There is almost no one in the United States who pays the top marginal tax rate. Pomerleau notes that the top rate starts around $400,000. The poorest members of the richest 1% don't even make that much:
The average household income of the 1% was $1.2m in 2008, according to federal tax data. The ultra-rich skew that average upwards: admission to the 1% began at $380,000 in 2008.And furthermore, much of the richest 1% mostly pays capital gains taxes, which are taxed at a much lower rate; the highest tax rate on capital gains is just 20% (and 15% prior to 2013). The richest 1% pay about 20% of their income in taxes, suggesting that income for this group overwhelmingly comes from capital gains. Famously, this means that Warren Buffet's secretary pays a higher tax rate than he does.
It's misleading in the extreme to talk about income taxes in isolation from capital gains taxes--especially if you want to talk about progressivity of tax systems, as Pomerleau clearly does. You can't talk about the supposed progressivity of the American tax system based on income tax rates when the wealthiest Americans don't pay income taxes, instead paying lower (20%) capital gains tax rates. We'll take up the issue of capital gains taxes below.
Value Added Taxes (VAT)
The social democracies also collect quite a bit in Value Added Taxes:
Denmark collects about 9.6 percent of GDP through the VAT, Norway collects about 7.8 percent, and Sweden collections about 9 percent of GDP. All three countries have VAT rates of 25 percent. The United States does not have a national sales tax or VAT. Instead, states levy sales taxes. The average rate across the country is about 7 percent. The much lower rate only collects about 2 percent of U.S. GDP in revenue.Some important points about VAT. First: What is a VAT? A VAT is kind of like a sales tax. Wikipedia's examples are the best I've seen explaining VAT. Here is how sales taxes work:
With a 10% sales tax:And here is how a VAT works:
- The manufacturer spends $1.00 for the raw materials, certifying it is not a final consumer.
- The manufacturer charges the retailer $1.20, checking that the retailer is not a consumer, leaving the same gross margin of $0.20.
- The retailer charges the consumer $1.50 + ($1.50 x 10%) = $1.65 and pays the government $0.15, leaving the gross margin of $0.30.
With a 10% VAT:Thanks Wikipedia.
With VAT, the consumer has paid, and the government received, the same dollar amount as with a sales tax. The businesses have not incurred any tax themselves. Their obligation is limited to assuming the necessary paperwork in order to pass on to the government the difference between what they collect in VAT (output tax, an 11th of their sales) and what they spend in VAT (input VAT, an 11th of their expenditure on goods and services subject to VAT).
- The manufacturer spends ($1 + ($1 × 10%)) = $1.10 for the raw materials, and the seller of the raw materials pays the government $0.10.
- The manufacturer charges the retailer ($1.20 + ($1.20 × 10%)) = $1.32 and pays the government ($0.12 minus $0.10) = $0.02, leaving the same gross margin of ($1.32 – $1.10 – $0.02) = $0.20.
- The retailer charges the consumer ($1.50 + ($1.50 × 10%)) = $1.65 and pays the government ($0.15 minus $0.12) = $0.03, leaving the same gross margin of ($1.65 – $1.32 – $0.03) = $0.30.
- The manufacturer and retailer realize less gross margin from a percentage perspective.
- Note that the taxes paid by both the manufacturer and the retailer to the government are 10% of the values added by their respective business practices (e.g. the value added by the manufacturer is $1.20 minus $1.00, thus the tax payable by the manufacturer is ($1.20 – $1.00) × 10% = $0.02).
However, Pomerleau is quite mistaken about VAT rates. He says of Denmark, Norway, and Sweden: "All three countries have VAT rates of 25 percent." This is wrong for Sweden and Norway. 25% is indeed the top VAT rate in Sweden and Norway, but it doesn't apply to all sales. In Sweden:
The VAT standard rate is 25 percent and there are two reduced rates of 12 and 6 percent as well as a zero rate. The 12 percent rate applies to food, restaurant and catering services, hotel stays and camping stays. The 6 percent rate apply to most public transport, transport in skilifts, books, magazines & newspapers, admissions to cultural events, sports, admission to zoological gardens. The zero rate apply to for example health care, education, postal services, financial services, insurance, pharmaceuticals sold on prescription and rental & sales of immovable property (ibid. p. 188).For Norway:
The standard rate of VAT is 25%. A reduced rate of 15% applies to foodstuffs. A super reduced rate of 8% applies to passenger transport, the national television licence fee and cinemas. Hotel and accommodation services are subject to VAT at 8% from 1 September 2006.And in Norway, exports are exempt from VAT, nearly all services are exempt from VAT, and certain goods, including books, newspapers, used cars, and ships are exempt from VAT.
Denmark only exempts certain newspapers from VAT; all other transactions are subject to that 25% rate.
I'm not sure how Pomerleau missed this. His employer, the Tax Foundation doesn't forget that not all sales are covered by American state and local sales taxes; why should he overlook the fact that not all sales in Scandinavia are subject to the highest VAT rate? Let's imagine a hypothetical Swedish family that spends a third of their income on food, a third on entertainment, and a third on rent, with zero savings. Rent is not subject to VAT; most entertainment is only taxed at 6%; and food is taxed at 12%. For this hypothetical family budget, VAT will only be 6% of income. Many common purchases would not be subject to VAT, nor are savings are not subject to VAT.
Clearly, Scandinavian VAT is not as simple as a 25% rate; nonetheless, the social democracies do collect a lot of tax revenue with VAT.
Pomerleau insists that VAT is regressive, which makes sense, because consumption taxes are generally regressive. This is because lower income households tend to spend a higher percentage of their income than high income households. This is simply because lower income households have less income and need to spend a higher percentage of their income to meet their basic needs. In turn--because a higher percentage of income is spent on consumption--the overall consumption tax burden on low income families (as a percentage of their income) is higher. Indeed, Citizens for Tax Justice points out the bitter unfairness of sales taxes in the United States. But it's not that simple for VAT taxes (emphasis added):
In the 15 remaining EU-27 countries [including Denmark, Finland, and Sweden], VAT payments as a fraction of expenditures are more than 0.5 percentage points higher for the richest households than for the poorest households; we therefore define these VAT systems to be progressive.Since these calculations of tax burden are as a percentage of household expenditure (rather than household income), it's more fair to characterize VAT as regressive. Clearly, however, there are important caveats.
Overall corporate tax revenues are similar in the United States and the social democracies. Pomerleau points out:
In 2012, the United States raised 2.5 percent of GDP from the corporate income tax, just below the OECD average of 2.9 percent. Denmark raised slightly more at 3 percent and Sweden raised slightly less at 2.6 percent of GDP.He also claims that:
In fact, their marginal corporate income tax rates are much more competitive than the United States’ rate...The U.S. marginal tax rate on corporations is much higher at 39.1 percent (average of federal and state).Wrong. This contains a pretty obvious contradiction: How can the social democracies simultaneously collect a higher percentage of GDP in corporate taxes, yet still have "more competitive" tax rates? In similarly wealthy countries, how can rates be lower yet revenue higher?
The answer is that the American corporate tax code is ridden with loopholes, which he chooses to ignore. He is correct about statutory rates--the statutory corporate tax rates in the United States are indeed higher than in the social democracies--but only ordinary people pay statutory rates. Large corporations are not held to this same standard (emphasis added):
Large, profitable U.S. corporations paid an average effective federal tax rate of 12.6% in 2010, the Government Accountability Office said Monday...In a report commissioned by Senators Carl Levin (D-Mich.) and Tom Coburn (R.-Okla.), the GAO looked at taxes paid by profitable U.S. corporations with at least $10 million in assets.I'll let the charts from one of my favorite reports of all time (Corporate Taxpayers & Corporate Tax Dodgers from Citizens for Tax Justice and the Institute on Taxation and Economic Policy) speak for themselves:
Even when foreign, state and local taxes were taken into account, the companies paid only 16.9% of their worldwide income in taxes in 2010...
"An individual's or corporation's tax rate shouldn't be dependent on their ability to hire a tax lobbyist," Coburn said. "It's especially wrong to ask families who are struggling to make ends meet to subsidize special breaks for corporations."
So it's misleading in the extreme for Pomerleau to claim that corporate taxes are more competitive in the social democracies; some corporations are better at tax avoidance in the United States than others. Statutory corporate tax rates are indeed lower in the social democracies but effective tax rates are higher--because the corporate tax codes in the social democracies aren't rife with loopholes. Nevertheless, approximately the same percentage of GDP is collected in corporate taxes in the United States and the social democracies.
Pomerleau writes of capital gains taxes:
Norway (27 percent) and Sweden’s (30 percent) capital gains and dividends taxes are more in line with the United States. The United States’ tax rate on dividends and capital gains of 28.6 percent is slightly higher than Norway’s and slightly lower than Sweden’s.He doesn't make it clear, but the 28.6 rate comes from a combination of federal, state, and local capital gains taxes for the top capital gains tax rate (that exact value comes from a report that he authored). The top federal capital gains rate is 20%, but until 2013 it was only 15%. And this is only the top rate; lower incomes are taxed at lower rates.
I've spilled much ink on this blog explaining how the social democratic model for social welfare is more efficient than the American model for social welfare. The American model seems less expensive than the social democratic model, but that's only because the aggregate cost of the American system is camouflaged in private, out-of-pocket spending. The social democratic model might seem more expensive, but it's actually less expensive in the aggregate and for most households.
If there's one conclusion to draw from this post, it's that everyone pays higher taxes in the social democracies. Again, most Americans would be financially far better off if the United States were a social democracy; for the vast majority of Americans, the increase in taxes would be more than offset by a reduction in out-of-pocket spending on social welfare services.
If we want to become a social democracy, we will have to increase taxes on everyone, and the existing social democracies are an example of how this can be accomplished in an efficient, equitable way.