For more than two decades tax debates have been muddied by a serious conceptual flaw which mistakenly holds that revenues raised and the real tax burden are one and the same. They are not. Tax revenues and taxes as a share of GDP are generally understatements of a nation’s true tax burden.

Al Hunt, in a 1993 Wall Street Journal essay, claimed that American taxpayers have it easy. Using 1991 data from the Organization for Economic Cooperation and Development (OECD), he ranked the tax burden of seven industrialized democracies. From highest to lowest, they were: France, Germany, Canada, United Kingdom, Japan, U.S. and Australia. Hunt concluded that Americans—next to last in his listing—were not overtaxed. Using the same OECD data, David Broder reached the identical conclusion in an April, 1995, Washington Post article, reporting that in the U.S. only “29.9 percent of the GDP was siphoned off in taxes,” a much lower figure than in Japan and a cause for joy rather than complaint. Similarly, an Investor’s Business Daily editorial last February provided a bar graph depicting the alleged ‘total U.S. tax burden,’ utilizing taxes as a share of GDP.  Finally, the Tax Foundation annually publishes what it calls 'tax freedom day,' "the day when America earns enough to pay taxes and starts working for itself each year."  Using this same standard methodology, their 2006 Tax Watch maintained that in "2006 Americans will work a total of 116 days to pay taxes--77 days for federal and 39 days for state and local.”

When a government spends more than it receives in tax revenue, the total diversion of resources from private purposes to public ones can far exceed the tax rate.

But if seeing the Journal and the Post agree makes you suspicious, then you are on to something. When a government spends more than it receives in tax revenue, the total diversion of resources from private purposes to public ones can far exceed the tax rate. Government grabs portions of the economic pie by its spending, which diverts resources away from alternate uses. That is the nature of the taxing (levying) process—more “pie” to the government and less for private individuals. It is via spending that Uncle Sam, like Pac Man, gobbles up chunks of the pie. While higher tax rates or increased borrowing are tools used to finance this process, it is via spending, not tax receipts, that government garners resources. Hence, spending is the real tax.

Under a strict balanced-budget rule, the size of the government’s true bite—spending—is matched by an equivalent amount in taxes. Here it matters little which indicator—spending or taxes—is used, since the values would by mandate be the same. For example, Germany’s tax collections in 1991 were 44.9 percent of GDP, while government spending was 44.6 percent. Such rough balance, however, is neither the contemporary nor the historical norm.

In a world of massive deficit financing, the OECD’s “revenue view of tax burdens” fogs realities and inevitably leads to inappropriate policies. Consider fiscal year 1992: U.S. federal spending was $1.38 trillion; tax receipts were only $1.09 trillion, with borrowing covering the $290.4 billion difference. The widely used ‘revenue approach’ ignored over $290 billion of government influence over our economy!

Had Hunt and Broder arrayed their 1990s data on the basis of real taxes—that is, government spending as a share of GDP—a very different picture would appear. Canada, in third place behind France and Germany, would move to the uncontested number one taxer, grabbing 48.1 percent of the GDP. The United States remained next to last, but had 34.6 percent in real taxes, almost five points higher than Broder’s claim. His measure was tantamount to ignoring the entire defense budget! Australia, which previously appeared to be the lowest taxer, actually took 34.8 percent of GDP, just above the U.S. Japan, alleged by both Hunt and Broder to be a higher taxer than the U.S., fell to last place by far, claiming a mere 26.2 percent of GDP!

Under a strict balanced-budget rule, the size of the government’s true bite—spending—is matched by an equivalent amount in taxes.

Contemporary data tell the same story, as the table demonstrates. While the 2005 tax receipts share of America’s GDP was only 26.8%, the real take (31.7%) was almost 5 percentage points higher, once again larger than the resources absorbed by defense outlays. However, there is some good news—real taxes in 2005 ran at a lower rate than the 34.6% of 1992. Without question the greatest distortion appears in Japanese figures. Japan’s 2005 taxes garnered less than 17% of the GDP, implying low taxes, but its spending took almost double that figure, about the same as the real burden in the U.S. By 2005 Canada’s real taxes had fallen to 41.2% of GDP, but still absorbed 6.7% more of the Canadian pie than the revenue/GDP measure indicated. And Germany’s large 2005 budget deficit resulted in a real take almost nine percentage points higher than the tax/GDP ratio indicated. Finally, France remained the highest taxer under both measures, with real taxes grabbing almost 51% of its 2005 GDP, while its tax revenues—a whopping 44.3 percent—were still significantly below the true gobble.

A crystal clear conclusion emerges—public spending is the true tax. And assessments of tax burdens—either domestic or international comparisons—which only reflect revenue-raising efforts mask a substantial portion of the real tax picture. The Tax Foundation placed its Tax Freedom Day for 2006 as April 26, but its omission of a near $250 billion federal deficit underestimated that date by more than a week!

This logic, of course, does not suggest that governments should neither provide for the common defense nor promote the general welfare. Nor does it judge how well governments use the resources they garner, which is largely an empirical question. But it definitely provides a much more accurate accounting of government levies.

A second conclusion is critical. There is only one path to real tax reduction—curb government spending. Cutting tax rates has a very appealing sound, and it is certainly true that properly tailored rate reductions have improved both production and public revenues. Nonetheless, crowing about lower tax rates when deficit spending is rampant is both misleading and distorting. Only by reducing or constraining the growth of Uncle Sam’s claims (spending) can real tax reduction proceed. Washington and the American public must get this message, and the sooner, the better!

          TAXES AND GOVERNMENT SPENDING AS SHARE OF GDP

                                                                      2005

                              Revenue Measure  Real Tax

                             T/GDP                 G/GDP           G/GDP –T/GDP    

                               %                           %            % Point Difference

Japan                  16.8                     31.0                    13.2

U.S.                      26.8                     31.7                    4.9

Canada               33.5                     41.2                    6.7

Germany             34.7                     43.4                    8.7

United Kingdom 37.1                     41.9                    4.8

France                 44.3                     50.9                    6.6

 Figures from: OECD in Figures 2006-2007

Donald Losman teaches economics at the Industrial College of the Armed Forces in Washington, D.C.  The views expressed are his own.

Image credit: Photo by Flickr user chadmill