Could the Tea Party be Right About Taxes?

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Today is Tax Day, so cue the inevitable griping. One story making the rounds is that nearly half of all America’s don’t pay taxes. This is silly stuff. The magazine I used to work for MONEY examined the suppossed free-tax rider issue nearly two years ago and found this: Yes, there are 50 million people who pay nearly no income taxes each year, but despite what you think you would not want to be part of the group. Most people who don’t pay taxes do so because they are very poor, or at the very least don’t make any money. Nonetheless, the tax myth of free riders along with the general feeling that we pay too much of our hard earned pay to the government has led to the second annual Tea Party Protests. And for that I am grateful. Because I do think there is something the Tea Party and other tax protesters do get right: Income taxes for many of us are too high. Here’s why:

Americans pay more in income taxes, as a percentage of overall taxes, than most other wealthy nations. (ht Washington Post, by way of the Tax Policy Center)

Americans do pay far more in individual income taxes than residents of other wealthy nations. Nearly 37 percent of U.S. tax revenue came from personal income taxes in 2006, about 10 percentage points more, on average, than in other industrialized countries. But we pay much less in sales taxes; 17 percent of 2006 U.S. tax receipts were from taxes on goods and services, or about half the 32 percent average for rich countries.

So the Tax Partiers are right that we pay too much income tax. But the emphasis is on income, not tax. When it comes to overall taxes (add in sales tax, and social security taxes and other government fees), we actually pay much less than other countries. (Again, ht WashPo)

In 2007, federal, state and local taxes claimed about $3.8 trillion, or 27 percent of U.S. gross domestic product. That’s nearly $13,000 for every American. Two-thirds of tax revenues went to the federal government.

It may sound like a lot, but other developed countries collect even more. In 2006, taxes in 30 of the world’s richest countries averaged 36 percent of GDP; only Mexico, Turkey, South Korea and Japan had tax rates lower than ours. And taxes in many European countries exceeded 40 percent of GDP because these nations offer more extensive government services than the United States does.

Here’s the problem. No one really likes to pay taxes, and yet we are better for it. Despite what many would like you to think, taxes in the long-haul are actually very economically stimulating. Taxes lower the deficit, bring fiscal stability and in theory lower long-term interest rates. And lower interest rates lead to higher growth. So if we want the economy to grow faster over the long-haul we should be raising taxes not lowering them, at least until we balance the budget. The problem is how do we get to a place where we can bring taxes up to the level to pay for our government spending. (Please no comments on how we can balance the budget deficit by cutting spending. Not Going To Happen. All studies show there is really not that much pork/waste in the fiscal budget.)

In theory, it really shouldn’t matter that much where we get our taxes be it from sales tax or from income taxes, as long as we get the taxes and spread the tax burden in a sensible way among the population. Making low wage earnings pay more than just a minimal share is obviously wasteful, because overtaxing them will just lead them back to social services, which cost the government money. But in practice it does matter how we are taxed because of the perception.

The problem is not taxes, it’s tax day. People don’t stop buying things because there is sales tax. So my feeling is that taxes are not the problem (other again then being too low), what is the problem is that we have this very big reminder each year of how much we pay the government. We see the number, which looks big, but is really spread out in very manageable payments throughout the year. If we relied more on a sales tax, or VAT tax system, or some other way the government charged us fees for services, there would be much less vitriol about taxes and the government would probably be able to collect more because few people would notice it.

Yes, we would have to work out some kind of system where lower-income families could get a pass on much of these fees, but I think that is doable. Also higher income people, who have seen their marginal tax rates plunge over the past 30 years would probably have to pay more. But that makes sense. As Warren Buffett is quick to point: He pays a lower marginal tax rate than his secretary. And that doesn’t make a lot of sense. Happy Tax Day.

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