December 6, 2011
Debt and Taxes: Settled ScienceBy Randall Hoven
When a Democrat says he is serious about our debt problem, what he means is that he's pleased as punch to have another way to sell you on a tax increase. Democrats, being smarter than Republicans, use math and logic to make the case: if you raise tax rates, you get more revenue; if you get more revenue, you decrease the deficit; decrease deficits and you get debt under control.
It all sounds so simple and unassailable: debt is the disease and taxes are the cure. Colin Powell calls it algebra.
However, the hidden assumption behind all those syllogisms is everything else equal. Unfortunately, everything else does not stay equal. Believe it or not, humans tend to change their economic behavior when you change their economic circumstances. (Hard to believe, I know.) To understand that, one needs to go beyond the Music Man's "think method" and look at real-world data.
The first syllogism, that raising tax rates yields more revenue, can be demolished by one simple graph: the federal government's top tax rates and tax revenues over time. The top rate has varied between 28% and 92%, yet total federal revenues have been consistently about 18% of GDP since World War II.
But let's move beyond that first syllogism, and assume you actually get more revenue, however you managed to do that.
If debt is the disease and revenue is the cure, we can simply look at a bunch of countries and see if more revenue leads to less debt in the real world. If it does, Democrats, Colin Powell, and other tax-lovers might be onto something.
The International Monetary Fund has the numbers we need. There are 26 countries that the IMF calls "advanced economies" for which it has both government revenue and debt data. Here is the plot of that data for 2011.
The data seem mixed. There are low-debt countries at both ends of the revenue spectrum, with plenty of high-debt countries at most levels of revenue. If you think you see a slightly downward trend, you would be right. However, that trend is not statistically significant.
If we put the countries into two groups, low debt and high debt (using the Maastricht Treaty threshold of 60% of GDP as the separator), the average level of revenue is 39.7% of GDP for the 15 low-debt countries, and 40.4% of GDP for the 11 high-debt countries. While the difference is negligible, the high-debt countries had more revenue, on average, than low-debt ones.
How can revenue be the cure for the debt disease if the high-debt countries had more revenues than the low-debt ones?
According to the IMF, all government in the U.S. took in 31.6% of GDP in revenue and had a net debt of 73% of GDP. There were eight countries (of 26) with higher net debt. All but one of them had higher revenue than the U.S. The only exception was Japan, whose revenues were only a hair lower than ours: 31.4% of GDP.
To say that more clearly: all seven European countries with higher levels of debt than ours also had higher levels of revenue that ours. Every single one: Greece, Portugal, Italy, Ireland, France, Belgium, and the U.K.
The worst country on the list for net government debt was Greece (sound familiar?), at 153% of GDP. Yet its government collected 40% of GDP in revenue, significantly more than the U.S. did. France collected 51% of GDP in revenue, yet its net debt was 81% of GDP, comfortably beating the U.S. in both categories.
If we go back to the above graph, the slight downward trend was really due to those countries on the bottom-right. A few countries had negative debt, meaning no debt at all, but surpluses. The three with the biggest surpluses happen to be the three Scandinavian countries of Norway, Sweden, and Finland. Denmark, another Scandi, had a net government debt of only 1.8% of GDP.
If we remove those four Scandinavian countries from the list, the graph looks like this.
Now the trend is up, meaning the more revenue collected, the more debt endured -- the exact opposite of Colin Powell's algebra. (Although the correlation is still weak -- not statistically significant.)
I'm not sure what the Scandinavian countries are doing right, but here are two things they have in common: (1) relatively flat tax structures and (2) significant cuts in the levels of government spending since 1993.
The Tax Foundation used OECD data to look at the tax progressivity of 24 OECD countries. Specifically, they looked at the ratio of taxes-to-income of the top 10% of income-earners. The most progressively taxed country of those 24 was the U.S., with a ratio of 1.35. Norway came in at only 0.95, a slightly regressive tax structure. Sweden came in with a ratio of 1.00, perfectly flat. Denmark was 1.02, virtually flat also. Finland was 1.20, a tad progressive, but not nearly as progressive as the U.S.
Just to be clear, a progressive tax structure means the rich (by income) pay a higher percentage of their incomes in taxes than the non-rich do. The Scandi countries certainly have high taxes, but they are paid in almost equal percentages across income groups. If you want to be like them, it would mean raising taxes most significantly on the non-rich. The Scandis don't get their revenues from the 1%; they get them from the 99%! (Funny, where are Norway's occupiers?)
On the spending front, Sweden's government spent 68% of Sweden's GDP in 1993, the highest in Europe at the time. By 2011 it was spending 48% (below France and Italy, for examples). While not a low number, that is a cut of 20% of GDP. The amount cut was the equivalent of the entire federal government of the U.S.! (Like a 200-pound man losing almost 60 pounds.)
Since 1993, Sweden cut government spending by 20% of GDP. Finland cut 11%, Norway cut 5%, and Denmark cut 3% of GDP. In contrast, the high-debt countries of Greece, Japan, France, Portugal, the U.K., and the U.S. all grew spending as a fraction of GDP since 1993. The U.S. in particular is at record levels of spending for peacetime.
To summarize: the everything-else-equal algebra of Colin Powell does not hold up in the real world. There's virtually no relationship between level of revenue and level of debt among advanced economies. Outside Scandinavia, higher revenue leads to higher debt, if it has any effect on debt at all.
And if you want to imitate the low-debt countries of Scandinavia, raise taxes on the non-rich most, and cut government spending.
Democrats, and those who love to compromise with them, advocate the exact opposite policies. Their "think method" syllogisms are all wrong.
Here is my tip to Democrats, global warming alarmists, and other "think method" aficionados: the real world should drive your models, not vice-versa.
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