Are Americans undertaxed?

Appearing in the September/October number of Foreign Affairs, the house organ of the Council on Foreign Relations, MIT political science professor Andrea Louise Campbell makes the argument that Americans are undertaxed relative to their peers in other developed democracies. Dr. Campbell examines both the total amount of tax revenue versus gross domestic product as well as data related to wealth redistribution to mount the case that Americans are less taxed than citizens of other countries. The data that Dr. Campbell cites is unassailable in making her case, but curiously missing from her argument is an examination of the fiscal stability of those other countries. In other words, how sustainable are the finances of the countries that Dr. Campbell holds out as models for the U.S.?

It’s strange timing, to say the least, to argue that the U.S. should emulate the social democracies of Europe. A deadly cocktail of demographic decline, underemployment, stagnant economic growth, bureaucratic incompetence, red tape, and overly beneficent social-safety programs has brought several European economies to the brink of self-destruction. Yet these are the countries Dr. Campbell applauds for having the right mix of wealth redistribution and taxation.

Complexity = Corruption 

Despite her propensity to cherry-pick data and overstate the benefits of redistribution, Dr. Campbell does make some very cogent arguments vis-à-vis the U.S. tax system. In the first instance, Dr. Campbell is very convincing in her criticism of the U.S. tax code’s complexity. When compared to other Organization for Economic Co-operation and Development (OECD) countries, the U.S. code places far higher costs of compliance on individuals and businesses, mostly because of the myriad deductions and credits that have grown like kudzu over the years. It is this labyrinth of deductions and credits that makes a mockery of what is otherwise a fairly high rate of tax for corporations and high-net-worth individuals. For instance, according to Dr. Campbell, while the top nominal corporate tax rate (state and federal) is 39 percent, the effective tax rate for corporations is much lower – about 13 percent. The same dynamic is present in the upper echelons of the individual income tax code. The top one percent pays an effective tax rate of 21 percent; that’s versus a nominal rate of 35 percent…quite a difference.

Needless to say, eliminating the sundry tax loopholes for corporations and high earners would have a huge impact on the collection of tax revenues, and as Dr. Campbell argues, such a policy would probably not lead to much of a change in the underlying behaviors that the current tax code is meant to modify. There is abundant research available that indicates mousing around with the corporate tax code via credits and deductions is an extremely inefficient means of modifying market behavior. For instance, many of the credits aimed at small and mid-market businesses to spur hiring and job growth have gone unused. Similarly, other credits meant to direct investment into green energy or environmental remediation go unused, because with or without the tax credits, the encouraged activity is simply too uneconomical to sustain.

But it is clear to me that the burgeoning tax code is a means of mischief for lawmakers. Too often, tax carve-outs and exceptions go to those companies and industries that spend large amounts of money lobbying congressmen. It is really not so different from bribery, and while it is tempting to use the tax code to modify corporate investment and behavior, in practice, the benefits of such engineering are overstated and merely encourage corruption.

Philosophy v. Policy

Dr. Campbell also makes an excellent point regarding the increasing disparity between the top and bottom of the economic ladder. While U.S. social conservatives have failed to eliminate most of progressivism’s signature policies, the income inequality between haves and have-nots are currently at pre-New Deal levels by several measures, suggesting that something fundamental has changed in the country’s redistributive policies. Progressives would probably agree with Dr. Campbell in pinning the blame on a system that she characterizes as having “mildly progressive taxes…matched with a not very redistributive state.”

Wealth redistribution is the specter that haunts American politics, and to my mind, it is the single-most polarizing feature of taxation. Indeed, I believe that, when liberals and conservatives hear the word “taxes,” they don’t quite “hear” the same thing. To a political liberal, redistribution is part and parcel of taxation – it is assumed. When a conservative considers federal taxes, redistribution is a tertiary factor, if it’s considered at all. To the conservative, federal taxation is a necessary evil and a means to fund the things that smaller localities can’t manage – interstate highways, levee systems, jet fighters, federal judges, and so on.

There is a huge philosophical disagreement on wealth redistribution, and when one examines it, the split isn’t necessarily one between haves and have-nots. After all, there are plenty of rich folks who favor redistribution, and plenty of middle class folks who loath it. Without consensus on this very fundamental issue, Dr. Campbell’s speculations matter very little. The bizarre U.S. tax code is not the product of policy-making failures, per se, but rather reflects the philosophical struggle among its politicians. Neither liberals nor conservatives have enough support to impose their philosophy on tax policy, and so what you get is a hodge-podge of policies that often cancel each other out.

Vox Populi 

But what do the American people think?

It seems that a majority of Americans support some kind of social safety net. While it is debatable that folks want a European-style system, it seems beyond argument that Social Security, Medicare, Medicaid, food stamps, and unemployment benefits receive wide support. But when you ask more nuanced questions about taxing and spending, the picture becomes muddied, such that one might come to the conclusion that many Americans simply aren’t aware of the math. For example, in an April 2012 poll, CNN discovered that only 3% of those asked felt their tax rates were too low, and despite the nasty rhetoric flying about, survey results seem to indicate we are not in the midst of a class war – when McClatchy asked people if “Congress should extend the tax cuts only for the middle class, but not for the top 2%, that is, households earning $250,000 or more,” 52% of those polled thought the Bush tax cuts should be extended for everyone.

When one wonders why the American tax code and spending habits are so screwed up, perhaps one should look no further than the American people. After all, the policies in place seem to reflect the general confusion of the electorate itself, an electorate who countenance neither spending cuts nor tax increases.