Entrepreneurial View #456                                                                    

International Tax Burdens

by Raymond J. Keating

When it comes to taxes, policymakers need to keep their eyes on two balls.

One ball is the type of tax system and the rates imposed.  For example, taxes focused on consumption are preferable to those concentrated on production. After all, the end point of the economic process is consumption.  Collecting taxes at that point, in a transparent way for the taxpayer, makes the most sense.

In contrast, taxing production - that is, the returns on working, saving, investing and entrepreneurship - discourages these undertakings that drive economic growth forward.  These taxes also hide the overall tax burden from consumers.

As for tax rates, the lower the better for the economy.  If policymakers choose to impose an income tax (a tax on production), the higher the tax rate, the lower the returns on working and risk taking, thereby diminishing incentives for such crucial activities.

Even with a consumption-based tax system - like a retail sales tax - if tax rates are too high, then consumption would be discouraged (and therefore production would be as well) and many purchases would be pushed into the underground economy.

Incidentally, the problems with gross receipts and value-added taxes should be noted at this point. These levies work more like consumption taxes, but because they are hidden from consumers, they are quite dangerous. They can be more easily increased to feed ever-growing government.

The second ball that elected officials and other policymakers must watch is the overall tax burden.  In addition to the type of taxation and tax rates that affect incentives, the overall level of taxation matters as well due to the stark differences between how government and the private sector function.

The incentives in government are political, and therefore point to accumulating bigger budgets, larger staffs and additional control or power.  All of this, of course, leads to waste.  Meanwhile, the private sector operates according to a completely different set of incentives driven by private ownership, profits and losses, prices and competition.  This points to increased innovation, invention, efficiency and productivity.

Perhaps the simplest way to think of the difference between government and the private sector is how failure is addressed.  In the business world, if consumers are not pleased, then the business must change or close its doors, with resources reallocated to more promising ventures.  In government, however, failure is subsidized. Think about it, if something is failing in government - like a local public school, for example - the response usually is to throw more money at it. Failure, perversely, is rewarded.

Therefore, the overall tax burden is a critical concern.  The more resources drained away from productive private sector ventures means more resources lost to government profligacy.  On October 17, the Organisation for Economic Co-operation and Development (OECD) released its latest estimates on the average tax burden - measured as total tax revenues as a share of GDP - among OECD countries.

For the U.S., there is bad news and good news.  On the bad news front, the U.S. in 2006 inflicted a tax burden of 28.6% of GDP, which was up from 25.6% in 1975 and 1985.  That is anything but a positive trend for the economy.

However, there is good news when looking at most other OECD nations.

The following table lists OECD nations according to their 2005 tax burdens from worst to best.  It also includes a column for 2006, which offers provisional and incomplete data.

Total Tax Revenue as a Share of GDP (Source: OECD)

Country                       2005                2006(p)

Swede                    50.7             50.1

Denmark                50.3             49.0

Belgium                 45.4              44.8

France                   44.1              44.5

Finland                  44.0              43.5

Norway                   43.7              43.6

Austria                   42.1              41.9

Iceland                  41.4                na

Italy                      41.0               42.7

Netherlands            39.1               39.5

Luxembourg           38.6               36.3

Czech Republic        37.8              36.7

New Zealand           37.8               36.5

Hungary                 37.2               37.1

United Kingdom      36.5               37.4

Spain                    35.8               36.7

Portugal                34.8                35.4

Germany               34.8                35.7

Poland                  34.3                  na

Canada                 33.4                33.4

Turkey                   32.                 32.5

Slovak Republic       31.6               29.6

Australia                 30.9                na

Ireland                   30.6               31.7

Switzerland              29.7               30.1

Japan                      27.4               na

Greece                     27.3              27.4

United States            27.3              28.2

Korea                       25.5              26.8

Mexico                      19.9              20.6

At least among these 30 OECD nations, the U.S. had the third lowest tax burden in 2005 (though it got a tad worse in 2006).  That is an important economic edge for the U.S.  And given the intensifying global competition for both capital and labor, the U.S. needs to expand this advantage.

How?

Well, the most basic step is to make sure matters don't get any worse.  That means making the 2001 and 2003 tax relief measures permanent.  That would help in both areas of tax policy - stopping a looming increase in tax rates (in the areas of personal income, capital gains, dividends and assets when it comes to estates), and restraining the growth of tax revenues as a share of GDP.

Other steps should focus on both reducing the overall tax burden, while making the tax system more pro-growth.  Eliminating multiple taxation of capital gains and dividends makes sense.  Allowing all businesses the option of expensing capital expenditures in the year made would be another positive reform.  For good measure, as noted in an April 20, 2007, SBE Council Cybercolumn, the U.S. has a very high corporate income tax rate compared to many other nations, and it needs to be reduced.

Of course, in the end, the current U.S. tax system should be tossed aside in favor of a simpler, fairer, more pro-growth code, such as a low-rate flat tax or a low-rate national sales tax, which also should be designed to reduce the overall tax bite from government.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

This article may be reprinted with appropriate citation and credit.