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Dilip sent me a couple links (here and here) of people trashing a new post by Mankiw. If they hadn’t done so already, I probably would have attached attacked the post. But since they have already trashed it, I’m going to defend it. Seriously. Mankiw notes that per capita tax revenue in the US is fairly typical of developed economies:

Here are the results for some of the largest developed nations:

“” France: .461 x 33,744 = 15,556

“” Germany: .406 x 34,219 = 13,893

“” UK: .390 x 35,165 = 13,714

“” US: .282 x 46,443 = 13,097

“” Canada: .334 x 38,290 = 12,789

“” Italy: .426 x 29,290 = 12,478

“” Spain: .373 x 29,527 = 11,014

“” Japan: .274 x 32,817 = 8,992

He argues that this weakens an argument often made by progressives, which is that the US should have much higher taxes. Apparently, we already have plenty of tax revenue; we just don’t use it very well.

Mankiw doesn’t mention this, but this example sort of reminds me of the charts that compare public spending on health care as a share of GDP, and total health care spending. Most developed countries have governments that spend about 8% of GDP on health care, with another 2% from the private sector. Their public expenditures cover almost their entire populations. The US public sector also spends about 8% of GDP on health care, but this only covers a modest fraction of the population. Another 8% or so is spent by the private sector. Actually, this example is even more surprising that Mankiw’s. Think about it; because per capita GDP in the US is higher than in other developed economies, in absolute terms our government actually spends more (per capita) on health care than almost any other government. Even before ObamaCare. We ought to be able to put the entire US population on Medicare and Medicaid without spending an extra dime. But that’s another long story. Here’s Mankiw’s argument:

Some pundits, reflecting on the looming U.S. budget deficits, claim that Americans are vastly undertaxed compared with other major nations. I was wondering, to what extent is that true? . . . The bottom line: The United States is indeed a low-tax country as judged by taxes as a percentage of GDP, but as judged by taxes per person, the United States is in the middle of the pack.

And here’s Yglesias’ counterargument:

Mankiw concludes that “the bottom line” is that the United States isn’t actually a low-tax country. But while I’m sure Mankiw believes the conclusion that raising taxes isn’t as viable as I (or, say, Paul Krugman) think, I seriously doubt that he believes this mode of analysis is correct. After all, why should the bottom line relate to the United States at all? Does Mankiw really think that Italy has more scope to increase taxes and the size of its public sector than does the United States? Or consider that in Slovakia per capita GDP is just $20,000. By Mankiw’s logic, Slovakia could raise taxes up to 65 percent of GDP and it would still count as a country with a below-average tax burden! The bottom line: The United States is indeed a low-tax country as judged by taxes as a percentage of GDP, but as judged by taxes per person, the United States is in the middle of the pack.

That’s pretty persuasive, and it would have been even more persuasive if he’d used the Congo or Afghanistan. But in the end I think Mankiw might be right. The clue is when he says:

The most common metric for answering this question is taxes as a percentage of GDP. However, high tax rates tend to depress GDP. Looking at taxes as a percentage of GDP may mislead us into thinking we can increase tax revenue more than we actually can.

Mankiw is too sophisticated to mention the Laffer curve in polite company, but what he is really doing here is a sort of cross-sectional test of supply-side economics. He’s saying higher rates may bring little or no extra revenue to the US government. So first let’s examine what’s wrong with Yglesias’s argument. Before considering Slovenia Slovakia, let’s consider the Congo and Afghanistan. It doesn’t take much thought to realize they don’t lie on the same Laffer curve as the US. They have lower levels of education, less political stability, and higher levels of corruption. But Slovenia Slovakia isn’t that different from the other developed countries, so what’s wrong with Yglesias’ counterexample? Here’s the problem, Slovenia’s Slovakia’s not done catching up. They abandoned communism a few decades back and since then have been gradually catching up to the West.

When I started studying economics the US was much richer than Western Europe and Japan, but was also growing more slowly than other developed countries. They were still in the catch-up growth phase from the ravages of WWII. But since Reagan took office the US has been growing faster than most other big developed economies, and at least as fast in per capita terms. They’ve plateaued at about 25% below US levels, when you adjust for PPP. This is the steady state. The big question is why.

Take a look at the data for Germany and Italy. On average they collect .416 of GDP in taxes, as opposed to the .282 ratio in the US. And yet the average amount collected is only slightly higher than US tax revenues.

Here’s the $64 dollar question for which I’ve never seen progressives provide a satisfactory answer. Why is per capita GDP in Western Europe so much lower than in the US? Mankiw seems to imply that high tax rates may be one of the reasons. I don’t know if that’s the answer, but if it’s not my hunch is that the factors that would explain the difference are other government policies that the left tends to favor (strong unions, higher minimum wages, more regulation, generous unemployment insurance, etc.) So I think Mankiw is saying that if we adopt the European model, there really isn’t a lot of evidence that we’d end up with any more revenue than we have right now. Further evidence for this hypothesis is that the few developed countries that do have much lower tax rates than the US (Hong Kong and Singapore) now have much higher per capita GDPs (PPP) than Western Europe. Yes, they are small and urban, but Western Europe is full of small countries of about 6 million people that have less than 5% of the population in farming.

Of course the progressives’ great hope is that we’ll end up like France. But Brazil also has high tax rates, how do they know we won’t end up like Brazil? For those who like cultural explanations, I’d point out that the US has many people of Spanish, Italian, German and British descent, but not many of French descent. And those 4 European countries raise about as much revenue as the US, but with much higher tax rates and much lower incomes.

France is more socialist that the US, but consider those industries where we have tried to emulate the French. We have nuclear power plants built by heavily regulated utilities. We have high speed rail built by government-owned Amtrak. Actually we don’t have high-speed rail, we have “high-speed rail.” And the reason we don’t is not a lack of money, but a different political system. Progressives imagine cities like Paris and trains like the TGV. I imagine Three Mile Island and the Acela. The French know how to run government projects better than we do, just as we run them better than the Italians.

In the end, it doesn’t matter what I think. What matters is what the public thinks. For several decades the most dynamic part of the US economy has been Texas. Rich people, middle-class people, and working class people are voting with their feet and moving to Houston and Dallas and Austin. Whites, blacks and Hispanics are moving to Texas. Not because of oil wealth (Louisiana has even more oil per capita), and not because of climate (California and Florida are more pleasant), but rather because it best epitomizes the US economic model. And they are leaving states with fiscal policies more to the liking of progressives like Yglesias and Krugman.

I’d much rather visit Paris, France than Paris, Texas. But on a recent visit to Houston I was impressed by how competently they run the place. It doesn’t have the art or architecture of Paris, but it’s a place where one can have an amazingly high standard of living on a middle income salary. Just don’t murder anyone.

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Tags: Taxation

This entry was posted on March 31st, 2010 and is filed under Fiscal policy, Misc., Supply-side economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



