What Taxes are for

I’ve already discussed how the American tax system can be made more progressive. But my post was mostly about taking the current system and tweaking it to ensure that people don’t have to pay taxes on below-poverty income. It’s more instructive to work from the ground up, looking at what government spending is necessary to sustain a modern society.

In 2001, the Congressional Budget Office projected revenues and spending 74 years into the future, coming out with a bleak picture of a US consumed first by spiraling Medicare costs and then by the deficits. In fact, five years later, it’s already too optimistic, largely because it projected a surplus through 2025 and constant tax revenues as a percentage of GDP from 2001 onward, both of which are now pipedreams thanks to Bush’s fiscal irresponsibility.

The CBO suggests a social security spending constant at 6%, health care spending rising to 15% of GDP (plus private and state expenditure), and other spending constant at 7%. GPO Access breaks down 2005 as 4.3% military, 1.7% interest, 6.9% Medicare and Social Security, 5.2% “other payments to individuals” (mostly Medicaid, I presume), 2.2% “other federal,” and 11.1% state/local. Wikipedia says Medicaid also hogs a quarter of state expenditure, i.e. 2.5%. Another 4.5%, almost entirely state/local, goes to primary and secondary education.

Now, let’s try reorganizing this, in a way that makes more sense. The US doesn’t need to spend a dollar more in education; its per-student spending is higher than this of many countries that get better results. What it needs is to equalize funding, which means pushing the level of spending up from local to state and from state to federal.

On health care, a single-payer system can provide health coverage to the entire population for about $2,000 per person per year, which works out to about 5% of the USA’s GDP; there needs to be some additional private spending of about 1-2%, but that doesn’t fall under taxation.

A good comparison would be to the British budget, which is convenient to use because the UK isn’t federal. In Britain, the projected 2006 GDP is £1.3 trillion, so the £550 billion budget is 42% of GDP (in the US, in contrast, it’s 31.4%); note, however, that it includes tax expenditures, which the US budget doesn’t. The most glaring difference is of course the 11.5% social protection part in the UK; in the US social security is about 4-5%, and welfare is about 1-2%.

In fact, since Britain’s cost-of-living-adjusted GDP per capita lags 20% behind the USA’s, per capita government spending is almost the same. But in fact, Thatcher broke the British welfare system to the same degree Reagan and Clinton broke the USA’s, so let’s fix social spending in the US at 10% of GDP, not including tax breaks, and counting the fact that the USA has the youngest population in the first world.

So we have 10% on welfare, which includes social security, and 5% on health care. This compares with the current situation of 5% on social security, 7% on health care, and 2% on other welfare programs (note: the link later asserts a causal link between Clinton’s welfare reform and the reduction in poverty in the 1990s; for refutation of that link, look at this chart of US poverty rates).

The US spends about 4.5% on primary and secondary education. For tertiary spending, the best way to go, I think, would be to look at a program that offers every American free education at a public college for 4 years; at 15 million people in the age cohorts times 40% who go to college times $4,000-something average tuition per year, the cost of this is $24 billion a year, which is negligible in this context. Even with room and board, or with minor increases in overall funding, this doesn’t break 5% of American GDP.

It will only break 6% with a massive infusion of money into primary and secondary education, possibly stemming from merely supplanting local education funding with a minimum per-student level to help poor districts, as opposed to nationalizing funding.

So far, we have 20% of GDP. Paying interest on the debt is another 2% or so; any defense spending beyond 2% a year is indefensible in a country whose enemy is a terrorist group, which needs to be fought with intelligence and policing; and let’s say 6% more is constant miscellaneous spending (it’s 6% in the US and, after adjusting for different GDPs, 8% in Britain; but this includes corporate welfare, which in the US appears to be 1.5% of GDP). That gives 30% of GDP that needs to be raised in taxes.

9 Responses to What Taxes are for

  1. SLC says:

    1. Back in the 90’s, Steve Forbes proposed a flat tax plan which is acutally more progressive then the existing system. His plan was a 20% flat tax with no deductions and a $7500 personel and dependent exemption. Thus, a family of 4 with an income of $30,000 would pay no tax at all. A family of 4 with an income of $100,000 would pay $14,000 in taxes, a rate of 14%. The problem with it was that it would raise less money then the system that existed at the time, mostly due to his proposal to eliminate the capital gains tax. Including a 10% capital gains tax would make up most of the difference (it would probably raise more money then the current system, due to the tax reductions inacted under the Bush administration). This would obviously be a very simple system and put tax lawyers, tax accountants, and Turbotax out of business. It would also cut down on the overhead at the IRS which is currently required to audit tax returns. Naturally, of course it never stood a chance.

    2. The estimate of 2% for defense assumes that China will never become a threat. That is a very optimistic assumption, one that I wouldn’t want to bet the ranch on. The main reason why the current system is so expensive is due to the armed forces being entirely voluntary. This requires that salaries paid to armed forces personnel be at least competitive with prevailing rates in the civilian government and private industry (they probably ought to exceed those rates because serving in the armed forces is a dangerous occupation). The percentage of military spending on personnel was much lower before the draft was eliminated (I am not advocating returning to the draft; the conscripted armed force was much inferior to the current one).

  2. Alon Levy says:

    1. Well, that makes sense, though I’m not sure a flat personal exemption is a good thing. A family of four doesn’t have four times the expenditure of an individual. Adding a capital gains tax and a corporate/dividend tax to the equation makes sense, but I’m not sure how much money it can raise.

    2. You’re of course absolutely right about China, and I considered including that in the post. If there erupts a new cold war between the US and China, American military spending will have to go up. On the other hand, on most things, it’s likely such a confrontation will be more economic and diplomatic than military. As it stands right now, there’s only one potential military conflict, Taiwan. Right now China bills itself as a kinder, gentler power that doesn’t invade random countries and is nothing to fear, but it’ll probably scrap that image by 2020.

  3. SLC says:

    1. A conflict over Taiwan is not the only potential flash point with China. Other possibilities include Vietnam and India, over which China has had military conforntations in the past. At this time, what I think is needed is a reallocation of resources, with less allocated to strategic bombers and missiles and more to the army and marine corps. If China develops as a threat, as I believe it will, we may have to take a hard look at naval forces also, particularly as China is expanding its navy at a rapid pace. If China is content to foment trouble in its immediate area, it doesn’t need aircraft carriers which are by far the biggest naval ticket item. Unfortunately, if this occurs, we will probably need a larger carrier force then the 12 currently active.

    2. I think that Forbes assumed that interest and dividends would also be included in income (there might be a certain base amount exempt from taxes, as is now the case with dividends). The main conflict was his proposal to eliminate the capital gains tax. I don’t recall what he proposed relative to the corporate tax, although given his conservative pro-business views, he probably proposed eliminating that also.

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