Taxation in the United States has always been the source of much debate and dissension in the political realms. Part of the discussion relates to what the taxes are used for, and, as an extension, what the government should be using the revenue for. Another part of the debate stems from differing views on the ability and appropriateness of using taxes to manipulate the economy. Many economists and politicians believe that lowering the tax rate will help to stimulate the economy - an important consideration in the current economic climate.
What people rarely hear debated is that America's taxes, as a percentage of its gross domestic product (GDP), are at historical lows and that the corporate portion of that tax benchmark is lower than almost any other industrialized country on the planet. Why does this measure matter? GDP represents the output of the economy and should be steadily rising. Taxes fuel this growth, both through direct government initiatives and through its impact on businesses and individuals. When taxes are too low, economic growth is more difficult to achieve and the government must cut programming due to lack of revenues. Here are three reasons why taxes should increase in the U.S.
The Effective Tax Rate Is Much Lower Than the Marginal Rate
The debate over lowering taxes generally looks only at the bracket rates, which represents the marginal taxation on the last dollar of income in that bracket. A much more important measure is the effective tax rate, which is based on the amount of taxes actually paid. The effective rate takes into account all of the deductions and credits taken that reduces taxable income. For example, even though the highest personal tax rate is 35%, according to the IRS the average tax rate paid by the country's 400 richest individuals was just over 18% in 2008. Part of the difference is that capital gains are taxed at a much lower rate than earned income, which is at the highest tax bracket. Another part relates to deductions, such as donations, that the wealthy can use to offset their taxes.
A Reduction in Corporate Taxes Doesn't Translate into Job Growth
One of the main arguments for lowering the corporate tax rate is that it will stimulate hiring, and, thereby, drive economic growth. However, according to the Congressional Budget Office, the corporate tax burden was 12.1% of profits, on average in 2011. This is the lowest it has been since 1972. Unemployment still remains at just over 8% (as of January 2012), so the low corporate taxes are not having an impact on jobless rates. One possible reason for this is that the largest corporations in the country are accelerating the outsourcing of jobs to other countries, especially in the manufacturing, technology and customer service areas. This expatriation of tax savings does nothing to stimulate the American economy.
Passive Income is Taxed at a Lower Rate Than Earned Income at Higher Tax Brackets
In some industrialized countries, taxes on investment income are higher than taxes on earned income. This stimulates inputs into the economy (labor) and puts a higher burden on dormant capital. In the U.S., it's just the opposite. In the higher tax brackets, parking money in investments attracts less tax than employing it directly into the economy. Reducing tax rates across the board will not change this dynamic.
The Bottom Line
The tax base as compared to the GDP is at historical lows in the U.S. and the corporate contribution to tax revenues is lower than almost any other developed country. The solution to America's economic woes may not be in lowering taxes further, but may, in fact, lie in increasing them.