April 16, 2012

Taxation, American Style

Veronique de Rugy

Senior Research Fellow
Summary

In many respects the U.S. government’s tax framework may be worse than Europe’s. It disproportionately relies on the top earners to raise revenue, it exempts a large class of taxpayers from paying any income taxes, and it conceals spending in the form of tax breaks.

This excerpt was originally published in the May issue of Reason. View the full article here.

Americans often tout the contrast between the bloated, tax-funded welfare states of the Old World and our leaner, cheaper government. But the data reveal that the U.S. may be closer to Europe than we think.

Contrary to common belief, the American tax system is more progressive than those of most industrialized democracies. A 2008 report by the Organization forEconomic Cooperation and Development (OECD), titled “Growing Unequal,” gave two different estimates of the progressivity of tax systems in 24 industrialized countries. One ranking found that the U.S. has the most progressive tax structure; in the other Ireland beat America by a nose. France, which has a notoriously generous welfare state, ranked 10th out of 24 in both of the OECD progressivity indexes.

Other countries have higher tax rates than the U.S. but manage to be less progressive overall. How can this be? The answer is that the rate structure alone doesn’t necessarily tell you much about the progressivity of a country’s tax system. The top rates kick in at much lower income levels in Europe than in the United States, making E.U. tax codes more regressive than ours. 

In his new book The Benefit and the Burden (Simon & Schuster), economics columnist Bruce Bartlett presents a chart (reproduced here) that shows the top statutory personal income tax rate and an “all-in rate” that includes payroll taxes in selected countries as measured by the OECD. Bartlett calculated that the “average [European] worker making an annual income in the $40,000 to $50,000 range is in the top marginal tax bracket.” A comparison of France and the U.S. is revealing: The top marginal income tax rate in the U.S. is 35 percent and kicks in at $379,000. In France the top rate is 41 percent and kicks in at $96,000.

The U.S. federal government also relies much more heavily on the income tax, rather than the regressive consumption taxes—such as the value-added tax (VAT), retail sales taxes, and gasoline and tobacco taxes—favored by most OECD nations. European countries generally have lighter taxes on capital as well, another regressive feature.

Finally, the U.S. tax code allows large deductions and personal exemptions for low-income households, distributing social benefits in the form of policies such as the child tax credit and the earned income tax credit. These adjustments increase progressivity.

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