What should we make of this? On the one hand, it’s good that there was little reduction in progressivity. The progressivity of federal taxes helps to offset the regressivity of state and local sales taxes.

On the other hand, there was a compelling case in the early 2000s (and still today) for increasing the progressivity of federal taxes. One of the chief rationales for progressive taxation is that those with high income can afford to contribute a larger share of that income. In the 1980s and 1990s, the top 1% of Americans enjoyed whopping income gains. Between 1979 and 2000,  the average (inflation-adjusted) income of households in the top 1% jumped from $350,000 to $1 million. For households in the bottom 20%, average income barely budged; it was $15,300 in 1979 and $16,500 in 2000. Given these developments, it would have been sensible to increase the effective tax rate a bit for those at the top and perhaps reduce it a little for those at the bottom. President Bush and the Congress instead chose to reduce rates for everyone.

The chief harm inflicted by the Bush tax cuts wasn’t to progressivity. It was to government revenues. The average effective federal tax rate for all households dropped from 23% in 2000 to 20.4% in 2007. Judging from the CBO’s data on income, that two-and-a-half percentage point decline subtracted roughly $300 billion from federal tax revenues in 2007. Proponents of the tax cuts hoped the economy would grow faster, mitigating the revenue loss caused by the lower rates, but that didn’t happen.

$300 billion a year wouldn’t address all of our revenue needs, but it could do a lot of good.

How much does economic growth benefit the poor? When and why does growth fail to trickle down?

How can social policy help? Is more social spending better for the poor?

Can a country have a sizeable low-wage sector yet few poor households?

Are universal programs better than targeted ones?

What role can public services play in antipoverty efforts?

What is the best tax mix?

Does improvement in the living standards of the least well-off require a sacrifice of other desirable outcomes?

A puzzle

Half a century ago, in 1960, taxes totaled about a quarter of GDP in Denmark, Sweden, and the United States. The tax take then began to rise in Denmark and Sweden, reaching half of GDP by the mid-1980s, where it has remained. In America it has barely budged, hovering between 25% and 30% of GDP throughout the past five decades.

Has heavy taxation hurt the Danish and Swedish economies? If so, how much?

Begin with GDP per capita. America’s is higher than Denmark’s or Sweden’s. But that’s a legacy of the distant past. Growth of per capita GDP in the three countries has been virtually identical, both in the five decades since 1960 when the divergence in tax levels began and in the three decades since the 1970s (shown in the chart) when the tax difference has been most pronounced.

(Here and throughout I use 2007, the peak year of the pre-crash business cycle, as the end point. Adding the crash and its aftermath would improve the standing of Denmark and Sweden relative to the U.S.)

Each year since 2001 the World Economic Forum has scored most of the world’s countries on a “competitiveness” index. The index aims to assess the quality of twelve components of a nation’s economy: institutions, infrastructure, macroeconomic stability, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market sophistication, technological readiness, market size, business sophistication, and innovation. In 2007 Denmark and Sweden were judged to be nearly identical to the United States in competitiveness. That was true throughout the decade. It also was true for the “innovation” components of the index in particular.

Employment, measured as average hours of paid work per working-age person, is a little lower in Denmark and Sweden (more here ). A larger share of working-age Danes and Swedes are employed — around 76%, compared to 72% in the U.S. But employed Danes and Swedes tend to work fewer hours than employed Americans — about 1,600 per year versus 1,800. This is due in large part to the fact that Danes and Swedes have more than five weeks of legally-mandated paid vacations and holidays, whereas Americans have none. This gap, in turn, is a function of historical differences in the strength of unions.

Employment hours increased between 1979 and 2007 in all three countries. The rate of growth was fastest in Denmark, followed by the U.S. and then Sweden.

Household income (after taxes and transfers) is higher in the United States at the ninetieth percentile (p90) of the distribution and at the median (p50). This owes to differences in per capita GDP, in income inequality, and in the degree to which citizens receive their income in the form of (tax-financed) public services. Here too the U.S. has not gained ground in recent decades. Household incomes in the middle of the distribution have grown more rapidly in Denmark and Sweden than in the U.S. (shown in the chart), and at the ninetieth percentile they’ve increased at about the same pace.

At the tenth percentile (p10), incomes are higher in Denmark and Sweden. And they’ve increased more. (See here and here.)

Denmark and Sweden have done better than the United States at keeping government debt in check.

Have high taxes required a sacrifice of liberty? Not according to the Freedom House measure of civil liberties or the Heritage Foundation-Wall St. Journal measure of economic freedom.

Finally, consider two social indicators of well-being: life expectancy and life satisfaction. On both counts, Danes and Swedes fare, on average, just as well as or better than their American counterparts.

If heavy taxation has harmful economic effects, why have Denmark and Sweden performed similarly to the United States during a period of several decades in which their taxes were much higher than America’s?

Three explanations that sidestep the puzzle

One common explanation is that small size facilitates administrative efficiency. The Danish and Swedish governments can function effectively because their scale is manageable. They are “big” governments, but in small countries. This might be true, but to say that heavy taxation isn’t a problem if government works well is to say that heavy taxation isn’t in and of itself a problem.

A second explanation looks to the mix of taxes countries use. The Nordic countries rely disproportionately on consumption taxes; in 2007 consumption taxes totaled 16% of GDP in Denmark and 13% in Sweden, compared to just 5% in the U.S. These are said to create less in the way of investment and work disincentives than do taxes on individual and corporate income.

Yet there is a sizeable difference in income taxation too. In the U.S. income taxes were 14% of GDP in 2007, versus 19% in Sweden and a whopping 29% in Denmark. More important, to suggest that heavy taxation isn’t harmful given an effective tax mix is to suggest that a high level of taxation per se is not necessarily harmful.

A third explanation points to tax compliance. Each April most Swedes receive a pre-prepared tax form. The relevant information about income, deductions, and the amount still owed or to be refunded has already been filled in by the Swedish Tax Agency. If the information is correct, the taxpayer simply confirms that by mail, telephone, or text message. Pre-prepared tax returns not only are more convenient for taxpayers; they also reduce cheating. Greater compliance, in turn, is likely to make heavy taxation more workable. If cheating is extensive, tax rates need to be higher in order to raise a given quantity of revenue, which increases the likelihood of disincentive effects on entrepreneurship, investment, and work effort. In a tax system with minimal cheating, more revenue can be raised at moderate tax rates.

This can’t be done in the United States, so the argument goes, because the American tax code (unlike its Swedish counterpart) has too many available deductions and rebates. But the U.S. could simplify its tax code to enable pre-preparation. Moreover, even with this advantage, income tax rates in Denmark and Sweden are a good bit higher than in the U.S. And a large portion of Danish and Swedish tax revenues come via payroll and/or consumption taxes, which are less vulnerable to evasion, in those countries and in the U.S. as well.

Two explanations that attempt to address the puzzle

Here are two accounts of Danish and Swedish economic performance that don’t sidestep the question of tax levels’ impact.

The first is hypothetical; I don’t know of anyone who’s offered this argument explicitly. It says that the adverse effect of taxation kicks in once a country passes 15% or 20% or 25% of GDP, and it doesn’t worsen the farther beyond that you go. Denmark, Sweden, and the United States each exceeded 25% already by 1960, so in this story we would expect the three countries to have experienced similar (poor) economic performance in subsequent years.

This hypothesis doesn’t strike me as especially compelling. None of the world’s rich nontiny democracies have had tax levels below 25% of GDP since the 1970s, and only a few have been below that level since 1960. Yet a number of these countries have had relatively good economic outcomes during this period.

A second explanation says the Danish and Swedish economies have performed similarly to America’s despite heavier taxes because they have some advantage(s) that I haven’t adjusted for. This certainly would be true if I had chosen Norway as one of the comparison countries. Norway’s economy has been boosted by extensive oil resources. Has Denmark or Sweden had any such advantage?

One possibility is catch-up. Laggard countries can get an economic growth boost by borrowing technology from the leaders. But this has become less relevant for Denmark and Sweden in recent decades, as they’ve invested heavily in education and R&D and become technological leaders in their own right (more here).

Ethnic and cultural homogeneity is sometimes mentioned as a key economic asset of the Nordic countries. This might help, though in rich nations diversity may have some benefits as well.

Corporatist policy making, which features institutionalized participation by business and labor representatives, is associated with faster economic growth in affluent countries in recent decades. This may have helped Denmark and Sweden. Yet both countries have made their share of policy mistakes.

Of course, the United States has some important advantages of its own, including a huge domestic market, excellent universities, a culture that prizes innovation and entrepreneurship, a well-developed venture capital system, bankruptcy laws that facilitate risk-taking, a tradition of regional mobility, and an attractiveness to talented immigrants. The question is: If taxation at Danish and Swedish levels has a significant negative economic effect, do Denmark and Sweden have advantages relative to the U.S. that are large enough to have fully offset that effect in recent decades? It’s a difficult question to answer with any certainty, but I think probably not.

A challenge

At what point does the harmful impact of taxes on the economy kick in? And how large is it? The Danish and Swedish experiences over the past generation pose a challenge for those who believe the answers to these two questions are “somewhere below 50% of GDP” and “large.” It’s a challenge that in my view has yet to be met.

These averages are determined by the share that have a paying job and the number of hours worked over the course of a year by those with a job. In the United States, for instance, the employment rate in 2007 was 72% and those employed worked an average of 1,800 hours (.72 x 1,800 = 1,296). In France, the employment rate was 64% and the average number of hours worked by those with a job was 1,550.

In a paper published in 2004, Edward Prescott concluded that taxes are the principal cause of the cross-country variation in working time. Prescott’s conclusion was based on the association between tax levels and work hours in the early 1970s and the mid-1990s in Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

The hypothesis is sensible. Taxes reduce the (direct) financial reward to paid work. This encourages people not to work at all or to work fewer hours.

But how large is the effect? After all, some people will work more when taxes are higher, in order to reach their desired after-tax income. More important, lots of other things affect people’s calculations about whether and how much to work, including wage levels, employment and working time regulations, paid vacation time and holidays, availability and generosity of government income transfers, access to health insurance and retirement benefits, the cost of services such as child care, and preferences for work versus leisure. A good recent study of work hours among those who have a job concludes that taxes seem to have an effect for women but not for men, and that taxes account for a limited portion of the cross-country variation. In own my research (here and here), I’ve found pretty strong indication that the tax mix matters; heavy reliance on payroll taxes is associated with slower increase in the employment rate over the past three decades. But that doesn’t necessarily tell us anything about the impact of overall tax levels.

Here is the association between annual work hours per working-age person in 2007 (before the crash) and tax revenues as a share of GDP over the years 1979 to 2007. The pattern looks supportive of the notion that high taxes reduce work hours.

But knowledgeable comparativists will notice a familiar clustering of countries. Here’s the same chart with three groups highlighted.

One group, in the lower-right corner, includes Germany, Italy, the Netherlands, France, and Belgium. These countries, along with Austria, have several features that might contribute to low work hours. One is strong unions. Organized labor has been the principal force pushing for a shorter work week, more holiday and vacation time, and earlier retirement. These nations also have been characterized by a preference for traditional family roles: breadwinner husband, homemaker wife. This preference, often associated with Catholicism and “Christian Democratic” political parties, is likely to influence women’s employment and work hours. It is manifested in lengthy paid maternity leaves, lack of government support for child care, income tax structures that discourage second earners within households, and practices such as German school days ending at lunch time and French schools being closed on Wednesday afternoons. These countries also fund their social insurance programs via heavy payroll taxes, the kind most likely to discourage employment growth.

A second group consists of the four Nordic nations: Denmark, Sweden, Finland, and Norway. These countries too have strong unions. But they also have had electorally successful social democratic parties, which have tended to promote high employment. Denmark and Sweden, in particular, have been at the forefront in use of active labor market programs to help get young or displaced persons into jobs, public employment to fill gaps in the private labor market, and government support for child care and preschool to facilitate women’s employment.

A third group of countries, in the upper-left corner, includes the United States, Japan, Australia, New Zealand, and Canada. These nations have relatively weak labor movements and limited influence of social democratic parties and Catholic traditional-family orientations.

The other five countries — Ireland, Portugal, Spain, Switzerland, and the United Kingdom — are a hodgepodge. (Some would include Ireland and the U.K. in the “weak labor” group and Spain and Portugal in the “traditional family roles” group. Doing so doesn’t alter the conclusion here.)

Based on their institutional-political makeup, we would expect the weak-labor countries to have comparatively high work hours, the social democratic countries to be intermediate, and the traditional-family-roles countries to have low hours. As the following chart indicates, that’s exactly what we observe.

So is it really heavy taxation that produces comparatively low work hours? Or is it strong unions and preferences for traditional family roles? If we adjust for institutional-political group membership, the negative association between tax levels and work hours disappears.

Given that the institutional-political groupings account for much of the cross-country variation in levels of work, we might be better able to detect the true impact of taxes by examining changes. The following chart shows change in work hours from 1989 to 2007 by change in taxation from the 1980s to the 2000s. There is no association to speak of; the regression line is negatively sloped, but it is nearly flat and the countries are widely dispersed around it. Perhaps most revealing is the pattern among the twelve countries bunched around zero on the horizontal axis; despite little or no change in tax levels over this period, these nations varied sharply in the degree to which average work hours changed.

Is it levels of taxation, rather than changes, that cause changes in work hours? No; here too we find no association.

While heavy taxation surely creates some work disincentives, the overall tax level doesn’t seem to be an important determinant of differences in employment hours across the world’s rich countries.

1. Luck. Many of the things that determine our incomes — intelligence, creativity, physical and social skills, motivation, persistence, confidence, connections, discrimination, occupation, employer, spouse, inherited wealth — are in significant measure a product of chance. They are heavily influenced by genes, our parents, our childhood neighborhood and schools, timing, and various fortuitous occurrences. Opponents of progressive taxation often emphasize the role of effort, but much of the variation in effort is itself a product of luck. (Progressive tax proponents sometimes fall into the trap of accepting the distinction between effort and luck; they’re then forced to argue that the latter matters more than the former.)

2. Ability to pay. Higher-income households tend to be able to pay not only more dollars but also a larger share of their income without suffering. One sign that this is true is that the savings rate increases with income; those with higher income tend to save a larger percentage. This may owe partly to a stronger future-orientation, but it’s mainly because they can afford to.

3. Income tax progressivity helps to offset the regressivity of other taxes. Some taxes are regressive, with higher-income households paying a smaller share of their income than lower-income households. Payroll (Social Security) and consumption (sales) taxes are the most prominent. If income taxes weren’t progressive, the tax system as a whole would be regressive.

Fairness is not the only criterion by which a tax system should be judged. We also need to consider how much revenue we want to raise and taxes’ impact on the economy. For my thoughts, see here and here.

Economic: The most important thing our federal government can do at the moment is to help the economy. Fiscal policy options are limited; there’s no chance of a second stimulus package. Extending the tax breaks for the richest will help — not a lot, since much of the money the rich get to keep will be saved rather than spent, but a little. More important, in exchange the administration got an extension of unemployment benefits for several million people and additional tax reductions for low- and middle-income Americans.

Political: The general line of commentary on the left suggests that compromising with Republicans on this issue hurts Obama politically. Comparisons to Jimmy Carter are becoming commonplace. But Bill Clinton got the same kind of flak. In the end, the key difference between the Carter and Clinton presidencies wasn’t clarity of vision, a big idea, decisiveness, toughness, progressiveness, or partisanship. It was how the economy performed as each approached reelection. If our economy gets back on its feet, President Obama and his party are likely to fare well in the 2012 elections, and images of Obama as Carter redux will be a distant memory.

More from Dean Baker, Jonathan Chait, Clive Crook, Kevin Drum, Howard Gleckman, Robert Greenstein, Greg Ip, Simon Johnson, Ezra Klein, Paul Krugman, Greg Mankiw, Robert Reich, Felix Salmon, John Sides, Mark Thoma, Matt Yglesias, and others.

At the same time that the rich have been pulling away from the middle class, the very rich have been pulling away from the pretty rich, and the very, very rich have been pulling away from the very rich.

The current debate over taxes takes none of this into account…. Our system sets the top bracket at three hundred and seventy-five thousand dollars, with a tax rate of thirty-five per cent…. This means that someone making two hundred thousand dollars a year and someone making two hundred million dollars a year pay at similar tax rates….

This makes no sense — there’s a yawning chasm between the professional and the plutocratic classes, and the tax system should reflect that. A better tax system would have more brackets, so that the super-rich pay higher rates. (The most obvious bracket to add would be a higher rate at a million dollars a year, but there’s no reason to stop there.) This would make the system fairer, since it would reflect the real stratification among high-income earners. A few extra brackets at the top could also bring in tens of billions of dollars in additional revenue.

Who stands to gain the most if Congress extends the middle-class [but not the top-end] Bush tax cuts: a middle-income worker or a millionaire? The millionaire….

The income tax operates as a staircase, not an elevator, so people who make $1 million a year don’t go directly to the top “floor” (i.e., to the top marginal tax rate, currently 35 percent) but instead take the “stairs,” paying tax on the first increment of taxable income at the bottom rate of 10 percent, paying tax on the next increment at 15 percent, and so on until reaching the top rate.

As a result, the 2001 tax law’s reductions in the lower tax brackets benefit not only middle-income people whose incomes fall into those lower brackets, but also people in the very highest brackets.

In fact, a family making more than $1 million will receive more than five times the tax cut benefit, in dollar terms, as a middle-class family making $50,000 to $75,000, if Congress extends the middle-class [but not the top-end] tax cuts.

If the president gets his way, in 2011 the top two income tax rates — now 33 percent and 35 percent — would revert to the levels before the Bush administration, 36 percent and 39.6 percent, respectively…. Republicans … say Mr. Obama is about to spring a big tax increase on many small-business owners who file their taxes as individuals. Analyses from the Joint Committee on Taxation and the Tax Policy Center, a nonpartisan research organization, show that less than 3 percent of filers with small-business income pay at the top two income tax rates, and many of those are doctors and lawyers in partnerships.

More on this from Howard Gleckman.

What is just?

What do Americans want?

Is there a tradeoff between social justice and a healthy economy?

What can government do?

How to pay for it

Bartlett argues that successful economic policies tend to be effective only in a specific set of circumstances. Their success, however, encourages supporters to believe their applicability is universal. Eventually they get overused, prove counterproductive, fall out of favor, and get replaced by new ideas.

This, according to Bartlett, is the story of both Keynesianism and supply-side economics. Keynes was a pragmatist. His recommendation to use fiscal policy to stimulate the economy was formulated in response to the conditions of the Great Depression. It worked. But then, in Bartlett’s telling, it came to be viewed as an appropriate remedy for all economic downturns. By the 1970s overuse of fiscal stimulus contributed to inflation without reducing unemployment. This led to its abandonment by many economists and policy makers.

Bartlett tells a parallel tale about supply-side economics. Its core thesis is that if marginal tax rates are too high, they discourage innovation, investment, and work effort. Bartlett says this was the situation in the 1970s. The Reagan administration’s sharp reduction of marginal rates in its 1981 and 1986 tax reforms was therefore effective medicine for the American economy. It “laid the foundation for higher real growth well into the 1990s.” But like the use of budget deficits to fight recession, the supply-side strategy of reducing tax rates came to be seen by its backers as an all-purpose cure — the appropriate tonic irrespective of the economy’s ailment.

The chief economic problem we now face, in Bartlett’s view, is not high marginal tax rates. It is the aging of baby boomers to whom we have made Medicare and Social Security commitments. Absent “massive and politically impossible cuts,” this will cause federal government expenditures to rise from 20% of GDP to around 30% over the coming generation. Supply-side dogma leaves Republicans ill-prepared for this challenge. “When the crunch comes and the need for a major increase in revenue becomes overwhelming,” says Bartlett, “I expect that Republicans will refuse to participate in the process. If Democrats have to raise taxes with no bipartisan support, then they will have no choice but to cater to the demands of their party’s most liberal wing. This will mean higher rates on businesses and entrepreneurs, and soak-the-rich policies that would make Franklin D. Roosevelt blush.”

A better result, according to Bartlett, would be to bring government revenues into line with projected expenditures via a value-added tax (VAT), a type of consumption tax. Heavy use of VATs is a key reason, he says, why “many European countries have tax/GDP ratios far higher than here without suffering particularly ill effects. They may not be growing as fast as they would if taxes and spending were lower, but neither are their standards of living significantly below those of the United States. Even strenuous efforts to show that Europeans are poorer than Americans show that the differences are merely trivial.”

I agree with a good bit of what Bartlett says in the book, and I’m particularly sympathetic to this diagnosis and prescription (see here and here). It’s a long way from Barry Goldwater, Milton Friedman, and Ronald Reagan.

I wish Bartlett had gone further. If modern conservatism is by necessity “big-government” conservatism, what principles should guide it? If conservatives must give up the goal of rolling back the welfare state, if they must acquiesce to government provision of generous cushions and supports, what should they aim for in economic and social policy? David Brooks, Ross Douthat and Reihan Salam, Will Wilkinson, Ron Haskins and Isabell Sawhill, and others have weighed in on this question. I’d be interested to know Bartlett’s take.

Some likely candidates:

A tax system conducive to entrepreneurship, investment, and work (Bartlett’s emphasis)

Employment incentives for able working-age adults

Enhancement of individual opportunity: early intervention, improvements to K-12 schools

Limited regulation of product and labor markets

Competition and choice in public services: charter schools, vouchers for schools and child care, maybe even a public option in health insurance

Decentralized administration of public services to ensure attentiveness to local conditions

Privatization of services where possible

Benefits and services targeted at the most needy rather than the middle class

Data. Many conservatives believe the poor are better off — more affluent and upwardly mobile — than government statistics and social scientists’ analyses tend to suggest. Why not allocate money for a large high-quality panel survey (something like a PSID on steroids) that will allow us to better assess this claim?

As it happens, we have a real-world illustration, albeit on a small scale, of what much of this — all of it except heavy privatization and targeting — looks like. It looks like this.

Here’s an answer. I’ll use numbers for 2006, since that’s the most recent year for which we have good income and tax data from the Congressional Budget Office.

Suppose we need to increase tax revenues’ share of GDP by 5 percentage points. As the following chart shows, that would still leave us near the bottom among the world’s rich countries. But if the money were used well, it would be a notable advance.

GDP in 2006 was approximately $13 trillion; 5% of that is $0.65 trillion ($650 billion). President Obama has pledged to not increase taxes for the bottom 95% of Americans, so let’s presume the added revenue will come from the top 5%. In 2006 this group, 5.9 million households, had an average pretax income of $564,200. Their total pretax income was thus $3.3 trillion. The $0.65 trillion needed in order to boost tax revenues by 5% of GDP amounts to 20% of that $3.3 trillion in income. Thus, the effective tax rate (taxes paid as a share of pretax income) on the incomes of the top 5% of households would need to be increased by 20 percentage points.

The following chart shows the effective federal tax rate on the top 5% of households going back to 1960. The data from Piketty and Saez begin in 1960; the CBO data begin in 1979. I use the federal rate not only because data are available, but also because these taxes — mainly individual and corporate income — are the ones most likely to enhance the progressivity of the tax system (also included are payroll and excise taxes).

Incomes are higher in the top 1%, so what if we focused on that group? In 2006 the average pretax income among those 1.1 million households was $1,743,700. Their total income was thus $1.9 trillion. The effective federal tax rate on this group would have to be raised by 34 percentage points in order to increase tax revenues by $0.65 trillion, or 5% of GDP. Here’s what that would look like in historical context.

Whether desirable or not, increases of this magnitude strike me as unlikely. It’s worth thinking about additional potential sources of revenue.

Let me emphasize that my aim isn’t to discourage increases in taxation of the richest. I favor doing that. Rather, it’s to encourage the American left to think beyond heightened tax progressivity when considering strategies for inequality reduction.

Note: I’ve corrected an error in the earlier version of this post.