Wednesday, January 16, 2013

Tax Revenue Versus Tax Rate

I occasionally hear the argument that high taxes promote growth more than they harm it because countries with higher taxes as a share of GDP have higher per capita income. It is true that rich countries have far higher tax revenue as a share of GDP than poor countries. However, this does not prove that high taxes are good for the economy. It is important to distinguish tax revenue from tax rates

Low tax revenue does not prove that tax rates are low. Poor countries can have high tax rates and still collect little in revenue. One reason is that the economy is less monetized. It is hard to tax an economy based on sustenance farming or barter. 

Moreover, disorganized countries tend to have trouble collecting taxes even on the monetized sector. This is even true in Europe and is obviously worse in the thirld world. Greece has far lower tax revenue as a share of GDP than Sweden though tax rates are similar.

The more well-organized and advanced a country is, the higher will tax revenue be for a given tax rate. This creates a significant causality problem when taxes as a share of GDP are compared with growth rates and / or income. 

Tax rates are difficult to summarize in one number since most economies have hundreds of different tax rates, depending on the level and source of income. The World Bank has produced an interesting standardized measure of the tax rate faced by business. They construct a fictional medium-sized business and see what taxes the same business would in total face in various countries. From the IMF we get data on government revenue (mostly taxes) as a share of GDP and on per capita income.  

  As you can see tax revenue correlates positively with per capita GDP.

However if we look at the profit tax rates for the same set of countries, the correlation with GDP is strongly negative. These graphs illustrate the fact that a lot of poor countries with little tax revenue actually have pretty high tax rates on business. The positive correlation between tax revenue as a share of GDP and per capita income should not be used to prove that high tax rates are good for the economy.


  1. One fun thing I did was to grab Outlays in the USA per decade and compare it to the top marginal tax rate. It was a fun exercise in order to show people that higher taxes on the rich did not translate to larger ( necessarily ) revenues on a decade level (since economics go through cyclical boom and bust periods )

    Now this is USA % of Revenue to GDP per Decade

    1950's - 18.17% ( 92% Top Tax Rate )
    1960's - 17.51% ( 91% to 70% )
    1970's - 17.29% ( 70% )
    1980's - 17.86% ( 70% to 38.5% )
    1990's - 18.37% ( 38.5% to 39.6% )
    2000's - 17.42% ( 39.6% to 35% )
    2010's - 15.39% ( 35% to 39.6% )

    In general the amount of revenue that is brought in has much more to do with the strength of the economy than it has to do with what the tax rate is. People will invest or spend the money they have, if the Government takes it and invests or spends it for them it should be pretty much a zero sum game as far as the GDP is concerned.

    Personally my issue with taxation is that the term 'fair' is all to often a question of belief rather than actual fairness. Using this word in order to justify taking more property from some and less from others causes me to feel dirty and a little evil since I am a party to mob theft at that point. You want to make things 'fair, say that x number of dollars for everyone is not taxed and everything over that is taxed at the same rate. While this may appear to be the same as changing peoples tax rate I prefer to look at it as setting a bar and saying simply that above 'basic subsistence' you must pay taxes. So in the USA if you were to set it at say $10,000 is tax free ( for people who are not dependents ) and every dollar after that is taxed at 33% then you would have generated last year in taxes $2.52 Trillion in taxes versus the $2 Trillion that were brought in. It would also make people hopefully much more aware of what the Government is doing which I think is the real purpose of a 'flat tax' When those same people realize that to actually have paid for Government Spending last year they would have needed to have been taxed at a rate of 39.5% (after not taxing the first $10,000 earned ) in order to balance the budget through taxation, I think the call to action would be to scale back spending rather than increase tax burden. Maybe I am incorrect on this though...People fall for the 'tax the rich' junk over and over again.

    Now to comment a little about what you wrote Tino... I think it is sort of a Duh statement to say if you tax a business more they would not have a negative correlation to ultimate profits as the portion of profit that the company gets to keep as a portion of GDP HAS to drop... Just saying that it is a little silly to suspect otherwise but then the proof is in the pudding I suppose.

  2. Nice article, thanks for the information.
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  3. You only pay 28% on the amount over that, so if it's only a few hundred or thousands, it should not have a big impact.

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