Back in 2014, I shared some data from the Tax Foundation that measured the degree to which various developed nations punished high-income earners.
This measure of relative “progressivity” focused on personal income taxes. And that’s important because that levy often is the most onerous for highly productive residents of a nation.
But there are other taxes that also create a gap between what such taxpayers earn and produce and what they ultimately are able to consume and enjoy. What about the effects of payroll taxes? Of consumption taxes and other levies?
To answer that question, we have a very useful study from the European Policy Information Center on this topic. Authored by Alexander Fritz Englund and Jacob Lundberg, it looks at the total marginal tax rate on each nation’s most productive taxpayers.
They start with some sensible observations about why marginal tax rates matter, basically echoing what I wrote after last year’s Super Bowl.
Here’s what Englund and Lundberg wrote.
The marginal tax rate is the proportion of tax paid on the last euro earned. It is the relevant tax rate when deciding whether to work a few extra hours or accept a promotion, for example. As most income tax systems are progressive, the marginal tax rate on top incomes is usually also the highest marginal tax rate. It is an indicator of how progressive and distortionary the income tax is.
They then explain why they include payroll taxes in their calculations.
The income tax alone does not provide a complete picture of how the tax system affects incentives to work and earn income. Many countries require employers and/or employees to pay social contributions. It is not uncommon for the associated benefits to be capped while the contribution itself is uncapped, meaning it is a de facto tax for high-income earners. Even those social contributions that are legally paid by the employer will in the end be paid by the employee as the employer should be expected to shift the burden of the tax through lower gross wages.
Englund and Lunberg are correct. A payroll tax (sometimes called a “social insurance” levy) will be just as destructive as a regular income tax if workers aren’t “earning” some sort of additional benefit. And they’re also right when they point out that payroll taxes “paid” by employers actually are borne by workers.
They then explain why they include a measure of consumption taxation.
One must also take value-added taxes and other consumption taxes into account. Consumption taxes reduce the purchasing power of wage-earners and thus affect the return to working. In principle, it does not matter whether taxation takes place when income is earned or when it is consumed, as the ultimate purpose of work is consumption.
Once again, the authors are spot on. Taxes undermine incentives to be productive by driving a wedge between pre-tax income and post-tax consumption, so you have to look at levies that grab your income as it is earned as well as levies that grab your income as it is spent.
And when you begin to add everything together, you get the most accurate measure of government greed.
Taking all these taxes into account, one can compute the effective marginal tax rate. This shows how many cents the government receives for every euro of additional employee compensation paid by the firm. …If the top effective tax rate is 75 percent, as in Sweden, a person who contributes 100 additional euros to the economy will only be allowed to keep 25 euros while 75 euros are appropriated by the government. The tax system thus drives a wedge between the social and private return to work. …High marginal tax rates disconnect the private and social returns to economic activity and thereby the invisible hand ceases to function. For this reason, taxation causes distortions and is costly to society. High marginal tax rates make it less worthwhile to supply labour on the formal labour market and more worthwhile to spend time on household work, black market activities and tax avoidance.
Here’s their data for various developed nation.
Keep in mind that these are the taxes that impact each nation’s most productive taxpayers. So that includes top income tax rates, both for the central governments and sub-national governments, as well as surtaxes. It includes various social insurance levies, to the extent such taxes apply to all income. And it includes a measure of estimated consumption taxation.
And here’s the ranking of all the nations. Shed a tear for entrepreneurs in Sweden, Belgium, and Portugal.
Slovakia wins the prize for the least-punitive tax regime, though it’s worth noting that Hong Kong easily would have the best system if it was included in the ranking.
For what it’s worth, the United States does fairly well compared to other nations. This is not because our personal income tax is reasonable (see dark blue bars), but rather because Barack Obama and Hillary Clinton were unsuccessful in their efforts to bust the “wage base cap” and apply the Social Security payroll tax on all income. We also thankfully don’t have a value-added tax. These factors explain why our medium-blue and light-blue bars are the smallest.
By the way, this doesn’t mean we have a friendly system for upper-income taxpayers in America. They lose almost half of every dollar they generate for the economy. And whether one is looking at Tax Foundation numbers, Congressional Budget Office calculations, information from the New York Times, or data from the IRS, rich people in the United States are paying a hugely disproportionate share of the tax burden.
Though none of this satisfies the statists. They actually would like us to think that letting well-to-do taxpayers keep any of their money is akin to a handout.
Now would be an appropriate time to remind everyone that imposing high tax rates doesn’t necessarily mean collecting high tax revenues.
In the 1980s, for instance, upper-income taxpayers paid far more revenue to the government when Reagan lowered the top income tax rate from 70 percent to 28 percent.
Also keep in mind that these calculations don’t measure the tax bias against saving and investment, so the tax burden on some upper-income taxpayers may be higher or lower depending on the degree to which countries penalize capital formation.
P.S. If one includes the perverse incentive effects of various redistribution programs, the very highest marginal tax rates (at least when measuring implicit rates) sometimes apply to a nation’s poor people.
P.P.S. Our statist friends sometimes justify punitive taxes as a way of using coercion to produce more equality, but the net effect of such policies is weaker growth and that means it is more difficult for lower-income and middle-income people to climb the economic ladder. In other words, unfettered markets are the best way to get social mobility.
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It is incorrect to say that the wealthy pay the highest marginal taxes.
It is actually single women with children and the disabled who face the highest marginal taxes, when you consider loss of benefits for earning additional gross income.
This article confuses the payment of taxes verses the collection of taxes.
Consumers pay taxes, in the final price they pay.
The collection points for the multiple taxes the consumer pays in that final price occur along the production process. All taxes paid by suppliers, personal income, corporate income, excise, payroll, real estate, gas, etc. That full price is passed on to the ultimate consumer who also pays all of the taxes accumulated by the producer. If magically there was only one tax based on sales, you would still differentiate between payment of the tax by the consumer and the collection by the corporation, at the point of sale.
Theoretically, in the absence of any taxes, you would only have to pay employees their current take-home pay and all tax reductions would go to reducing the price of the final good or service.
Therefore a government that taxes at 50% forces prices to be twice as high as they would without tax, since the final price is 50% tax.
Marginal motivation to work vs extra income declines with rising income — naturally, all by itself — even before marginal tax rates are applied. Of course taxes, and even more so progressive taxes, make things worse in terms of motivation.
There are many brilliant people whom we never hear of, who could have become multimillionaires or even billionaires. But we never heard of them because they said: “Eh, I made 2-5-10-20 million, that’s enough, let’s just take it a little (or a lot) easier now; and so they never attain the headline wealth and fame of the billionaires.
What I’m getting to is that there is already tremendous loss of potential prosperity even with current taxes — and if one considers the compounding effect of lower growth then the prosperity loss is truly staggering. In other words, we’re way past the maximizing point of the Rahn curve, and after many years lost potential growth has compounded to epic proportions.
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In most countries the total marginal tax rate also depends on what you buy with your income. For example in most of Europe if you use that last dollar to buy gasoline, then once you have paid income, payroll, VAT, excise, and climate change carbon mitigation taxes, the marginal tax rate is upwards of 85%. So if you are a competent person in those countries, who also likes personal mobility, then your marginal tax rate is higher. Remember that when you buy, say, gas you also indirectly pay many other taxes, such as the real estate tax for the gas station building, the taxes that the gas station employee pays etc.
In general, if you live in a country where government consumes, say, 50% of GDP then one way or another half your work effort is haircut and sequestered by the state, that is, by the democratic majority of your fellow country men, and the politicians whom they elect who want to manage as high a percentage of GDP as possible, so that politician power, politician compensation, and number of politicians per capita, grow ever bigger. If you live in a country with progressive tax rates and you are competent then your haircut would exceed 50%.