'Fiscal cliff' reality check: Are US taxes low or high?

As Washington confronts the 'fiscal cliff' and seeks a deal to reduce the deficit, one key issue is the tax rate. Comparatively, US taxes are low, but politically, a big hike is a nonstarter.

At the heart of the current debate over the so-called “fiscal cliff” is a fundamental question: Are US budget deficits so high because the government spends too much or because Americans are paying too little in taxes?

Or is the answer a bit of both?

Something has to give. Both President Obama and Republicans in Congress agree the country must take steps to reduce budget deficits, even as it’s also wise to soften the impact of the fiscal cliff – the negative impact of tax hikes and spending cuts that are currently slated to go into effect on Jan. 1.

One lens on the debate is global – checking how the US compares with other advanced economies. Such a check-up gives some useful context to the debate, even though the exercise isn’t meant to imply that the US should mimic other nations.

The upshot: Judged by global comparison, the US is taxed relatively lightly, so much so that the country could close its deficit over the next decade entirely via tax hikes, while still keep its tax revenue below European levels.

But America also appears to have a spending problem – notably when it comes to health care – over the longer term. And just because American taxes are on the low end of the scale doesn’t mean that raising taxes would be easy for the economy to bear.

Another big lesson from overseas: America isn’t alone when it comes to having chronic budget deficits. It has company from Japan and many European nations. The point here is that higher taxes alone do not guarantee balanced budgets. One still must spend appropriately.

The Organization for Economic Cooperation and Development (OECD) estimates that in 2010 American individuals and businesses paid taxes (federal, state, and local) that amounted to 24.8 percent of US gross domestic product. That compares with 33.8 percent of GDP for the OECD overall, encompassing more than 30 advanced economies.

That’s a big gap. Nine percentage points of GDP, to be precise.

And every other large advanced economy in the world ranks higher than the US in the percentage of GDP paid in taxes. On the OECD list, only Chile and Mexico have lower overall taxes as a share of GDP (about 20 percent and 19 percent, respectively).

Democrats can point to this as evidence that higher taxes should be part of the solution.

In fact, although this idea is politically unpalatable, Congress could close America’s budget deficits over the rest of this decade entirely through tax hikes – and America would still have below-average taxes among OECD nations.

As an illustration, consider that Obama's most recent budget plan (which he proposed in February) envisions bringing deficits down to 3 percent of GDP at the end of the decade through relatively modest changes to current policy: some spending restraint and some tax hikes that amount to about 1 percent of GDP. So, operating from the Obama template, even if you eliminated the plan’s spending restraint, the tax hikes needed to eliminate deficits altogether wouldn’t be large enough to push US taxes up to 34 percent of GDP.

OK, we’ll get real now. Politically that scenario is a nonstarter. The presidential election was a contest between Mitt Romney, who wanted to keep taxes low for all Americans, and Obama, who pledged to keep taxes low for 98 percent of households – while raising them modestly for the rich.

On economic grounds, too, just because other nations tax more doesn’t make their level of taxation the right one. In fact, European tax rates vary widely, ranging from nearly 48 percent of GDP in Denmark to 27.6 percent in Ireland.

Some economic research concludes that, on balance, nations with a smaller size of government will enjoy faster economic growth. Note that European economies still haven’t caught up to America’s when it comes to GDP per capita. Some economists argue that “big government” in Europe has dampened GDP growth there, and that the US risks slower growth if it follows a European path on taxes and spending.

America's gross national income per person was about $49,000 in 2011, according to the World Bank. That was lower than a few small European nations: Switzerland, Luxembourg, and oil-rich Norway. But Germany came in at $40,000, and Britain and France just below $36,000 (near non-European countries Canada and Japan).

Moreover, if US taxes are “low,” they’re not as low as you might think. To some extent, the 2010 figures on taxation were made smaller due to temporary tax cuts – a policy effort to revive growth after the recession.

And keep in mind that other nations finance a higher share of their health care through taxes than the US does. British or Japanese consumers are buying a product, via taxes, that in America is mostly paid for in the private sector.

The topic of health care brings us to the next point of global comparison: A quick look at other nations suggests that America has a spending problem, not just a revenue problem.

Specifically, US spending on health care, combining public and private expenditures, was 18 percent of GDP in 2010, much higher than in other OECD nations. For comparison, health care’s share of GDP totaled about 10 percent in Britain and Japan, 11 percent in Canada and Switzerland, and 12 percent in Germany and France.

Again, much of the US spending occurs in the private sector. But the federal costs are large and fast-rising. The long-run worry about America's fiscal solvency centers heavily around the costs of paying for programs such as Medicaid and Medicare.

That rise in those costs is projected to remain a fiscal problem even if America raised taxes enough to bring the federal deficit down to zero by 2020.

The choices facing US policymakers aren’t easy. There's no public consensus how to best control health-cost inflation without sacrificing desired care and insurance coverage. And on the tax-revenue side of the puzzle, many budget experts say tax hikes are at best part of the fiscal solution. The current slow economy makes it a tricky time to impose tax hikes, and in the longer run, raising taxes too much could inhibit growth.

But the International Monetary Fund, among others, has warned that the US needs to make some fiscal adjustments. With Europe already wrestling with a public-debt crisis, the IMF recently warned that “the United States and Japan must promptly define and enact clear and credible plans to return to fiscal sustainability over the medium term and buttress investor confidence.”