America will never have a European welfare state without VAT
AGOVERNMENT EXPENDITURE more and more it becomes more and more important that they carefully design their taxes. Large European welfare states like Sweden or Germany rely on value added taxes favorable to growth (VATs) to help raise the huge amounts of money they are handing out. America cannot get away with a tax system that is grossly inefficient and unnecessarily complex just because the amount of revenue it generates overall is relatively small.
Small, but growing. Democrats in the House of Representatives are studying how to pay for President Joe Biden’s social spending bill, under which America would take a step towards Europe with cash donations for parents, grants for child care, green investments and more money for health care. The bill will likely be watered down in the Senate, but its current size is $ 3.5 billion (1.2% of forecast GDP) over the next decade. To help pay for it, lawmakers are proposing the biggest tax increase since 1993.
The plan does little to advance the tax efficiency that would be necessary if America ever had the European-style welfare state that many Democrats aspire to. This is because the proposals were developed to increase taxes only on households with incomes above $ 400,000. The left thinks that the rich are not paying their fair share. They would like to increase the maximum federal income tax rate from 37% to 39.6% and introduce a new 3% levy on income over $ 5 million. They also want to raise the federal corporate income tax rate exceeding $ 5 million, from 21% to 26.5% (ignoring the fact that wages will drop at least a little as a result). The plan would increase the capital gains tax rate and introduce various new levies.
The federal government has some leeway to raise more money from higher incomes. But the idea that the main problem with the existing system is that tax rates are too flat is wrong. In 2018, the lowest fifth of employees paid no net federal tax on average. The richest 1% paid a total rate (that is, after all deductions) of 30%, according to the Congressional Budget Office. Include state and local taxes, and high incomes face a marginal tax rate on every additional dollar they bring home – the rate that counts for work incentives – which is average by standards in the workplace. rich countries. Tax refunds for poor families are exceptionally generous. In 2019, a single parent with two children earning two-thirds of the average wage faced a total net labor tax of just 10%, according to the analysis of the OECD, a club of predominantly rich countries. In egalitarian Sweden, the rate was almost 33%.
Ineffectiveness is a bigger problem in America than the failure of rates to be progressive enough. A myriad of deductions allow the very rich to disguise labor income as lightly taxed capital income. And the reluctance to perceive a VAT, which is a tax on consumption, means that America relies on taxes that discourage labor and investment. America is one of only three wealthy countries to collect more than 70% of its tax revenues from labor income and corporate profits. Sales taxes, levied by states and towns, are the only significant taxes on consumption.
The plan does far too little to increase efficiency. On the plus side, this would narrow the deferred interest loophole that allows investment managers to classify their fees as capital gains, not income. This would reduce tax evasion by strengthening law enforcement, for example through audits of top income tax returns, which is more than cost effective. And he would try to get more money from “passing” businesses, shells that allow many professionals to treat their income like business profits, with a lower tax rate.
Still, a lot is wrong with the Democrats’ plans. They seem to have given up on closing one of the costliest loopholes, which nullifies capital gains when assets are inherited. The corporate tax hike would bring the total rate, including average state and local taxes, to 31%, the third among rich countries. In the House, they do not seem interested in a carbon tax to fight climate change. And while it’s not in the plan yet, they’re talking about lifting the cap on an exemption, on federal taxable income, on money used to pay state and local taxes. The cap was introduced in 2017 under Donald Trump. Lifting it would subsidize heavily taxed states more and benefit the rich almost exclusively. Democrats would raise the highest tax rates while reducing the tax base, the opposite of good tax policy.
The US economy would survive these proposals. But its creaky and cumbersome tax code shouldn’t be asked to support the size of government many Democrats want in the long run, which includes, for example, government-funded universal healthcare. Republicans know this is implausible. They generally oppose VAT because they see it as too convenient a source of funds. Democrats don’t like the tax because it is slightly regressive. But there is a reason VATs underpin European-style welfare states: there is no desirable alternative. ■
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This article appeared in the Leaders section of the print edition under the title “Ways and Means”