Saturday, May 29, 2010

Should We Mimic Brazil's Tax System and Tax Rates?

In some off-the-cuff remarks at the Brookings Institution, Secretary of State Hillary Clinton has asserted that the "rich" are not paying their fair share of taxes in light of the nation's high unemployment rate or, as she put it: "in any nation that faces the kind of employment issues [American currently faces]." She then cited Brazil as a purported counter-example, that is, a country that has imposed high taxes on the rich, spurred economic growth and reduced poverty. As she put it: "Brazil has the highest tax to GDP rate in the Western Hemisphere and guess what --- they're growing like crazy. And the rich [in Brazil] are getting richer, but they're pulling people out of poverty. There is a certain formula there that used to work for us until we abandoned it, to our regret in my opinion."

Before the United States imposes even higher taxes on "the rich," it might want to consider the following:

1. Brazil apparently imposes LOWER taxes on "the rich" than the United States. According to several sources, the top individual tax rate in Brazil is 27.5 percent. By contrast, the top rate in the United States is 35 percent. That 35 percent rate does not include state income taxes. In Virginia, for instance, the top income tax rate is 6 percent. In some US states the top rate is even higher than that. In some others it is lower. Click here for a link to one such source reporting that Brazil's top tax rate is 27.5 percent:

Following Secretary Clinton's logic, perhaps we should be cutting income taxes on "the rich," not increasing them.

2. How is it, one might ask, that Brazil nonetheless maintains such a high tax to GDP ratio? The short answer is "payroll taxes." In Brazil employers pay payroll taxes of just over 37 percent of wages, and employees pay between 7.65 percent and 11 percent, depending upon their income. (Note, however, that the employee payment is capped, thereby reducing the amount of such taxes that the rich would otherwise pay.) I doubt Secretary Clinton would advocate the imposition of such payroll taxes here. Taxing payrolls is a great way to kill job creation during a weak recovery, assuming we are in a recovery.

3. Income inquality in Brazil is more pronounced than it is in the United States, despite (or perhaps because of) Brazil's high tax burden. The conventional method for measuring income inequality is called the "Gini coefficient." A Gini coefficient of 1.0 represents a society in which one individual receives all of society's income, while a Gini coefficient of zero represents a society in which each individual receives exactly the same income. According to the CIA, Brazil's coefficient is 56.7, while the USA's is 45. Apparently Brazil's high tax burden has not produced the sort of income equality for which progressives yearn. (Though perhaps the nation's inequality would be even MORE pronounced without such a high tax burden?)

4. It's not entirely clear that Brazil IS growing like gangbusters. According to one source, Brazil's GDP grew less than 2 percent annually in the 2007-2009 time frame and grew just 2 percent in the first quarter of this year --- less than the United States. Hat tip to the American Thinker for this citation on Brazil's growth.

In any event, whatever its growth rate, Brazil's per capita GDP is less than one fourth that of the United States. It stands to reason that nations with relatively low per capita GDPs can grow more quickly than those with higher per capita GDPs, simply because such nations employ production processes that are less capital-intensive (both in terms of human and physical capital) than wealthier countries, with the result that the incremental return on invested capital is higher than it would be in wealthier nations. Brazil's purported growth may simply reflect this economic truism.
5. The State Department, it should be noted, attributes a portion of Brazil's recent growth to an aggressive privatization campaign, including the privatization of highways. According to the Department:

"Government-initiated privatization after 1996 triggered a flood of investors in the telecom, energy, and transportation sectors. Privatization in the transportation sector has been particularly active over the last 20 years. Many antiquated and burdensome state management structures that operated in the sector have been dismantled, though some of them still exist. The Brazilian railroad industry has been privatized through concession contracts ranging from 30 to 60 years, and the ports sector is experiencing similar, albeit less expansive, privatization. In response to the dramatic deterioration in the national highway system, the federal government has granted concessions for existing highways to private companies, which in turn promise to restore, maintain, and expand these highways in exchange for toll revenues generated. New opportunities are expected to arise with the opening of the Brazilian civil airports to private management and investment through a federal concession model, but the initiative faces obstacles due to questions surrounding sovereignty and opposition from airport unions. The United States and Brazil signed an Air Services Liberalization Agreement in 2008 that significantly expanded air services between the two countries."

Perhaps the Obama administration will take these conclusions to heart and advocate privatization of various state-owned enterprises, such as schools and the automobile industry!

6. Secretary Clinton did not explain why she selected Brazil as her analogy. There are other countries that have grown faster in recent years. Ireland is a case in point. Between 1994 and 2004, the "Celtic Tiger" grew by an average of 8 percent annually, compared to growth rates in the U.S. of less than 4 percent. (Growth in the E.U. was even lower than that in the U.S. during this period. Here is a chart summarizing Irish growth rates during this and previous periods.

Many, including Irish officials, attribute Ireland's rapid growth in part to its very low corporate tax rate of 12.5. (By contrast, the corporate tax rates in the United States and Brazil exceed 30 percent.) Perhaps in the future Secretary Clinton will make some off-the-cuff remarks calling for a drastic reduction in the U.S. corporate tax rate.

7. Finally, it should be noted that inter-country comparisons of ratios between taxes and GDP receipts are hazardous for several reasons, two of which I'd like to highlight here. First, high taxes can induce some firms and individuals to conduct economic activities "off the books," and such activities may not be captured when countries measure their GDPs. If so, then the tax to GDP ratio in some admittedly high tax countries may be lower than it initially appears. Second, the optimal tax to GDP ratio may vary depending on a nation's state of economic development. For instance, the per capita cost of certain governmental services may rise more slowly than a nation's per capita GDP. It should not, for instance, cost the USA four times more per person than Brazil to teach elementary school students to read and write or to provide safe streets and sanitation. Other things being equal, then, we might expect the tax to GDP ratio to fall as a country's per capita income rises. If so, then the tax to GDP ratio of a relatively low income nation, such as Brazil, even one that is growing quickly, may not be a useful benchmark for a high income nation such as the United States.