Tax burdens may soon start to ease in OECD countries. Certainly the political pendulum of the last two decades has been in favour of reducing taxes in proportion to the size of the economy. But while recent evidence may point downwards for some countries at least, since 1965 there has been a persistent and largely unbroken upward trend in the ratio of tax to GDP across most of the OECD area. Moreover, the OECD average rose further in 1999 and, according to provisional figures, in 2000.
Very few countries have bucked the trend; only in the Netherlands are tax ratios currently below their 1975 level. In only three other countries, Mexico, the United Kingdom and the United States, has taxation remained stable, with tax receipts rising broadly in line with GDP over a long period. And a few more, including Ireland, Japan, New Zealand and Sweden, have succeeded in reducing the tax ratio from their peaks of 10 or 15 years ago, but not by large amounts. As for transition countries, like the Czech Republic and Poland, tax revenues have fallen relative to GDP, but they appear to be stabilising.
So, if the historic trend has been upwards, why should the next batch of tax revenue figures show tax ratios declining? One reason is that moves to tighten up on public spending take time to show up in tax ratio figures in several countries. Also, the buoyant economic cycle of the late 1990s lifted the tax take even when rate cuts were being implemented because companies became more profitable (and so paid more corporate income tax). The slower OECD-wide growth in 2001 should mean that the effect of any reductions will show through in the fiscal data for 2001.
Still, some countries could face increased burdens in the years ahead. Already, as Switzerland carried out healthcare reforms, its tax ratio, now at about 35%, has risen faster than the average in the 1990s, albeit up from just 31%, a base which is below the OECD average. Other countries, like the UK and New Zealand, have expressed their intention to invest more in healthcare too, though it remains to be seen whether this leads to higher taxes as a result. Meanwhile, poorer OECD countries, like Greece and Portugal, will continue their process of convergence within the European Union, and this is likely to cost tax money as they develop their social protection systems and infrastructure. Several others, like Korea and Spain, must meet the challenge of financing increased social security entitlements from their ageing populations.
Over 80% of tax revenue may come from three sources – income taxes, taxes on goods and services, and social security contributions (payroll taxes and other taxes being negligible in most countries) – but the amount collected from each varies widely. Australia and New Zealand do not collect social security contributions at all, for instance, but manage social spending from core taxation. Property taxes are generally lower in Europe (5% of tax revenue) than elsewhere (9%) – although the UK is quite high (11%). And whereas EU countries tend to rely more on consumption taxes and social security contributions than on personal income tax, the US collects more in personal income tax and property tax. Japan falls somewhere between, with a low share of consumption and personal income taxes, but more emphasis on corporate tax and social security contributions.
Despite these different tax structures, there has been an overall shift in the last 35 years towards general consumption taxes, particularly VAT, more at the expense of other taxes on goods and services (like excise duties) than personal and corporate income taxes. This change reflects an acceptance that broad-based consumption taxes are both less distorting and more effective in raising revenue. Exceptions would be New Zealand and Turkey, where the introduction of general consumption taxes has led to deep cuts in personal income tax. New Zealand reduced the personal income tax share of overall tax revenue from 60% in 1985 to 46% in 1990. Turkey cut its share from 44% in 1980 to 28% in 1985. And in Japan, general consumption tax revenues have risen to compensate for falling receipts from corporate income taxes in the 1990s.
The rise in social security contributions is another notable trend of the last three decades. The OECD average went from 18% of tax revenue in 1965 to 25% in 1999. In fact, in most OECD countries, more money has been raised from social security contributions than from personal income tax. This shift probably reflects the growing pressures on social security expenditure, particularly from population ageing.
Lower income tax rates
Most countries’ top marginal rates of income tax have been cut recently, by an average of over 10 percentage points. The US cut its marginal income taxes in 2001 (see p25). However, while top rates of personal income tax have come down, personal income tax revenues have barely moved overall: they were 10.3% of GDP across the OECD area in 1998, compared with 10.5% in 1980. This is because strong economic growth moved taxpayers into higher tax brackets and because many governments partly financed their rate cuts by reducing allowable deductions against taxable income.
Apart from cutting top rates, the number of tax brackets in OECD countries has been cut back too, from more than 10 on average a decade ago to five or six today. Fewer brackets make the tax system easier to manage and understand, both for taxpayers and administrators. What they do not do, despite some claims to the contrary, is make income tax more regressive against lower-income groups. Marginal rates may fall, but the proportion of income paid in tax is still greater for high-income earners. Also, most of what makes an income tax progressive (i.e. redistributive) comes from the first (lowest) slice of income, which in most cases is tax-free.
Corporate tax rates falling
Trends in corporate income tax have followed personal income tax down, again by about 10 percentage points since the mid-1980s. Various incentive schemes have been limited or abolished in Australia, Austria, Finland, Germany, Iceland, Ireland, Portugal, Spain and the US, including schemes for particular regions or sectors, investment credits and property-related “tax shelters”. Also, several countries have reduced the allowances for depreciation of capital equipment that companies can use to cut down on taxable income, bringing them nearer to the actual reduction in the economic value of the equipment. Still, taxes on companies and personal taxes on capital income (dividends, interest etc) are generally less heavily taxed than labour income, mainly because of social security contributions.
The rise of VAT
Personal income tax may well be what people think about first when it comes to taxes, but nearly as much revenue is raised from indirect taxes levied on sales of goods and services – more in many cases, examples being France, Korea, Mexico, the Netherlands and Poland. These taxes have increased with the substitution of Value Added Tax (VAT) – or the Goods and Services Tax (GST) for retail and wholesale sales taxes. When countries first introduced the VAT, the average standard rate was 12.5%; in 1998 it was 17.5%. Australia recently introduced a Goods and Services Tax, leaving the US as the only OECD country without a VAT-type tax. Its much smaller sales tax (which accounts for less than 8% of total taxes) is quite different from VAT in several ways; in particular, it is only charged on some goods at the point of sale and cannot be claimed back by business purchasers.
Some services, like property-letting, medical care, financial services, education and gambling, may be exempt from VAT. Also, some countries apply reduced or zero rates to some goods and services, such as books and newspapers, transport and food. The main reason for this is altruistic: some goods, like food, are necessities. And newspapers and books might not be taxed, as reading is something governments do not wish to discourage. Another feature of VAT is that its base can be widened by applying it to new items. Governments have taken advantage of this to help maintain tax revenue flows and to reduce the likelihood of consumers focusing their spending on exempt items.
What does the future hold?
So, are taxes really falling? Personal and corporate income tax rates have come down, but the overall tax burden continues to rise, although its rate of increase appears to be easing. Whether this slower increase reflects the revenue-enhancing effects of high growth rates remains to be seen.
When assessing tax, though, it is also important to know what is done with it. It would be foolhardy to look forward to the day when taxes cease to exist. Taxes help countries to run, they allow investment in important areas that are either beyond the reach of most individuals to finance by themselves or can only be provided collectively. And they are typically spent by democratically elected governments. There will probably always be the need for public money to fund services, and when it comes to health and education in particular, people want those services to be of good quality. Cutting taxes for the sake of cutting can therefore be counterproductive. What we can aim for is a more efficient use of taxation: enhancing its reach and making sure spending is not wasted, but boosts welfare and actually enables economies to grow. Perhaps the imminent dip in the tax burden reflects this new efficiency. And in this age of increased transparency and accountability, a shift towards “better taxation” would be the least we can expect.
• Taxing Wages, OECD, 2000.
• Revenue Statistics, OECD, 2001.
©OECD Observer No 230, January 2002