Americans have had a testy relationship with taxes since before there were even Americans. Unhappiness with what was rightly perceived as unfair taxation 240 years ago led a group of colonials to throw crates of imported tea into Boston harbor in December 1773 instead of paying duty (a form of tax) on it. The Boston Tea Party, as it was dubbed, was one of the triggers of the Revolutionary War that eventually drove out the British and resulted in the birth of the United States of America.
Today, Americans continue their hate/hate relationship with taxes, especially those imposed by the federal government. Residents of Washington, D.C., have a particularly strong gripe with taxes: They pay income tax to the federal government but don’t have a vote in Congress. President Barack Obama’s limousine and other presidential vehicles have been sporting license plates with D.C.’s protest slogan, “Taxation without Representation,” since January in a show of support for the U.S. capital, where, after all, Obama has lived for four years now. The slogan is taken from a phrase attributed to colonist James Otis in the 1700s: “Taxation without representation is tyranny.”
At this time of year, even Americans who never catch a glimpse of a D.C. license plate have their heads full of taxes because the country is smack-dab in the middle of tax season. In the United States, filling out an income tax return is a process mired in a level of convolution and complexity that is probably unparalleled anywhere else. The U.S. tax code is so complex that even the Internal Revenue Service (IRS) commissioner gets someone else to prepare his taxes for him. But, then again, he has other things to do — including, maybe, simplifying the tax code.
Cracking the Code
Both Republicans and Democrats on Capitol Hill have talked a lot recently about simplifying America’s tax code to stimulate business and bring in revenue. But talk is one thing — getting down to the nitty-gritty of taking away tax perks that benefit huge corporations and average citizens alike is quite another.
In fact, Congress has made nearly 5,000 changes to the tax code since 2001, an average of more than one a day. The total number of words is approaching a staggering 4 million, and the tax code is around 16,000 pages long. Add IRS rulings to it, and it’s more than 70,000 pages long. That’s an increase of 16,000 pages since 2003 and of 69,600 since 1913, when the U.S. tax code comprised a slim 400 pages all together.
In comparison, the British tax code was around 18,000 pages long for 2010 to 2011, but “if non-statutory material and duplicated and repealed legislation were excluded there would be 5,430 pages,” Andrew Goodall, news editor of the Tax Journal, wrote last year. To their credit, in 2010 the British created an Office of Tax Simplification, which is tasked with “simplifying the UK tax system, with the objective of reducing compliance burdens on both businesses and individual taxpayers.”
France, too, pales in comparison to America’s voluminous tax code. A copy of the 2012 edition of the French “Code général des impôts” was available on Amazon for 1.99 euro — all 4,200 pages of it. The French tax code next to the American one is like putting a short story next to “War and Peace.”
Because of the complexity of the U.S. tax code, individual American taxpayers and businesses spend an estimated 6.1 billion hours a year doing their taxes, according to a 2012 report to Congress by National Taxpayer Advocate Nina Olson.
“It obscures comprehension, leaving many taxpayers unaware how their taxes are computed and what rate of tax they pay; it facilitates tax avoidance by enabling sophisticated taxpayers to reduce their tax liabilities and provides criminals with opportunities to commit tax fraud; and it undermines trust in the system by creating an impression that many taxpayers are not compliant, thereby reducing the incentives that honest taxpayers feel to comply,” Olson said in the report.
Cheating the System?
The labyrinth of exemptions, deductions, credits and plain-old loopholes buried within the tax code also breeds resentment among taxpayers — mostly between the rich and everyone else (though middle-class taxpayers also complain that the poor pay little to no taxes). Who pays what became a hot-button issue in the recent presidential election, as Barack Obama sought to paint his Republican challenger Mitt Romney as a corporate raider who sheltered his wealth in overseas tax havens while profiting at home from loopholes to pay a lower rate than middle-class Americans.
In 2011, Romney paid an effective tax rate of 14 percent on the $13.7 million he made that year (Obama’s was about 24 percent). Most of Romney’s income was from investments, which accounts for the lower tax rate because capital gains and dividends are taxed significantly less than earned income — thanks in part to the Bush tax cuts. In 2003, Congress set the top tax rates for both capital gains and dividends at 15 percent, lower than they had been since the 1930s.
Billionaire investor Warren Buffett notably stood with Obama that those lower rates do not encourage greater investment but, rather, have led to yawning income disparities (he famously pointed out that he pays a lower tax rate than his secretary does).
“Between 1951 and 1954, when the capital gains rate was 25 percent and marginal rates on dividends reached 91 percent in extreme cases, I sold securities and did pretty well,” Buffett wrote in a New York Times op-ed. “Under those burdensome rates, moreover, both employment and the gross domestic product (a measure of the nation’s economic output) increased at a rapid clip. The middle class and the rich alike gained ground.”
Today, however, Warren pointed out that the fortunes of the super-wealthy have skyrocketed — Forbes estimates the wealthiest Americans made $1.7 trillion in 2012, compared to $300 billion in 1992 — yet their tax bills have steadily shrunk.
Obama’s populist attack that the wealthy need to pay their fair share of taxes clearly struck a nerve. He won the election, after all, and used his renewed mandate to push through a “fiscal-cliff” deal in early 2013 that raised tax rates for families with incomes above $450,000 and individuals above $400,000 back to Clinton-era rates of 39.6 percent rate, up from 35 percent. It also raised taxes on capital gains and dividends to 20 percent for those same income levels.
But any debate on who should pay more in taxes comes with numerous caveats. While it’s true the wealthy are paying less in taxes than they would have a few decades ago (and the top 1 percent is worth more collectively than the country’s entire bottom 90 percent), the richest Americans still pay the most taxes because of their higher incomes. According to Forbes, the top 5 percent of the U.S. population paid 61 percent of all income taxes, and 44.3 percent of all taxes.
On the flip side, about half of all Americans don’t pay any federal income tax whatsoever because between what they earn and standard deductions and credits, their liability comes out to about zero. Some even get money back from the government. This rankles many conservatives, but it’s important to remember that low-income Americans still pay taxes — state sales taxes, payroll taxes, local taxes, etc.
Most taxpayers, of course, fall somewhere in between the very poor and very rich. And because the Bush tax cuts remained in place for the majority of Americans, many are paying less in taxes today than they did in the 1990s. In fact, according to a New York Times analysis that took into account not only federal income taxes but also state and local taxes, “Tax rates at most income levels were lower in 2010 than at any point during the 1980s.”
You certainly might not know that though from all the griping that inevitably arises around tax time.
Taxes Around the World
Indeed, many Americans feel they pay too many taxes, but how much do they really pay compared to the rest of the world? Statistics compiled by global audit, tax and advisory company KPMG put the United States, where the effective income tax rate on incomes of $100,000 is 18.7 percent, in 55th place out of 94 countries. Employee social security contributions in the United States at that income level are around 7 percent, bringing the total to around 26 percent.
At the high end of the scale at this pay bracket in the Organization for Economic Cooperation and Development (OECD) are the Danes, with a 42.1 percent effective income tax rate, and the Swedes, who pay 36.3 percent. Employees in Sweden pay no social security taxes while their employers pay around 31 percent, and in Denmark both the employer and employee pay less than half of 1 percent each.
Put more simply, KPMG also compiled a list of the highest rates of personal income tax around the world. For 2012, the U.S. rate was 35 percent, hewing close to the world average of nearly 29 percent. In comparison, Aruba’s tax rate was 59 percent; the United Kingdom came in at 50 percent; Canada at 48 percent; South Africa was 40 percent; Mexico was 30 percent; Panama, Latvia and Egypt all came in at 25 percent; Angola 17 percent; Yemen 15 percent; Russia 13 percent; Albania 10 percent; and Kuwait, Qatar and the UAE all had a tax rate of 0 percent (it’s nice to have oil and gas money).
Again, comparing overall averages, the Nordic nations tend to come out on top. Sweden’s effective income tax rate is 56.6 percent, according to KPMG, while Denmark’s is 55.4 percent.
Get What You Pay For?
But do Danes complain about their high tax rates? Are they unhappy? Nope.
Denmark was ranked as the happiest place on earth by researchers at the University of Leicester in England, who in 2006 put together a happiness map. (Similar surveys also consistently rank the Nordic countries at the top of indicators such as happiness, life satisfaction and best nation in which to be born.)
The British researchers found that happiness was most closely associated with health, followed by wealth and education. “When people are asked if they are happy with their lives, people in countries with good health care, a higher GDP per capita, and access to education were much more likely to report being happy,” they found.
Danes’ health care and retirement contributions come from their taxes, with the highest earners paying a rate of about 55 percent. In 2009, per-capita spending on health in Denmark was $4,464, the vast majority of which was covered by Danes’ taxes. Everyone is covered for doctor’s visits, hospitalization and most medical procedures, routine or emergency. While the cost per person might seem high, it is around half the per-capita expenditure on health in the United States — and nearly 50 million Americans have no health insurance at all. Life expectancy in Denmark was 79.1 years, or one year longer than in the United States. And last year, Denmark shot into the Melbourne Mercer Global Pension Index, which ranks countries’ retirement systems, at number one, becoming the first country ever to get an “A” in the rankings.
“Denmark’s unique ‘A’ grade ranking has been awarded in recognition of the country’s well-funded pension system, its high level of assets and contributions, the provision of adequate benefits and a private pension system with well-developed regulations,” Mercer says on its website.
Like its Nordic neighbors, Denmark’s social safety net has been credited with helping it weather economic turbulence. A direct comparison with the United States is difficult because each nation’s economic circumstances are unique, but the Northern European nations share several key economic traits: a strong welfare state that cushions consumers in an economic downturn; trust in the government to fairly and efficiently distribute tax revenues for the betterment of society; an emphasis on high-skill, high-wage jobs; and increasing government spending during harsh times, while adopting austerity measures during boom times.
Today, Denmark’s economy is strong and stable. Unemployment is around 6 percent, and the budget deficit is hovering around 4 percent of GDP but expected to drop to 2 percent. Reuters news agency reported that tax revenues on accumulated pension wealth were helping to cut Denmark’s budget deficit.
The United States, meanwhile, was ninth out of 18 in the Mercer pension ranking and got a grade of “C.” To improve its ranking, it was given a list of half a dozen steps to take, including increasing mandatory contributions to pension programs. More than 22 percent of Americans age 65 and older live in poverty; in Denmark, only 10 percent do. The U.S. rate of elderly citizens living in poverty — defined by the OECD as living with incomes less than 50 percent of median household disposable income — was almost the same as the rates in Greece and Spain, both hard hit by Europe’s financial crisis.
Deeply Rooted Tax Distrust
But getting American lawmakers to agree to increased pension contributions is highly unlikely. The country was built on a wariness of government and a reluctance to pay taxes because, as mentioned earlier, before Americans were Americans, they weren’t getting anything for their tax dollars. It’s tough convincing them now that they should pay more while they’re working in order to have a more comfortable life when they no longer have to work.
“Historically, the United States has been low-tax for a reason: There’s more distrust of government and skepticism about what government can do with people’s money,” William McBride, chief economist at the Tax Foundation in Washington, D.C., told The Washington Diplomat. “People are much less excited in the United States about what they get for their tax dollar” than their European counterparts are.
Income tax is “the biggest source of revenue for the federal government, raising about $1 trillion a year,” McBride noted. In most OECD countries, value-added tax, or VAT, is the largest source of revenue. The United States also has the highest corporate tax rate in the OECD, making for what McBride called “the most inefficient system in the OECD.”
Several steps could be taken to improve the U.S. tax system, including broadening the number of people who pay taxes to begin with. This includes people at both the bottom and top ends of the tax spectrum. Many low-income Americans pay no federal income tax, “but because it’s such a complicated system, there are a couple of thousand millionaires who pay no income tax,” McBride pointed out.
A complicated system also naturally leads to confusion. University of New Mexico economics professor Kate Krause said in a report published in the Public Finance Review that, “When laws are complex or ambiguous, compliance and enforcement suffer. In the United States, the federal income tax is a familiar example of this. Often, neither the taxpayer nor the Internal Revenue Service (IRS) can perfectly determine a taxpayer’s true tax liability.”
Which is why McBride suggests that Washington follow in the footsteps of its old colonial ruler (although he didn’t put it that way) and take steps to simplify the tax system.
“We need to move toward a simpler, more transparent system so taxpayers have some idea what is happening to them,” McBride said.
“Right now most taxpayers are simply confused by the whole process. They don’t know if their taxes are going up or down because we have an extremely byzantine tax system.”
About the Author
Karin Zeitvogel is a contributing writer for The Washington Diplomat.