The myths around Europes high taxes 2005-03-10

According to the Christian Science Monitor, a flat-tax movement stirs Europe.

The article makes much of the idea of how high taxes are in Europe. However, while the tax levels are in many cases higher than in the US the gap is generally smaller than people believe it to be.

The article also presents a lot of the arguments used for a flat tax rate, but leave out most of the usual counter arguments.

I'll briefly discuss both of these points.

I'll compare the US and UK levels since the UK level is the European nation I have direct experience with. The UK is generally seen as having less of a tax burden than countries like France and Germany, or the Scandinavian countries. However my own experience from Norway is that while there are some differences, you need to earn well above average to see much of the difference.

The average salary for men in full employment in Great Britain in 2003 was ca. 525 GBP a week, or ca. 27300 a year which using todays exchange rate translates to roughly $52500. The median salary for men in full employment in the US in 2003 was $40668.

So let's look at the tax burden of people earning $40k and $50k respectively. Let's also look at someone earning 100.000 GBP, or roughly $200k. In the UK, that correspond to around 1% of the population.

In the UK, income tax for these three levels can be calculated based on this table. I've used the numbers for the 2003-2004 tax year.

For someone earning the equivalent of $40k, the tax would be ca. 3300 GBP, or less than 16% of their earnings. At $50k, the tax would be ca. 4700, or ca. 17% of their earnings.

Even our rich guy - the GBP 100k/$200k earner, ends up paying "only" about 33% tax. The UK is listed in the 40%-49% bracket in the CS Monitor article because the top tax bracket is 40%, but that is only in income in excess of around UKP 35.000 (ca $70k), well above the average income.

Add to this an average council tax bill of around UKP 1200 per household, and the effective tax rate rise to around 22% if our $40k and $50k earners are the sole earners in their household, and around 34% for the $200k earner.

How does the US measure up? Lets start with the federal rates. At $40k federal tax is ca. 16.8%. At $50k about 18.5%, and at $200k about 26.6%.

So in other words, you need to earn well above average before you start seeing the differences based on UK income tax vs. US federal tax.

Let's estimate some state taxes... That's harder, but most of the highly populated states operate with several relatively low brackets bringing you to 3-5% easily with the income levels we're looking at. Some, like California, can approach 9% for high earners.

Assuming 3%, it would bring our guys in at slightly below 20%, 21.5% and 29.6%. The gap to the UK income tax + council tax is low. Given that the council tax is per household, it would be even lower in a household with two or mor earners (UK council tax is also generally half for households with only one person).

What about local taxation in the US? This table claims that state and local taxation for most states will be around 10% of income.

Taking that into account, our three guys would end up with 26.8%, 28.5% and 36.6%...

Now who has high taxes?

Note that this comparison doesn't take into account health insurance vs. UK National Insurance. The latter is compulsory, and charged together with your tax. Adding in national insurance would bring the total UK personal taxation levels up to approximately the same levels as the US, but with significant added services (free health service and some access to free dental services)

It also does not take into account the differences in sales tax / VAT. UK VAT is low by European levels, at 17.5%, but high by US levels. I have on purpose not included this, as "ordinary people" tend to talk about the personal tax rates when complaining about tax levels and including VAT / sales tax directly would also require you to consider the differences in purchasing power and price levels.

So why do people think that taxation in Europe is so high?

Personally, as a quite well paid engineering manager, my TOTAL tax burden (including local taxes and national insurance) in the UK is around 32%, and with full health insurance on top of what NHS provides I'd pay an extra 1% max.

My answer is because of articles like the CS Monitor article that compares the top rate for the highest tax bands, ignoring that almost nobody pays those rates for more than a small part of their income.

In other words: Europes taxation levels looks high because we for the most part have a highly progressive tax system.

Which brings us to the next part...

The arguments AGAINST flat taxation

Much is made of how "everyone" gets to pay a "low" rate of 19% income tax in Slovakia. But as we've seen, in a country with an extensive health system such as the UK, the tax rate for average earners, who earn FAR MORE than the average earner in Slovakia isn't significantly higher.

What happens with a flat rate is that the vast majority end up paying higher rates than what they would in a progressive system, as a TINY minority gets tax reductions.

The typical argument for this system is that it stimulates investment. However, that is baloney. It stimulates migration of investment from places with higher tax rates for the rich. Now, for a nation such as Slovakia, that is fine - they need the investment. The overall end result for them might be positive even if low income earners pay higher tax as a result.

However it is not a sustainable way of attracting investment, as if enough capital is drawn away from other sources, they'll find way to give tax breaks to prevent the capital drain.

If capital remains in the country, there are few reasons to believe that lower tax significantly increases investment activity - in a high tax envirnonment, on the contrary, you need to be significantly more aggressive to see the same net return and achieve the same increase in wealth. Investors won't lean back and say "ok, we've made enough money now, because you work harder we'll just be taxed more".

This is even more apparent in countries like Norway, which taxes not only income, but also personal wealth, so that if you don't put your money to use, the combination of inflation and taxation will eat away at your capital.

Add to that a strong sense that progressive taxation is more just - a 20% tax rate for someone just making ends meet really affects their standard of living - a 35% tax rate for someone making GBP 100k is peanuts. The tax burden is already by far heaviest for people who make little to start with.

These are a couple of reasons why, contrary to what the CS Monitor might claim, we hardly hear about flat tax here. Even the right wing parties don't usually suggest it in western Europe at least.

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