Don’t Mess With Taxes

Every spring, the Tax Foundation, a Washington-based advocacy group, announces Tax Freedom Day: the date by which the average employed American will have earned enough income to pay off his or her taxes for the year. This year, that day will be April 12. The Adam Smith Institute, a London-based, free-market think tank that makes a similar calculation for Britain, suggests that British taxpayers will have to work until around May 30 to pay off their own dues.

Tax Freedom Day is a clever-enough gimmick if your aim is to stir up ire over the government stealing income that rightfully belongs to the good people who have earned it through the toil of their labors. In an environment where Joe "the Plumber" Wurzelbacher is considered an expert on fiscal policy, it might even work. But it is worth remembering that, from a global perspective, how much we earn is actually 95 percent luck and maybe 5 percent toil. And it isn’t heavy-taxing big government that affects your income — it’s bad government.

The idea that anyone who works hard enough can become rich is a powerful one; for Americans, it’s not just appealing but central to national identity. The problem is that this vision of social mobility doesn’t hold true within the United States — and on a global scale, it’s just plain silly. The reason you earned as much as you did last year has far less to do with how hard you worked than with where and to whom you were born. In the United States, of those children born to parents in the bottom 10 percent of incomes, around one-third remain at the bottom as adults, and over half remain in the bottom 20 percent. Only one out of 77 children born into the bottom 10 percent of incomes reaches the top 10 percent as an adult, according to Samuel Bowles and Herbert Gintis writing in the Journal of Economic Perspectives.

But the advantages of being born rich rather than poor in America — large though they are — pale in comparison with the advantages of being born in a wealthy country rather than a developing one. The average rural Zambian will enjoy a lifetime income of about $10,000, compared with a lifetime income of around $4.5 million for the average resident of New York City. That’s not because Zambians are all soulless and corrupt. It’s because a Zambian with the same skills, intelligence, and drive earns a lot less in Zambia than she would in the United States — as is made abundantly clear every time a Zambian moves to the United States and starts earning a lot. The same people doing exactly the same job earn much, much more if they move from a poor to a rich country to do that job. In 1995, a construction carpenter’s wage in India was $42 a month. In Mexico, it was $125 a month. A South Korean carpenter, by contrast, made almost 10 times what his Mexican counterpart did; an American one made almost 20 times more.

For those of us lucky enough to be living in a rich country, are taxes really holding us back from a life of ease? In a word, no. Over the (not very) long term, it isn’t tax rates that decide how much money you take home — it is rates of economic growth. If a British person in 1984 paid no taxes at all, receiving as manna from heaven infrastructure, health care, education, policing, pensions, welfare benefits, and all the other services that the state provides, his or her take-home income (adjusted for inflation) would still be below that of post-tax Britons today. The same would be true of an American in 1988. People in the West are lucky enough to have been born in — or nearly as lucky to have moved to — countries that have seen a lot of economic growth over the past two centuries. That’s the reason they’re rich.

Of course, an anti-tax advocate would respond that low taxes and a correspondingly small government are the secret to a country’s riches — an idea that is appealing, widespread, and very wrong. The last 100 years or so have seen the fastest rates of global economic growth in history; they’ve also seen the biggest governments of all time. From William Easterly and Sergio Rebelo writing for the National Bureau of Economic Research to Ross Levine and David Renelt in the American Economic Review (as well as numerous other analyses), economists have consistently failed to find robust cross-country evidence that a government’s size — measured by tax take or spending as a percentage of GDP — has any bearing, positive or negative, on its economic growth. Want further proof? Many developing countries see personal income tax receipts that would make a Tea Partier tip his tri-cornered hat in admiration, amounting to less than 2 percent of GDP. If a small income tax burden really was the determining factor in driving growth, those countries would all be richer than Luxembourg.

But while there isn’t a proven link between government size and economic growth, there is an important relationship between the quality of government and growth. If a government can’t ensure a basic level of security, stability, fair dealing, and public goods like infrastructure and education, whether it’s large or small is irrelevant — that country will be poor. If the government is providing those basic requirements, it doesn’t matter if it’s also blowing 10 percent of its GDP on bridges to nowhere, high-tech bombers for the last war, or corporate subsidies for ethanol production — that country will be rich. Better government equals richer people — it is as simple as that.

So why do rich people think it is all about effort rather than the luck of the draw? For one thing, there’s the oft-repeated finding from social psychology that people blame their own failures on circumstances beyond their control ("I was fired because the boss never liked me") and the failures of others on personal flaws ("He was fired because he never did any work"). The reverse also holds: People take far more credit than they should for successful performance as part of a group, particularly if they do not know other group members personally. All of us — not only the rich — are just incredibly narcissistic by nature.

The second factor is that when we make comparisons it is usually to our peers, not the world as a whole. And our peers tend to have gone to the same type of school, work in the same field, and live in the same part of the world. Within these narrow groups, income differences — however small on a national or global scale — are more likely to be about ability and hard work. The fact that you earn more than your colleague who joined the firm at the same time as you did probably does have something to do with your different personal characteristics. The fact that you earn more than a peasant farmer in Lesotho doesn’t. At the same time, you rarely stop to care about how much a peasant farmer in Lesotho earns — despite the fact that the income gap between you and the farmer is many multiples larger than the gap between you and your colleague. However powerful our psychological foibles and narrow frames of reference may be, though, they are beside the point when it comes to public policy.

There are lots of reasons to hate current tax codes — not least because they are ridiculously complex and stuffed with loopholes for groups that can afford the best lobbyists. And governments the world over remain wasteful and spendthrift — including America’s, of course. Especially in poor countries, people ought to be focused on making government more efficient, equitable, and transparent — an effort that will entail lower government revenues in some cases and less government regulation in lots of cases. But the focus should be on better government, not smaller government. And the idea that taxation takes money that is rightfully ours alone, or that if only we managed to reduce the tax burden by a few percentage points we’d all be rich, is laughable. If you are in a wealthy country and it is tax time, be thankful you live somewhere where government works — and pay up.