Don’t Hold Your Breath (Part 1)

Key Points

  • Taxes are here to stay, but the level of taxation is sure to change over time.
  • In the U.S., taxes account for about 25% of GDP, which is lower than most of the 35 OECD countries, which averages 33%.
  • There are tangible benefits to higher tax rates, according to research.

Governments need taxes to operate and provide services. We might debate this point down the road, but let’s take this assumption at face-value for now. As the saying goes, there are only two certainties in life: death, and taxes. So don’t count of either of these things going away any time soon.

As such, to raise funds, governments around the world rely on many different forms of taxation. In this post, we’ll note some remarkable differences around the world when it comes to what is taxed and by how much.

Too High? Not High Enough?

In the United States, taxes make up about a quarter of GDP. Again, GDP represents the value of a country’s output over a given year. So more specifically, in 2015, taxes accounted for 26% of the country’s GDP. This is relatively low when compared to other developed countries.

The average is 33 percent for the 35 member countries of the Organisation for Economic Co-operation and Development (OECD). And from this list, the U.S. ranks 30 out of 35 member countries. The OECD was founded in 1961 to stimulate economic progress and trade around the globe. As of 2017, these 35 member countries represent about 62.2% of global nominal GDP.

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Chart 1. Total Tax Revenue Across 35 Developed Countries as of 2015 (Source: OECD)

Chart 1 above provides the full range of taxation rates across all of the OECD member countries. On the low end, taxes account for around 16% of Mexico’s GDP. And on the high end, taxes account for over 45% of Denmark’s GDP. Many European countries on the list have considerably higher taxes than the United States. As you can image, the services provided by the government are far more expansive in these countries as well.

But what is the benefit of higher taxes? After all, if higher taxes lead to worse outcomes, then we should consider policies that lower taxes. Or we should all move to Mexico.

But if higher taxes lead to better outcomes, then perhaps higher taxes are warranted. So far, this all sounds really simple, but of course, the reality is far more complicated.

Better Outcomes, Not So Fast

One chief complexity is how do we measure “better outcomes”. And “better outcomes” for who exactly? The rich, the average citizen, the poor?

A standard metric for prosperity is GDP, which we have discussed in the past as the market value of all the final goods and services produced in a country for a given year. There are two issues with this metric.

First, countries with more people will naturally have a higher GDP. The way to adjust for this is to simply divide the GDP by population to get GDP per capita.

Second, GDP is often measured in U.S. Dollars. But the purchasing power of the dollar varies across the globe. For example, a Big Mac in Switzerland in 2018 costs $6.57; while the same burger in Egypt costs only $1.75. As such, if you earned $2 dollars an hour (after accounting for taxes!) in Egypt, you could buy a Big Mac in less than an hour. But in Switzerland, you would have to work over three hours to earn the same burger based upon the same wage. Given all this, an adjustment for the purchasing power of the dollar is warranted when comparing GDPs of different countries. Thus, economists use Purchasing Power Parity to adjust for these types of effects.

Purchasing power parity (PPP) is a way of measuring economic variables in different countries so that irrelevant exchange rate variations do not distort comparisons. — Wikipedia

Hence rather than our traditional, nominal GDP, economists use PPP GDP to evaluate the relative performance of different countries. PPP GDP can be measured a few different ways, but a good source for this data is the International Monetary Fund (IMF).

2019-05-27-PPP GDP Per Capita IMF Top 25 Countries
Table 1. Top 25 Counties by PPP GDP Per Capita. (Source: IMF)

Table 1 represents the Top 25 countries in terms of PPP GDP Per Capita, and on this list, the U.S. ranks 10th. For a cursory evaluation of the data provided in Chart 1 and Table 1, it might not be clear if there is a relationship between taxation level and PPP GDP Per Capita. For example, Denmark has the highest taxes, but it ranks 19th in terms of PPP GDP Per Capita. Yet, the United States ranks 30th in terms of taxes but ranks 10th in terms of PPP GDP Per Capita.

More Data

A high-level view is perhaps not the best way to uncover a pattern here. In the next post of this series, we’ll use some statistics to see if there is a relationship between overall taxation by a country and a country’s output.