The State's Take

--US and Industries countries tend to tax more in income while BRIC, especially China and Indian tends to tax more on consumption.

--The chart lists the revenue sources of major countries.

Nov 19th 2009 From The Economist print edition Governments differ dramatically in how they tax—and how much they raise THANKS to the collateral damage from the financial crisis, government deficits have surged across the rich world. Once the recovery is entrenched this fiscal deterioration will need to be tackled. Although spending cuts could, and should, be the preferred route to prudence, taxes are all too likely to be part of the mix—at least judging from the experience of those countries that have already acted. Spain will raise its value-added tax rate (VAT) from 16% to 18%. Ireland has raised its top income tax rate from 41% to 46%. In both Britain and America current law promises higher future tax rates on wealthier folk. The economic consequences of raising taxes will depend not just on the scale of the tax increase, but also on how the revenue is raised. 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 table above compares government revenue and its sources for some of the world’s biggest rich and emerging economies. 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. Broadly speaking, total government revenues (including both central and local) are a bigger share of the economy in continental Europe than in Anglo-Saxon economies, and are higher in richer economies than in poorer ones without generous social safety-nets. But not all emerging economies have a low tax burden. At almost 35% of GDP, Brazil’s government revenue is bigger relative to the size of its economy than America’s. Taxes of varying kinds form the bulk of governments’ revenues. But non-tax receipts—such as profits from state-owned enterprises—are often significant sources of cash, especially for commodity exporters. Russia’s overall government revenue, which includes oil proceeds, is almost 50% of GDP. Its tax take is closer to 30%. These broad ratios suggest that there is less room to increase taxes in Europe than elsewhere. But they mask big differences in how governments raise their funds. Anglo-Saxon economies tend to rely most on income taxes (on wages, profits and capital gains). In Australia 60% of tax revenue is raised from such levies. In America it is almost 50%. Most governments gain the bulk of their income-tax revenue from individuals, though in both Japan and South Korea almost half the total is extracted from firms. Contrary to popular perception, European countries rely much less on corporate taxes than America does. European countries reap a bigger share of revenue from payroll taxes and other social contributions, as well as from indirect taxes on spending. France and Germany gain more than 40% of their tax take from social contributions and around a quarter from expenditure taxes, particularly VAT. America, the only industrial country without a VAT, gets only a sixth of its government revenue from expenditure taxes, most of that through sales taxes at the state and local level. Brazil’s tax structure roughly mirrors that of European countries, while China and India raise more money from indirect taxes than any other big economies. Over 60% of China’s central government tax revenue comes from expenditure taxes. How best to inflict pain Which of these combinations is best for economic growth? 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.) An analysis of the relationship between tax structure and growth in 21 rich countries between 1970 and 2004 by Jens Arnold of the OECD bears out these theoretical insights. He found property taxes were the least damaging to growth, followed by consumption taxes. Income taxes were the least growth-friendly, especially those levied on firms. The study suggests that shifting tax revenues from income to consumption and property taxes could have a significant impact on GDP per head. Most tax systems have become more growth-friendly in recent decades. The top rate of marginal income tax in OECD economies, for instance, has fallen from an average of almost 70% in 1981 to just over 40%, with the biggest declines in Japan and America. Still, 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. Though Europeans still rely too much on job-deterring social contributions, they have been able to extract higher revenues overall thanks to greater use of more efficient taxes, especially VAT. Expenditure taxes are not always well designed, however, particularly in federal countries. Brazil has long been trying to reform its VAT, which is levied in a fragmented manner at the state rather than national level. India, too, is trying to reform its potpourri of expenditure taxes. China’s heavy reliance on consumption taxes may not be optimal in an economy that saves too much and spends too little. 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. http://www.economist.com/opinion/displaystory.cfm?story_id=14924473