economics

April 21, 2010

Don’t Fear the Invisible Tax By CASEY B. MULLIGAN Today’s Economist Casey B. Mulligan is an economics professor at the University of Chicago.

Filed under: Uncategorized — ktetaichinh @ 6:45 pm
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Opponents of the value-added tax complain that it is not sufficiently visible to voters, and is thereby an obstacle to responsible public spending. But in fact government spending is no lower in countries with more visible taxes.

Last week I explained how reforming the income tax system — perhaps by replacing it with a more efficient value-added tax (VAT) — might fuel further growth in government spending because less efficient taxes create more political pressure against big government.

Some economists agree with my conclusion, but for a different reason. Because the VAT is collected at each stage of production and, unlike our state and local sales taxes, is not shown to consumers separately from purchase prices, it has been said that VATs are not visible enough to voters to create much electoral resistance to raising their rates.

John Kass of The Chicago Tribune even suggested perhaps the ultimate in tax visibility — that income taxes be collected only once per year: the day before election day.

The pattern of social security taxes across countries provides a test of these theories, because countries differ in how they collect public pension payroll taxes. Some countries, like the Netherlands, take most of the tax out of employee paychecks, while others, like France, levy most of the payroll tax on employers. The United States and several other countries take an equal amount from employee paychecks and from employers.

Payroll taxes are no less efficient if they are taken from employers rather than employees, but the taxes on employees are clearly more visible to employees. Indeed, economists themselves sometimes forget that their employer is liable for payroll taxes on their behalf!

Together with Xavier Sala-i-Martin of Columbia and Ricard Gil of the University of California, Santa Cruz, I studied the patterns of payroll tax collections across countries over the years 1958-95.

Interestingly, democracies collect the payroll tax more visibly (that is, a greater share from employee paychecks) than nondemocracies do. But countries that put more of the tax on employees do not manage to spend less on public pensions (Social Security, as we call it in the United States).

The scatter diagram below shows public pension spending as a percentage of gross domestic product, versus the fraction of payroll taxes levied on employees rather than employers. Countries such as the United States with equal payments by employers and employees are shown up the middle of the chart: they all have an employee share of 0.5 but each has its own different propensity to spend on public pensions.

DESCRIPTIONCasey B. Mulligan

If more visible payroll taxes helped restrain payroll taxation, then we should see countries that take relatively more of the payroll tax from employees rather than employers — those in the right part of the chart — spending less of their G.D.P. on the public pensions for which these taxes are earmarked.

Instead, the correlation between the two variables is essentially zero (neither economically nor statistically significant). This result holds up when adjusting for a host of other variables that determine public pension spending, and excluding the Netherlands (an apparent outlier in its payroll tax collection).

I am not especially surprised that tax visibility is empirically unrelated to the amount of taxation and government spending, because the impressions of voters who see the more visible taxes are by no means the only determinant of government spending. Special interests matter too.

And even governments that are not held accountable by elections manage to restrain their taxation as much (or as little) as democracies do.

In the case of the payroll tax, one of the important interest groups would be the employers themselves, who are of course quite aware of payroll taxes levied upon them. Employers may even resist such taxes more if they thought those taxes were invisible to, and thereby unappreciated by, their employees.

It is wise to consider how transforming our tax system might affect the propensity of government to spend. But making taxes more visible to voters would be all show, and deliver no results.

Disappointed
France
April 21st, 2010
10:33 am
What you say? VAT is not stated separately from the purchase price? Mr. Mulligan, if you would like, I would be happy to send you a few dozen receipts from various European countries that clearly separately state VAT separately in the purchase price. I just pulled out of my wallet, at random, a receipt from a French book store showing a total price of Euro 7.10 which reflects VAT of Euro 38 cents at the reduced VAT rate of 5.5 percent for books. In essence, the price paid to the consumer, because it is the final step in the sales chain, reflects the total VAT charged in the entire production and distribution chain. I realize many American economists are new to the VAT system, but comments like this make me wonder with the rest of the article is worth reading at all.
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3.
wallywabash
indiana, usa
April 21st, 2010
10:28 am
Invisible VAT? Get out of town and take a look. The Canadian VAT, the goods and services tax, is added to the transaction at the cash register, just like the way we do it in the United States. Furthermore, in many countries of Europe, vendors have their cash registers programmed to report at the bottom of the receipt exactly how much VAT was paid on the total transaction. The receipt looks pretty much like the cash register receipt we get with a retail sales tax — just look at the bottom to see how much total tax was paid. And, given that US stores tend to sell a mix of taxed and untaxed items, that’s pretty much the only way to know how much retail sales tax you have paid on a trip to the grocery store.
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Doug
San Francisco
April 21st, 2010
10:33 am
Yours is a false analysis. Public pension is viewed by wage-earners as an investment that will be repaid to them in the future. Changes in the rate are expected to correlate to payouts later (though they won’t). I have no doubt that, were we to take up John Kass’ suggestion and write a check for tax payment the day before elections, there would be a sea change in the electorate’s appetite for free-spending politicians.
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6.
Urbie
RI
April 21st, 2010
10:29 am
I work for H&R Block, and I can tell you that my clients have no idea what they’re paying for income and payroll taxes — despite the fact that the latter are “visible.” To these people, it’s not visible unless they have to WRITE A CHECK. Kass, to whom you refer, nails it — probably because he’s not an economist. Take away withholding, and voila!, taxes are now visible. Millions of people would spend every dime of their paychecks, then owe thousands on April 15th, and you’d see a massive revolt that makes the Tea Party protests look like… well, a tea party!

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