Explaining Effective Tax Rates

At the 100 Days panel discussion last night there were a number of issues raised that deserve further discussion, if only to explain how wrongheaded some of the assertions made were. However, one exchange I thought was interesting enough to return to it here. While responding to a question about the oppressive taxes in this country from a College Republican in the audience, I referred to the fact that we actually have some of the lowest effective tax rates in the developed world. Hardly exciting stuff, but the interesting thing was the response that invoked. A number of students from the College Republicans and the Student Liberty Front (think Ron Paul...) reacted immediately as though I misspoke or made an obvious error. To them it was obvious that we have oppressively high taxes.

They were confused, however, about nominal tax rates and effective tax rates. Behold, the data.

Anyone who has taken any economics understands the difference between nominal and effective rates. It's a distinction that's crucially important when discussing interest rates, for example. Nominal tax rates are the marginal rates levied, the numbers actually specified by statute. Effective tax rates, however, are what companies actually pay. The difference, of course, is that large corporations, as is their prerogative, spend a fair deal of effort lowering their actual tax liabilities through loopholes and tax shelters. While nominal marginal rates can certainly affect business decisions, effective tax rates are more relevant to a discussion of the effect of taxes on the economy, and for anyone claiming oppressive taxation.

This was actually relevant back during the campaign. John McCain praised Ireland as a model of low tax growth, but while the US has a corporate top marginal rate of 35% and Ireland's is only 12.5%, Ireland raises corporate tax revenue equal to 4% of GDP, while the United States raises only only 2% of GDP. Ireland has fewer loopholes and thus levies their taxes on a broader base.

I'm sure many liberals would be happy to trade lower nominal rates for a broader push at corporate tax reform to prevent sheltering, and lobbyist driven loopholes. Just ask Matt.

Relatedly, I would recommend this Bruce Bartlett column regarding effective tax rates on Americans, summarized in this handy chart.I think that the reflexive opposition to the fact that US tax rates aren't actually all that "oppressive" was an interesting insight into the mentality of some of the student groups here at Drexel.