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Oct 13th 2014, 15:57 by Buttonwood
THERE has been a lot of debate about austerity in recent years and about the
long-term viability of developed government finances, given their aging
populations. Should governments cut spending and hurt the poor, or raise taxes
and clobber the rich? Alternatively, should they pursue neither approach, given
the potentially adverse effect on demand of tighter fiscal policy, and rely on
a rebounding economy to restore the fiscal balance?
One factor that isn't often mentioned is the remarkable stability of tax
revenue as a proportion of GDP (see graph).
I came across this in the case of Britain, when preparing for a debate last
weekend, but the US tax take is even more stable.
What is striking is that tax policy in both countries has changed very
frequently. From a top rate of 95% in the 1960s (prompting George Harrison to
write the song Taxman "Let me tell you how it will be, it's one for you,
nineteen for me"), Britain has seen the introduction of VAT under Edward Heath,
a slashing of top rates under Margaret Thatcher and most recently, an attempt
to take lower-paid people out of the tax net. Through all this, the tax take
has never fallen below 30.5% or risen above 38.5%. The smallest tax take was
back in 1965, and the peak, surprisingly, was in 1982 under Margaret Thatcher.
Since the start of the millennium, the range has been very narrow - between
34.4% and 36.4%.
America has seen high top rates of tax in the 1970s, followed by Reagan tax
cuts, Clinton tax increases and Bush junior cuts. None of it made much
difference to the overall take. The two years with the lowest take were under
the supposedly "socialist" Obama (admittedly a function of the weak economy)
and the highest tax take was under Clinton, at the height of the dotcom boom in
2000.
Does this suggest that there is some natural limit to the amount of tax a
government can raise? Clearly, it is possible to raise more than the US or UK
achieve; France and Sweden both raise around 45% of GDP. Cultural factors may
be at work; there may be more acceptance of the role of government in France
and Sweden and a greater willingness to pay tax. America could increase its
take if it introduced a national sales tax, or VAT, if there were the political
will. But it is also plausible that at some rate, a higher tax take starts to
damage economic activity; certainly, Sweden has been trying to cut back the
state's take from the even higher levels that pertained in the early 1990s.
When one turns to spending, the fiscal problems become clear. In Britain,
public spending has only been below 38.5% of GDP (the peak for tax revenues) in
six years of the last 50. Currently, it is around 42.5% of GDP. In America,
total government spending has rarely dipped below 30% of GDP in the last 20
years. As populations age, and governments spend more on pensions and
healthcare, it seems very unlikely that this will fall very far.
In other words, there is a gap between the "normal" level of government
revenues and that of spending; this only closes at the peak of booms. Distrust
anyone who says that higher taxes will close this gap, and also distrust those
who think it will be easy to cut government spending (the British government
has laboured to do so for four years and still has a deficit of 5% of GDP).
As our recent special report pointed out, technological changes may be creating
a two-tier economy of low and high-skill occupations, with a proportionate
income gap. In the US and UK economies, this has led to the creation of a lot
of low-wage, part-time jobs; in much of Europe, where labour markets are less
flexible, unemployment is still high and the divide is between insiders with
job protection and outsiders with no job at all. Neither outcome is good for
tax revenues; despite Britain's recovery, income tax receipts are down on the
year, and the tax base is now very narrow.
A final point. I often mention in this blog that labour is mobile these days,
particularly within the EU, and there is a limit to the tax rates one can
expect people to pay. Some readers are doubtful but a recent survey of
highly-educated workers found that almost two-thirds of respondents would be
willing to work abroad and one-fifth already had done so. There is a reason
some 300,000 French people are in the UK and it's not the weather.