Wednesday, March 06, 2013

A Look at U.S. Taxes and Hauser's Law

The implicit dynamic here is that when taxes exceed 20% of GDP, participants modify their behavior to lower their taxes

Frequent contributor Jim S. recently submitted a collection of charts on U.S. corporate taxes and Hauser's law, which contends that Federal tax revenues rarely rise above 20% of GDP, regardless of where nominal tax rates are set.

Hauser's observation is more a socio-political trend than a law per se, but the point is that total tax revenues are remarkably stable despite changes to the mix of revenue sources and tax rates.
Clearly, Hauser's observation applies only to U.S. Federal taxes, as many European nations collect total tax revenues around 40% of GDP. Furthermore, total taxes (including state and property taxes) exceed 40% of household income in many U.S. locales.

The subject of taxes arouses all sorts of emotions and critiques, and one reason it is difficult to compare apples to apples in national tax revenues is that nation-states have extraordinarily different (and often convoluted) tax structures.

France, for instance, has a television tax. Japan sends tax collectors door to door to wheedle the national NHK network tax from households. Here in the U.S., a large percentage of total taxes paid by households in some states is in the form of property taxes. Using myself as an example, Federal tax paid in 2011 was $15,000, California state income tax was about $3,000, and local property taxes were almost $13,000.

California sales tax (which varies due to county tax add-ons) is 8.75%, but it does not apply to food or services such as dentistry. Hawaii's sales tax (for the majority of residents) is 4.5% but it applies to virtually everything and so it represents a very significant percentage of total taxes paid by households.

As a result, it makes no sense to isolate Federal tax and make all sorts of broad assumptions from that basis when in places such as California, Hawaii, Illinois, New York, etc., state and local taxes might easily exceed total Federal taxes paid.

What the central government provides varies as widely as tax revenues. If you paid a 40% tax rate in Denmark, for example, what you get in the way of entitlements is quite a bit different from what you get in the U.S.

In the U.S., the government will guarantee student loans that give you semi-permanent status as a debt-serf. (Some Federal grants are also distributed that do not have to be paid back, but these rarely cover all college costs.) In Denmark, tuition and other major expenses are paid in full by the government, and qualified students receive a stipend to live on while attending university.

In the U.S., you must be over 65 years of age or qualify as a low-income household to receive government-paid healthcare services. Everyone else pays insane sums for private healthcare insurance, or their employer pays insane sums for private insurance. In Denmark, everyone gets basic healthcare coverage paid by the government.

We pay $13,000 annually for bare-bones healthcare coverage for two adults. If we want to compare apples to apples in the tax rates for the U.S. and Denmark, shouldn't we add what households pay for healthcare insurance to the U.S. total? If we add up all the many layers of taxes our household pays, including healthcare insurance, dental bills, etc. that would be covered by taxes in Denmark, our total equivalent taxes paid is $15,000 (Federal), $3,000 (state income taxes), $13,000 property taxes, $4,000 sales taxes/junk fees and $15,000 in healthcare insurance (and related costs that would be paid by taxes in Denmark): $50,000 which is roughly 50% of our income.

Some people object that Social Security taxes shouldn't be included in Federal tax revenues because they are are not income taxes. Fine, but then you have to remove all the equivalent tax revenues collected in other nations when you compare tax rates. It all boils down to two simple concepts:

1. The only tax total that matters is the total of all taxes paid to all layers of government.

2. You get what you pay for. If one nation pays higher taxes to fund a national healthcare plan, then that nation's tax rate cannot be compared to one where the government only pays healthcare costs for a small percentage of its residents.

So please don't talk about "low-tax America": taxpayers in the U.S. should get T-shirts that read "I paid taxes in the U.S. and all I got was this lousy Empire."

Into this mess comes the emotional hot-button of corporate taxes. Let's look at some charts to establish some context:

Here's a chart that inflames almost everyone: corporate profits are rising while corporate taxes are declining: Arrgghh!

As corporate taxes are declined, individual income taxes paid rose. Double-arrgghh! Once your blood pressure drops to normal, note that both individual and corporate tax revenues have meandered within a fairly narrow range for the past 30+ years.

While the GDP has expanded, corporate taxes paid have remained flat-lined.

Meanwhile, the nominal U.S. corporate tax rate remains one of the highest in the world.

Despite the supposedly different nominal corporate tax rates of various nations, corporate tax revenue as a percentage of GDP is about the same for Canada, the U.S., France and Japan. The lowest corporate tax revenue as a percentage of GDP is export powerhouse Germany.

States such as the U.K., Sweden, Korea and Denmark have corporate tax revenues that are only modestly above those of the U.S. when measured as a percentage of GDP.

Clearly, nominal rates have little to do with the actual tax collected. They also have little to do with the total taxes paid by global corporations. For example, "Exxon Mobil conducts the majority of its business outside the U.S. and paid $28.8 billion in taxes to foreign governments, but only owed and paid $1.5 billion to the U.S. government." (source: Top Companies Paid 9% U.S. Tax Rate)

It is not realistic to compare corporate tax rates in a unipolar world (circa 1950) when the U.S. economy represented roughly half of global GDP to today's global economy.Those who enthusiastically demand a return to high corporate tax rates forget that U.S. global corporations are not bound to the nation-state of the U.S.A. Push them into an anti-competitive tax situation and they will transfer their operations elsewhere.

Even worse in terms of fairness, high corporate tax rates punish those companies that do not have the elaborate tax avoidance scams of global companies. Some U.S. companies pay close to the nominal rate while the average pay roughly one-fourth of the official rate. Ours is a blatantly unfair system where corporate capture of the political machinery offers a well-greased back-door method of lowering taxes for those able to buy political influence.

A much better tax collection strategy, and a much fairer one, is a flat corporate tax of 8% that aligns the U.S. nominal rate with the rate actually collected. Actual tax revenues collected would be about the same or perhaps even rise as gaming the system is no longer rewarded, and all the wasted motion of tax avoidance would go by the wayside.

Non-U.S. corporations doing business in the U.S. should pay the same 8%. Currently, many non-U.S. corporations selling billions of dollars of goods and services here pay negligible Federal corporate tax.

The point that many miss is the mix of taxes is a social/cultural decision. In general, corporate taxes are low in Germany and individual taxes are high, while in France business taxes are high and individual tax rates are (relative to its EU peers) generally low. The total tax revenue collected as a percentage of GDP ends up being about the same.

What this suggests is some tradeoffs are necessary. Better to have flat rates that are actually collected than byzantine tax codes and high nominal tax rates that incentivize gaming the system and result in unfairly disparate real tax rates.

Despite changing the nominal rates on corporate taxes, payroll taxes and individual income taxes, total Federal tax revenues have remained close to 20% of GDP for decades.

Federal tax revenues swing between 15% and 20% of GDP. In a $15 trillion economy, that 5% is a significant chunk of cash: $750 billion.

The implicit dynamic here is that when taxes exceed 20% of GDP, participants modify their behavior to lower their taxes. Corporations will shift operations overseas. Those in the higher tax brackets will lobby the political class for lower tax rates. Some high-wage earners will simply work less, reducing their income to lower tax brackets. Small business owners will decrease their compensation, cut back their workload, or simply bail out. Others will leave the high-tax market and slip into the cash/informal economy where the tax rate is zero.

In a $15 trillion economy, this suggests the maximum Federal tax revenue that can realistically be collected is around $3 trillion. Currently, Federal tax revenues are around $2.5 trillion, and Federal spending is about $3.8 trillion.

That leaves a $1.3 trillion deficit that is filled with borrowed money.

Taxes are zero-sum to the taxpayer: collect another $500 billion in Federal taxes and that's $500 billion taxpayers don't have to spend, save or invest in the economy. So policy-makers fear raising taxes will trigger a recession, yet running deficits that are 35% of Federal expenditures is not sustainable.

Tradeoffs will have to be made. That is the essence of adulthood. Too bad we've become a nation of spoiled adolescents.
Spoiled Teenager Syndrome (January 3, 2013)
Is masking risk, cost and consequence a strategy that leads to success? No; it is a pathway to catastrophic failure.

Roundtable discussion with CHS, Gordon T. Long and Bill Laggner: China, Japan & Central Banking (25 Minutes, 34 Slides)

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

go to print edition1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

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To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, J.M. S. ($100), for yet another outrageously generous contribution to this site -- I am greatly honored by your steadfast support and readership.Thank you, Ann B. ($20), for your exceedingly generous contribution to this site --I am greatly honored by your support and readership.

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