David Cay Johnston
Oct. 20, 2010
Who benefits from the taxes we pay seldom gets examined, but two reports on the redistributive effects of taxes and transfers shed some revealing light on this issue. One report deals with the United States and the other with Canada.
In America, taxes and transfers have a significant impact on income inequality, which has been rising since 1980, according to a report by Thomas L. Hungerford of the Congressional Research Service. You can see the report here.
Hungerford warns that new tax policies, aimed at bringing what we levy in line with what we spend, need to be evaluated in terms of the redistributive effects to avoid unintended consequences.
But for taxes and transfers, America would be the 19th most unequal nation in the world, if you apply Hungerford's data to the annual CIA World Fact Book report on income inequality.
Inequality, keep in mind, is the result of many factors, including how government rules shape economic outcomes. Policies that artificially raise prices, for example, or that favor some with quality education affect how much money individuals can save, make in profits, and earn in the labor market.
Hungerford's report uses the standard Gini index to examine equality. If everyone had equal income, the Gini number would be zero, while if one person had all the income, it would be 100, at least for the few minutes before hunger prompted us all to revolt.
Hungerford's report shows that before taxes and transfers, American household income has a Gini figure of 51. That would put us in the same economic equality neighborhood as El Salvador, Papua New Guinea, Zambia, and Niger -- not exactly the kinds of countries we imagine being akin to American values or economic success.
After taking into account taxes and transfers, like Social Security, the Gini index drops to 43. That puts us in the hardly more desirable neighborhood of Nicaragua, Cambodia, Kenya, Thailand, Russia, and Senegal, all with Gini indexes from 43 down to 41.
The CIA, by the way, puts the United States Gini at 45, slightly higher than Hungerford's analysis for Congress. (For the CIA report, see https://www.cia.gov/library/publications/the-world-factbook/rankorder/2172rank.html.)
And what of those countries most like America in terms of culture, economics, and wealth? What of those countries we think of as modern industrial societies, the ones we compete with in the global economy? Japan comes in at 38. Much more equal are Canada, Spain, Italy, and the European Union as a whole, which are all around 31 or 32. Germany is at 27, while we find Norway, Sweden, and Denmark between 23 and 25.
Hungerford goes on to detail how nine tax law provisions have redistributive effects, five of them decreasing inequality and four of them increasing it.
In order of significance, the progressive effects come from the child tax credit, the earned income tax credit, the exclusion of all or some Social Security income from taxable income, the alternative minimum tax, and the phaseout of personal exemptions and itemized deductions for higher-income taxpayers.
The regressive results come from reduced rates on capital gains, itemized deductions, reduced tax rates enacted during the Bush administration, and tax-exempt interest on municipal bonds.
Amazingly, the four regressive items are significantly larger than the progressive ones. In fact, they are 43 percent larger.
Hungerford's analysis also shows that transfers have a greater redistributive effect than taxes.
This brings us to the Canadian study, "Canada's Quiet Bargain: The Benefits of Public Spending," which asks the audacious question, "Are taxes saving you money?" (For the Canadian report, see http://www.growinggap.ca/files/Benefits%20From%20Public%20Spending.pdf.)
The authors of the study, which was based on Statistics Canada's data and simulation models, say that it "adds a dimension that has been missing to the public debate over taxes and public spending in Canada. It weighs the benefits of public services provided by federal, provincial, and municipal governments against the benefits of recent tax cuts."
That issue is also largely missing from American debates -- what are the losses in public benefits because of tax cuts, and how do the benefits of public spending stack up against the benefits of reduced taxes?
The study comes from the Canadian Centre for Policy Alternatives in Toronto and is designed to build public support for government spending and weaken support for tax cuts, which is not surprising given that public employee and other unions are behind it.
Authors Hugh Mackenzie, a union economist, and Richard Shillington, a statistician, assert, "Tax cuts implemented by federal and provincial governments over the past 15 years have reduced the living standards of the majority of Canadians. The majority of Canadians would be better off if their governments had invested in improving and expanding local public services instead of cutting taxes."
Mackenzie said, "It's amazing how often you see 'analyses' of the tax system from economists that talk about every purpose and potential impact of the tax system except the most important one -- raising money to pay for public services."
He is right. But what I also found fascinating, from my own reanalysis of the study data for the chart accompanying this column, is that except for those making less than C $30,000 -- the poor and the near poor -- the distribution of benefits per person comes remarkably close to what people would get with zero redistribution.
At C $40,000 to C $50,000, government benefits equal 95 percent of what this group would get with a 1:1 distribution ratio, as shown by the line marked "Ratio: Share of Benefits to Share of Population." Just below this, at C $30,000 to C $40,000, benefits are 105 percent of what that group would get based only on its share of the Canadian population.
The top 3 percent, who make C $200,000 or more, get 88 percent of the benefits they could expect with no redistributive effects.
The fine details of the report show that healthcare, which Canada provides through a universal one-payer system that frees businesses from this burden, declines as a benefit with income.
The greatest benefit goes to those making C $10,000 to C $20,000, who on average receive a health benefit worth $5,364 each. But when you consider that 23 percent of those in this income group are retirees, the number does not seem out of line.
Indeed, this income group gets 1.82 times the benefits that it would under a formula that had no redistributive effects. Why such a large figure? It's the result of the costs of old age.
Canada, like the United States, has a national government retirement income system. It is more generous than the American Social Security system. Combined with provincial plans, government old-age retirement checks provide two-thirds of the income of retirees.
Of the 2.2 million Canadians in this C $10,000 to C $20,000 income category, the study shows that 23 percent are senior citizens. So a half-million Canadians, who for decades paid taxes so that others could have a guaranteed income in their old age, and who made larger incomes when they were working, are now getting paid back. On average, income transfers to those in this income group are C $12,484, more than twice the overall average of just under C $6,000 per person.
Add in the somewhat higher cost of healthcare for this group with its high concentration of older Canadians, and you explain most of the redistribution effect.
But is this redistribution the way politicians talk about it in the United States? Or is this a timing transfer, rather than an income transfer?
Societies by their nature engage in all sorts of transfers based on timing. Children get free educations, with adults paying taxes so that the next generation can create economic activity in the future. This is, in effect, an investment of some of today's resources in the future. This investment pays a societal dividend as children mature and go to work, the degree of rigor introduced into the gray matter between their ears playing a major role in their ability to earn and, thus, the government's ability to tax so that the next generation of children can be educated.
On entering life, people get subsidies, and they get the same on the way out, but in between they finance benefits for those who come before and after. It's the cycle of taxes and benefits.
Look closely at the chart and you will also notice that in Canada, like the United States, it is the affluent who get hit harder than the rich. Those Canadians making C $100,000 to C $120,000 get back in government benefits just 81 percent of what they would receive under a nonredistributive model -- much less than the richest Canadians, who get back 88 percent.
Looked at another way, the bottom line in the chart shows that the poorest Canadians get by far the greatest benefit from government. Their benefits equal 642 percent of their own incomes. This should not be surprising.
The poorest Canadians are largely disabled, sick, or otherwise unproductive in the measurements used in modern cash economies. We do not expect the few people in iron lungs to make a living, so taxes sustain them, and their benefits vastly exceed any income they earn. That kind of support is very costly, but what is the alternative?
We need solid, detailed, and competing analyses of how the American tax system produces benefits and distributes them. What we have now is piecemeal and freighted with ideology.
We have reports on this or that specific benefit or cost. We know how much military spending, for example, contributes to incomes in each state, county, and, most significantly, congressional district. We know how much is paid in subsidies to farmers, including those with Park Avenue addresses. We know how much the George W. Bush, Bill Clinton, and Ronald Reagan tax cuts saved the richest Americans, but too little about what each cost so we can weigh both sides.
A detailed, systematic examination of benefits that matches what the Canadian study did would be a good start. So would understanding how the American tax system, seen as a whole, results in what is pretty much a flat tax, the latest evidence for which is in a report by Citizens for Tax Justice. (For the report, see: http://www.ctj.org/pdf/taxday2009.pdf.)
That report shows that the top 1 percent made 22.2 percent of all reported income and paid 23 percent of all taxes, hardly an unfair burden, especially because their average income was more than $1.4 million last year. At the other end, the poorest 60 million Americans made 3.2 percent of all income and paid 2 percent of all taxes, according to the report's economic model.
America needs research that goes much deeper than the Canadian study. We need to look beyond transfers alone, as the Canadian study did, and to examine them in the context of time so that we can measure what are really investments and what are giveaways. That research would add enormously to the quality of our debate on the costs and burdens of government.
Distribution of Public Benefits in Canada
Source: "Canada's Quiet Bargain: The Benefits of Public Spending,"
Canadian Centre for Policy Alternatives, available at
http://www.growinggap.ca/node/170.
It would also help us recognize the costs of tax cuts and not just the immediate benefits to those who receive them. It would help to know whether a dollar saved by the richest Americans through a tax cut benefits society or costs us several dollars in lost productivity because of inadequate education of the young, as well as inadequate infrastructure to move goods and services and maintain public health.
And what of the effect of tax cuts, and the design of the tax system, on crime?
Is a 10 percent tax cut worth the price if it results in a 1 percent increase in murders? Would you trade an extra $50 a week in your pocket after taxes for a 1 in 50,000 chance that a criminal will shoot your spouse or child or you? How about one in a thousand -- or a million? What is the tax price point?
With more information, we would determine what role, if any, taxes play in these facts:
Canada's murder rate is one-third that of America's.
Canada's homeownership rate is virtually the same as America's even though mortgage interest is not deductible in Canada.
Canada has not had to bail out its banks or investment houses.
Canadian business owners do not have to divert any time from making a profit to dealing with healthcare for themselves and their workers, giving them a competitive edge.
Could a redesign of our tax system to encourage more investment and more labor income lower crime rates, reduce drunk driving and other social pathologies, and make us a more productive and healthier society?
We cannot begin to answer these questions until we have information that enables us to take a comprehensive look at tax policy that goes beyond the burden of taxes to understand public benefits across income classes and across time.