More Efficient Tax Systems Lead to Bigger Government

Taxpayers offer less resistance to increases in flat tax rates than in rates of more onerous and less efficient forms of taxation.

In addition to putting hours into record keeping and completing their tax returns, most people spend their incomes and assets in ways that would make little economic sense with a simpler tax structure. Complaints about the complexity and inefficiency of the federal tax code explain the support for a simpler, flatter, and broader tax, such as a proportional tax on consumption, or a fixed percentage tax on incomes above a given level. Unlike an income tax, a consumption tax does not double tax savings, while a relatively low flat income or consumption tax rate does not have the same distorting effects on hours worked and other decisions of the marginal income tax rates of 40 percent and higher in the current American tax system.

However, these advantages alone do not make the case for tax reforms because of the failure to consider their effects on government spending, according to a recent NBER Working Paper by Gary Becker and Casey Mulligan. In Deadweight Costs and the Size of Government (NBER Working Paper Number No. 6789) , they conclude that flatter and broader taxes also tend to encourage bigger government because taxpayers offer less resistance to increases in flat tax rates than in rates of more onerous and less efficient forms of taxation. Any decline in the resistance of taxpayers leads to larger government budgets since an endless number of groups agitate for greater government support.

Flat tax rates, such as the VAT and Social Security taxes on earnings, usually start at very low levels but invariably increase over time. The VAT is now 20 percent and higher in some countries. And payroll taxes began at a modest 2 percent in the 1930s in the United States, but have been increased 21 times to the present 15 percent combined rate on employees and employers. Social security taxes are even higher in some European and Latin American countries. As a result of such increases, countries that receive a larger fraction of their tax revenue from flat taxes tend to have considerably bigger governments. More generally, there is a close link observed by the authors between the ease of collecting tax revenue and the amount of government spending. For example, governments in oil producing nations tend to spend a lot more when the world price of oil is much higher.

In the past, economists have obscured major issues of political economy by neglecting the impact of tax reforms on government spending. Without effective controls over spending, a broader, flatter, and simpler income tax system may only transfer taxpayer pain from complexity and tax inefficiency to larger tax bills and bigger government budgets, the authors conclude.