Last week, we observed that it was analytically useful to separate the impact of taxes from the impact of transfers on market income inequality. Alan Krueger, unfortunately, conflated the two, thus leading him to conclude that the U.S. tax system is far less progressive than that of other market democracies. In fact, as the House Budget Committee’s Republican staffers have observed, is is actually U.S. social transfers that are more regressive than the post-industrial norm.
Tim Worstall offers more detail on this subject, drawing on the work of University of Arizona sociologist Lane Kenworthy:
If you want to reduce inequality and you want to reduce inequality the same way that other countries have successfully reduced inequality then you need to do what other countries have successfully done to reduce inequality. Which is, in short, to have a more regressive tax system than the United States and a more progressive benefits and transfers system than the United States.
Quite whether the Federal income tax system is more or less progressive than other countries I’m not sure. Certainly the top rates are lower than in many other places. However, the tax free allowance is also much higher than in many other places (I think I’m right in saying that only 50% of the working population pay any federal income tax at all? Or is it 50% of the adult population?) These might well balance each other out. The addition of FICA certainly makes total taxation of incomes more regressive than just the income tax is. But other countries have things very similar to FICA and normally at much higher rates too (for example, total FICA, employer and employee, is 12 and a bit percent in the US. In my native UK it’s just passing 25% for our equivalent, national insurance.) so the total Federal taxation of income becomes more progressive.
However, the really big thing about the Federal taxation system is that it doesn’t include any (apologies, very little, the Federal gas tax for example) consumption taxation. There is no nationwide VAT or sales tax for example. This makes the US Federal taxation system considerably more progressive than those of most other OECD countries. Almost all of whom have a high and national VAT or consumption tax. 25% in Sweden for example (it’s even 22.5% on food I am told) and yes that does make the tax system considerably more regressive.
Then in the US system we move down to the local taxation systems, where the sales taxes are, and this then makes the total US system a little less progressive and a little more regressive.
My view is that federal taxes should be somewhat progressive to balance against somewhat regressive taxes at the state and local level, in large part because state and local governments should levy more regressive taxes, because capital and labor are considerably more mobile at the subnational than at the international level. At the same time, social transfers should be far more progressive, whether via curbing the use of tax expenditures that disproportionately benefit the affluent or through means-testing programs like Social Security and Medicare according to lifetime average income. We will return to this subject in a moment.
