Some Taxes Are More Equal Than Others

The Economist: The state's take
Governments differ dramatically in how they tax—and how much they raise

The less efficient the type of taxation, the greater the burden on the economy. There is already striking variation in the size of the state and the structure of taxation, both among advanced economies, and between them and their emerging counterparts. Comparing countries’ tax takes can offer useful clues to the most efficient ways to raise funds in future.

The state looms largest in France, where almost 50% of GDP flowed through the government’s coffers in 2007 (the most recent year for which statistics comparable across all countries exist). In China, in contrast, government revenue accounts for less than 20% of GDP.

In theory, expenditure taxes are better than income taxes, since they do not punish saving. Flat tax-rates on a broad base are less distortive than high marginal rates on a narrow base. By the same token, taxes on things that cannot be moved easily, such as property, are less distortive than taxes on mobile economic agents, particularly firms. Among expenditure taxes, a flat tax-rate on final goods is less distortive than a panoply of excise taxes since it affects spending decisions less. (That said, sometimes, such as with carbon taxes, the goal is to influence decisions.)

America’s tax system stands out as one of the least efficient. The heavy reliance on income taxation is compounded by the narrowness of the tax base, thanks to oodles of complexity-inducing deductions.

Nor is tax policy only about efficiency. Politicians also care about fairness and political appeal. Property taxes may be non-distorting, but they are deeply unpopular with voters. Tax progressivity is often at odds with efficiency. A VAT, for instance, falls disproportionately on poorer people who spend a higher share of their income than richer folk. Thanks to its reliance on income taxes, America—by some measures—has the most progressive tax system in the OECD. Different countries will always strike different compromises between efficiency, fairness and simplicity. But as their debt burdens rise, the world’s big rich economies would do well to focus most on efficiency.