Numbers mislead when comparing the tax systems of the United States with the social democracies

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.

Income taxes
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.

Comparing median household income in the United States versus the social democracies

Image: Median income and median per capita income of the United States vs. the social democracies (source)


As this graph clearly shows, median household income (blue bars) is pretty similar between the United States and the social democracies. I'm using Gallup World Poll data, and as the authors point out, these data correlate tightly to aggregate wage data. This is a good validation of their results. Per capita household income (orange bars) is simply each household's income divided by the number of people in that household.

Some technical notes:

Just how regressive are the tax systems in the social democracies?

Image: George Stephanopoulos says Bernie Sanders "wants the United States to look more like Scandinavian countries," which may mean that Stephanopoulos believes Sanders has a plan to move the Norwegian fjords to America. (source)



A follow-up post (update: here) will consider how the tax systems of the social democracies differs from the tax system of the United States. Here, I'm going to focus exclusively on the question whether the tax systems of the social democracies are progressive or regressive.

This is a very important question because it's very fashionable among conservatives to argue that because the social democracies tax regressively, progressive taxation is incompatible with social democracy.

But the social democracies do not tax regressively, and it only appears that way because would-be tax policy analysts assume too many similarities between the American and social democratic models for tax and social welfare. Many Americans--experts included--assume that the social democratic model is the same as the American model, just more generous. That is flatly false: the social democratic model for taxation and social welfare is not a more generous American model--it's a different model entirely. Superficial similarities betray experts of the American tax system into making very basic mistakes.

Kyle Pomerleau at the Tax Policy Blog is typical in this regard. I could cite examples all day (here and here, for instance) of professionals making a mess of analyzing the tax systems of the social democracies. I myself have fallen into some these traps before. So don't think that Pomerleau has created some uniquely bad analysis. To the contrary, I'm picking on him because he's assembled a uniquely competent analysis. Most American tax policy wonks who try to characterizing the tax systems of the social democracies make such a mess that it's impossible to criticize what they've written; it's simply all wrong. I can use Pomerleau's post as an example because he manages to get enough things correct that I can fill in missing information. Most other examples are so hopelessly muddled as to be beyond repair. Pomerleau gets the raw numbers right, but fails to understand how the tax systems of the social democracies work.

Here is his very suspect summary statement of the tax systems of the social democracies (emphasis added):

In a recent interview on ABC’s This Week, Presidential hopeful Bernie Sanders reiterated his position that he wants the United States to look more like Scandinavian countries policy-wise:

George Stephanopoulos: “I can hear the Republican attack ad right now: ‘He wants America to look more like Scandinavia.’”

Bernie Sanders: “What’s wrong with that?”

Specifically, Sanders wants the United States to adopt a lot of the spending policies that many of the Scandinavian countries (Denmark, Norway, Sweden) are commonly known to have. Policies such as government sponsored college education, paid parental leave, and universal healthcare.

Many of these new government programs would be expensive and necessitate higher taxes. It is instructive to look at how Scandinavian countries structure their tax systems in order to raise revenue for these programs. Interestingly, some of the ways that Scandinavian countries raise revenue may make Sanders, who is a proponent of highly progressive taxation, uncomfortable.

Just how regressive are taxes in the social democracies?
In the above blockquote, I bolded two misleading statements. The first one is very tangential and Pomerleau shouldn't be faulted because he's a tax guy and not a social policy guy. He wrote, "Many of these new government programs would be expensive and necessitate higher taxes." I've spilled much ink on how the American social welfare system is just as expensive as the social democratic model. Aggregate (private plus public) spending on social welfare is basically the same in the United States as the social democracies. It's not a difference in overall cost; it's a difference in how programs are administered and financed. It's a difference of program efficiency and how well the true cost of each system is concealed with out-of-pocket private spending.

The second statement is more problematic:

Interestingly, some of the ways that Scandinavian countries raise revenue may make Sanders, who is a proponent of highly progressive taxation, uncomfortable.

Pomerleau later calls the tax systems of the social democracies "actually rather flat." That's wrong--but before we can continue, we have to be a little bit more specific of what we mean by tax progressivity.

As I pointed out with inequality measures (specifically the Gini coefficient) and gender discrimination, when studying things that affect all society, there can be no single measure that accounts for everything. In particular, the Gini sometimes gives nonsense conclusions, simply because it quixotically attempts to characterize an entire income distribution. Tax progressivity measures are the same: they also attempt to measure an entire income distribution are thus also create nonsense conclusions.

If the rich pay the highest tax rate but the poor pay a higher rate than the middle class, is this a progressive tax system? Or would it be better to say that some parts of the tax system are progressive and some parts of the tax system are regressive? Clearly--as with inequality--we need to look at multiple measures; a single measure will not suffice. We can never say that one tax system is more progressive than another. We are limited to claiming only that certain aspects of one tax system are more progressive or regressive.

Revisiting aggregate social welfare spending of the United States and the social democracies

Here, I revisit a previous post, or specifically, this graph by the OECD:

This graph shows the total (public + private) social welfare spending of OECD countries as a percentage of GDP. The take-home is clear: the United States does not actually have a less expensive social welfare system than the social democracies. Once we account for private spending on social welfare, it is clear that the American social welfare system costs just as much as the social democratic model.

Two things prompted me to return to this graph. First, the OECD updated the web page the graph was on (my original post linked to the page in 2014), and the graph is no longer at that link. Thus, it is no longer clear where the data from the graph comes from. Second, I didn't initially realize how important this graph is. This graph deserves its own post.

The page where I got the above graph is actually the home of OECD's social expenditure (SOCX) dataset. SOCX compares national expenditures on social welfare and--according to this dataset--the social democracies spend about 30% of GDP on social welfare, the United States about 20%. This only includes spending on government benefits.

However, in 2011, a team of OECD researchers realized that these data were extremely misleading and detailed their findings in a working paper, Is the European Welfare State Really More Expensive? (Adema, Fron & Ladaique). I'll focus on their findings for the United States and the social democracies since this is my primary concern on this blog. There was also a 2014 update, which we'll take a look at after reviewing SOCX methodology and the refinements of Adema, Fron & Ladaique.

First, the SOCX dataset greatly overestimates the the social spending in the social democracies. The biggest issue is cash benefits. In the United States, cash benefits (like Social Security payments) are not subject to income taxes. But that's not so in the social democracies, and the result is that a huge amount of social welfare benefits are actually returned to the welfare system through income taxes. Adema, Fron & Ladaique refer to this as "claw-back." Clearly, it makes no sense to count every dollar in social welfare benefits as a social expenditure, since much of those benefits will be taxed and thus returned to the welfare state. In Denmark, the amount of public social welfare benefits that are returned to the welfare state by direct taxation amounts to a whopping 4% of GDP. Clearly, SOCX is wrong to disregard this.

Comparing new parent social welfare benefits of the United States vs the social democracies

Courtney Jung points out the hypocrisy of American social welfare benefits for new mothers (emphasis added):

In 2010, the Fair Labor Standards Act was amended to require employers to "provide reasonable break time" and space for women to pump breast milk at work. To be clear, those breaks are unpaid, and the Department of Health and Human Services encourages employers to have mothers come in early or stay late to make up the time they spend pumping. Since 2013, the Affordable Care Act has required insurance companies to cover the cost of a breast pump for new mothers.

Such policies have quietly realigned our expectations of what new mothers should do to care for their newborns, making mothers work harder, for less pay, under conditions that risk compromising their dignity and professionalism.

They are also explicitly conceived as business-friendly strategies that enable women to comply with the injunction to breastfeed at no cost to employers. Who needs a lavish European-style maternity leave when we've got breast pumps?

Actually, free markets aren't efficient in theory, either

Image: If we don't get the biggest pie, then what's the point? (source)




The fundamental assumption of free market capitalism is that the free market can provide goods more efficiently than the government, or any other system. If the government interferes in the free market--even with the best of intentions--it will only make things worse. Rent controls cause a housing shortage; price controls cause oversupplies; minimum wage laws increase unemployment. The further we get away from a pure free market, the worse the inefficiencies and unintended consequences. It may be necessary to assist the less fortunate sometimes, but government should interfere as little as possible in order to avoid making things worse. Interference will certainly do harm; it could easily do more harm than good.

A more technical way of expressing this free-market-is-always-best ethos is to say that the free market will naturally reach an efficient equilibrium. An equilibrium of prices will ensure efficient allocation goods to all members of society. It may not be the most socially just distribution, but it will certainly be the most efficient distribution that can possibly be attained. Making the distribution more just--that is, making each person's slice of the pie closer to equal--will result in less pie overall. We can have a full pie with very unequal pieces; we can have a smaller pie with less unequal pieces; but we can't have a full pie with less unequal pieces. In other words, there is a trade-off between equity (or fairness) and efficiency. Increasing equity necessarily results in less efficiency.

Pushed to its limits, this idea is actually a liberating, social justice imperative. With a free market ensuring the most efficient outcome, the pie becomes so big that even with very inequitable slices, the poor are still better off. Even with a very unequally-cut pie, free market capitalism creates such an enormous pie that even the poor have a bigger slice than they could ever hope for in any other pie, no matter how egalitarian the slices are cut. Sure, a market might produce winners and losers, but when the pie is big enough, even the losers are better off.

This idea--that government programs which increase equity are necessary less efficient--underpins bipartisan social policy adventures such as school choice vouchers and privatizing social security. The idea is that--because markets are so efficient--any (real or otherwise) problems with anything can be improved by making them function more like free markets.

Obviously, if the equity-efficiency trade-off exists, we are essentially arguing over values. I may prioritize equity over efficiency while someone else may prioritize efficiency over equity, and there is no right answer, per se. But that the equity-efficiency trade-off exists is utterly fundamental to free market capitalism. Without that trade-off, free market capitalism makes no sense. If free market capitalism doesn't produce the biggest pie, then what's the point? If free market capitalism can't produce the biggest pie, why should we tolerate the incredible inequities it creates?

George Orwell and Karl Marx don't want your iPhone: communism, capital, and private possessions

Image: Street art inspired by George Orwell's Animal Farm (source)



Animal Farm
The novel Animal Farm by George Orwell is remembered as a cautionary tale against the inevitable problems of leftism. In Animal Farm, the farm animals--led by the pigs Snowball and Napoleon--rebel against their drunk and incompetent farmer, eventually prevailing and setting up a farm where all the animals are better off. The animals all learn to read and write, and plans are in the works for all the animals' stalls to have electricity and running water. In order to realize these admirable goals, the animals agree to give up all their possessions so they can be used to benefit the entire farm, and the animals all work hard to contribute to the common good. But Napoleon is able to drive away Snowball, and rather than continuing with the egalitarian projects, Napoleon starts using the community's wealth to improve the condition of the pigs. As a result, the quality of life of the rest of the animals declines until they are far worse off than before the revolution, and--unbeknownst to the animals other than the pigs--some of the animals are even assassinated in order to improve the power and wealth of the pigs. The pigs eventually obtain so many special privileges at the expense of the other animals that they become indistinguishable from the oppressive farmers, and the golden rule of the revolution: "All animals are equal" becomes "All animals are equal, but some animals are more equal than others."

It is impossible to argue that the scenario in Animal Farm isn't more or less what happened in the Soviet Union, Cuba, and Ethiopia. In the name of the common good, a privileged few were able to exploit the rest of society. And this scenario was certainly played out to a horrific level in Cambodia. Yet Orwell could not possibly have intended his work to be a cautionary against leftism generally. Ironically, Orwell considered himself a socialist--and not one of those Scandinavian social democrats who call themselves socialists but actually seek to create a more humane form of capitalism--Orwell was a true socialist who believed that private ownership of capital should be abolished. He traveled to Spain to fight alongside the socialists in the Spanish Civil War, where he was wounded, nearly fatally.

The book's resemblance to the actual history of Soviet-style communism is no coincidence. Orwell wrote Animal Farm as a critique of Soviet-style communism generally and Joseph Stalin in particular. Ironically--given the way the novel is remembered today--Orwell felt compelled to write Animal Farm to counteract the fact that Joseph Stalin was held in very high regard in capitalist Great Britain in the early- to mid-1940's. Orwell believed that Stalinism should be spurned due to its Reign of Terror and dictatorship, even if the Soviet Union was an ally against the Nazis.

Many often assume that communism necessarily demands an Animal Farm-style collectivization of wealth, and the inevitable seizing of society's wealth by the powerful--as if that's even different from our capitalist world where 1% of people own half of all world wealth and half the world lives in abject deprivation, or the United States where the richest 1% controls over a third of all wealth, the richest 10% control over three quarters of all wealth, and the richest 0.1% are about as wealthy as the poorest 90%. Yet Orwell is not alone on the left in his views on collectivization. Karl Marx himself was careful to make the distinction between productive capital and personal possessions, since personal possessions cannot be used to exploit people, but capital can. Your house, mementos from a deceased loved one, family heirlooms, books, pets, smartphone, etc--all of these things are not capital because they cannot be used to exploit people. I'm with Karl and George on this one. If your iPhone makes you happy, keep it, because you can't use it to exploit people.