Too Much Tax?

The Centre for Independent Studies have produced another paper on taxation (PDF file). You’ll never believe it, but this one concludes that Australians are taxed too highly – a finding nearly as unexpected as if the Institute of Public Affairs had come out arguing for deregulation of the labour market, or the Australia Institute had come out saying that we should spend more on social services.

This paper starts off by saying that when comparing Australian tax rates to those in other OECD nations, we should weight each country by their population or the size of its economy. In fact, it doesn’t just start off with this point, it finishes with it. “Weight by size” is just about the only point that this paper makes. Despite – or perhaps because – of its trivial simplicity, the paper has managed to garner some good media coverage this week. Perhaps we can all learn something from that.*

The CIS argues that unweighted comparisons ignore the “gorilla in the room”: the United States. But it never stops to ask why you would or wouldn’t weight the US according to its population or the size of its economy. To continue the analogy, imagine that you’re looking at a roomful of monkeys, chimpanzees and gorillas. If we’re interested in how each of them behave, why would we weight our findings in favour of the big ones?

OK, so the CIS may be making a more subtle point. Let’s suppose that the reason you’d weight by population size is because tax systems represent an aggregation of popular opinion.** But this is going to have a “supermajority problem”. Like the winner-take-all US electoral college, weighting the US by its population assumes that all Americans want America’s small tax system. At best, this must be an oversimplification.

The CIS points out that the OECD is a pretty arbitrary bunch of countries, including Mexico but not Chile, the Slovak Republic but not Singapore. So it then goes on to argue that we should compare ourselves with our trading partners – an argument nicely demolished by Nicholas Gruen in a piece due out shortly in the Courier Mail (I’ll link to it when it appears).

The bottom line? Among those countries with per-capita incomes in the same ballpark as Australia, these 17 countries have higher tax/GDP ratios: Sweden, Denmark, Belgium, Finland, Austria, France, Norway, Italy, Luxembourg, Netherlands, Iceland, Germany, Greece, UK, Spain, New Zealand, Canada. And these 5 countries have lower tax/GDP ratios: Switzerland, Ireland, US, Japan, Singapore.

* Next time I relegate a discussion of weighting to a data appendix, I’m going to consider whether in fact I can produce a separate paper on the topic.

** I can’t think of a sensible rationale for weighting countries by GDP – something else the CIS do.

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8 Responses to Too Much Tax?

  1. Andrew Norton says:

    I would take this whole debate a step backwards – does it really matter much what other countries are doing? In pure policy terms I don’t think it does.

    However the left, using logic I find obscure, argues that we should come closer to OECD averages in government spending as a % of GDP. On the basis that you have to deal with debates as you find them, this CIS paper has relevance.

    But the real test of ideological manhood is not to call for lower taxes, but to show what should be cut to pay for them. That’s an exercise that has not been done for years, and in my view is overdue.

  2. Andrew Leigh says:

    Andrew, I think the reason we look at other countries is a bit like why we care about the results from drug trials — to get a sense of what tax-spend combinations can work. Over an infinite time horizon, we could just try them all ourselves, just as we could try all possible drugs ourselves if we had enough time (and health). But policy learning is an efficient way of getting to a better equilibrium more speedily.

    As to the need to combine a call for lower taxes with a call for cutting spending, I’m in complete agreement with you. In this sense, the Oz’s “Too much tax” series last year was really the work of a bunch of economic girlie men.

  3. Sinclair Davidson says:

    ‘I can’t think of a sensible rationale for weighting countries by GDP – something else the CIS do.’

    Isn’t this something everyone actually does – weight by GDP. It seems to me that this is the basis for comparison to the OECD. If you read the letters page to the AFR, just Wednesday, teh chief beggar for ACOSS was arguing taxes are low by OECD standards.

  4. Andrew Leigh says:

    Yes, but in this particular context, how would you justify weighting by GDP?

  5. Sinclair Davidson says:

    Imagine two economies. One high GDP with low tax rate and one low GDP with high tax rate. Should we take a weighted or unweighted average? The CIS argument is take a weighted average.

    If you don’t like GDP as a weight, take a trade weighted average. As the CIS reports, Australia has a high tax rate if we do that.

    Calculating weighted averages is something economists do all the time. Using GDP as a weight, or trade, is also something we do all the time as well. Why, when applied to tax considerations, is this new, novel or outlandish?

  6. Andrew Leigh says:

    Sinclair, my understanding of the exercise is that we’re trying to see what “most of the developed world” does with its tax system. For this purpose, it seems most logical to count countries, though I can see an argument for counting the systems that “most of the people in the developed world” live under. But it’s hard for me to see an argument for trying to find the tax system that “most of the dollars are spent under”.

  7. Sinclair Davidson says:

    It seems very logical to me to examine the tax system most of the wealth is earned under. While what ‘most of the developed world’ is an interesting comparison it doesn’t tell us anything about what we could or should be doing. I agree that finding the ‘tax system that most of the dollars are spent under’ may not be useful. But finding the tax system associated with more wealth and creativity is a useful exercise.

  8. Andrew Leigh says:

    Ah, that’s a different exercise. Now you’re interested in regressing change in GDP on tax ratios (or d tax ratios). Worth doing – but not a rationale for weighting by income, methinks.

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