Source: The Economist: Buttonwood
ALL around the developed world politicians are struggling to figure out the best way of balancing their budgets, at least over the medium term. But is it easier to get spending down or taxes up?
The charts show the recent record on tax and spending for America, the euro zone and the OECD as a whole. The spending numbers are slightly more variable and consistently higher than the tax take. Both tax and spending are subject to cyclical effects. Spending has a cyclical component because of the cost of unemployment benefit as well as the use of deliberate Keynesian stimulus. On the tax side revenue from corporate profits and capital gains falls sharply during downturns, although consumption taxes are more stable.
What is striking is the narrow range within which the tax take has moved. Since 1994 euro-zone taxes have not been below 44.6% or above 46.6% of GDP. In America the total tax take has been between 30% and 35% of GDP since 1970. Such stability may be partly due to efforts by reforming governments of the 1980s and 1990s to reduce taxes. But it raises the question of whether there might be some upper limit to the amount of tax governments can grab.
In a globalised economy people and capital can move to escape high-tax regimes—France’s new 75% top income-tax rate comes to mind—or base their operations in low-tax places such as Ireland. Tax competition is clearly not the only thing at work; otherwise it would not be possible for the euro zone to have a tax take 14 percentage points higher than America’s. The big difference between the two is consumption taxes; Europe has hefty value-added tax and America has no national sales tax. Europeans are unlikely to migrate to escape VAT.
Nevertheless, there are signs of a narrowing in the spread between the highest- and lowest-taxing jurisdictions. In 1994 the five highest tax regimes in the OECD had an average tax take of 55.7%; this year, it is 53.6%. The five lowest tax regimes in 1994 had an average take of 30.5%; now it is 33%.
Countries do not “compete” on government spending. But if there is a tax constraint on policy you would expect that high-spending governments would eventually have to cut their coat to meet their cloth. The six highest-spending countries of 1994 (France and Norway were tied for fifth place) were spending 59.4% of GDP; this year they are spending just 52.8%. France is the only one of the group with a higher tax take than in 1994.
By contrast low-spending (and taxing) governments have faced no such constraint. The five lowest spenders of 1994 have seen their average outlays rise from 32.7% to 36.5% of GDP. In short, fiscal policies are converging rather than diverging.
Much economic analysis of tax regimes focuses on the optimal system: the maximum marginal rate, the balance between taxes on consumption and income, the need to reduce loopholes and so on. When it comes to discussing the overall tax take from GDP the debate tends to be ideological. Conservatives favour a smaller state on grounds of both liberty and economic efficiency. By destroying the incentives to work, welfare states weaken growth, they say.
In contrast Peter Lindert of the University of California, Davis claims that historical analysis suggests no link between high social spending and growth rates. A rough-and-ready look at the past 18 years certainly provides no clear pattern. The low spenders of 1994 included Japan and Switzerland, neither of which have grown very rapidly since. The low-spending group also included South Korea, where GDP has more than doubled since 1994. In that time, however, the country has also seen the largest rise in spending relative to GDP of all OECD nations.
A reasonable guess is that nations will continue to converge in their fiscal policies. High-spending Europe is undergoing austerity; lower-spending countries are grappling with the costs of an ageing population. In America, as national politicians bicker, state and local authorities face huge pension-fund deficits; higher taxes are likely to be part of the answer.