The United States is a low-tax country compared to its European allies, especially for lower-income and middle-income workers. Keeping taxes low should be a primary goal of lawmakers. However, low taxes are not sustainable if America continues to move toward a European-style social welfare system.
Paying for the currently projected government spending will require large tax increases on all Americans. Paying for new entitlement programs, such as Medicare for All, free college, a national job guarantee, or paid family and medical leave, will require yet higher taxes.
It is mathematically impossible to pay for large new spending programs with tax increases only on high-income Americans. Under an expanded government welfare system, middle-class Americans should expect their taxes to increase dramatically. In Europe, single workers making $40,000 are left with $22,467 of personal income after taxes. In the United States, the same worker would have almost $6,000 more, or $28,352, in useable income after taxes. Europe provides an illustrative example of how countries pay for big government in practice.
Taxing Like the Europeans
On average, about 37 percent of all economic activity is taxed by the governments of the 23 countries that are members of the European Union as well as of the Organization for Economic Co-operation and Development (EU–OECD). In the U.S., taxes consume 27 percent of economic output (gross domestic product (GDP)). Taxes on wages (individual income and payroll taxes) make up the largest share of revenue in every EU–OECD country and the United States.
Value added taxes (VATs) comprise the second-largest portion of most countries’ tax revenue. The United States is the only country in the OECD that does not use a VAT to raise a majority of consumption tax revenue. Instead, most consumption-tax revenue in the U.S. is collected by state governments through a sales tax at the point of sale. The average EU–OECD standard VAT rate was 21.8 percent in 2016. The average state and local sales tax rate across the U.S. states and the District of Columbia was 6.4 percent in the same year.
Expansive government services and government-run health care exist in most European countries. If Congress is unwilling to reduce the growth rate of spending, and American voters continue to demand European-style government services, American taxpayers should be ready to pay European-style taxes. European welfare states do not rely on overly progressive tax systems. Instead, they use broad-based taxes like the VAT, high payroll taxes, and relatively flat income taxes, which fall heavily on taxpayers in the middle of the income distribution.
High Taxes on Low-Wage Workers
Single workers with no children in EU–OECD countries earning two-thirds (67 percent) of the average wage face average tax rates of 43.8 percent. The same worker in the U.S. pays an average effective tax rate of 28.5 percent.
The tax burden is made up of four main components: (1) income taxes, (2) employee payroll taxes, (3) employer payroll taxes, and (4) VATs/sales taxes. Income taxes and employee payroll taxes are paid directly out of workers’ wages. The employer payroll tax is legally paid by the business, but the economic cost of the tax is paid by the worker in the form of lower wages. Similarly, the VAT is paid by businesses, but the long-run cost falls on workers through lower wages and higher prices.
In the U.S., a single worker earning two-thirds the average wage would be paid about $40,000 in the absence of any taxes in 2018. That worker pays $5,056 in income taxes, $5,968 in payroll taxes, and $623 in sales taxes, leaving her with $28,352 of personal income—71.5 percent of her total earnings. A similar worker in the EU–OECD pays $3,884 in income taxes, $11,344 in payroll taxes, and $2,306 in VAT, leaving her with $22,467—56.2 percent of her total earnings. (See Chart 1.)
In Belgium and Germany, low-wage workers pay average tax rates of 50.6 percent and 50.2 percent, respectively. More than half of every dollar earned by someone making around $40,000 in these high-tax countries is taxed away.
Across the EU–OECD, marginal taxes on low-wage workers are even higher, representing how much tax a worker must pay on the next dollar of income earned. High marginal taxes reduce the incentive to take a side job or work as hard to get a raise or promotion. In the United States, a single person earning two-thirds the average wage faced a marginal tax of 32 percent in 2018, lower than in any EU–OECD country. In eight countries, marginal taxes are above 50 percent for the same low-wage worker. In France and Belgium, marginal rates on below-average incomes are 70 percent and 68 percent, respectively.
High Taxes on Upper-Middle-Class Workers
Single workers with no children in EU–OECD countries earning 167 percent of the average wage face an average effective tax rate of 51.7 percent. The same workers in the U.S. pay an average effective tax rate of 34.1 percent.
In the U.S., a single worker earning 167 percent of the average wage would be paid about $100,000 in the absence of any taxes in 2018. That worker pays $19,579 in income taxes, $14,498 in payroll taxes, and $1,418 in sales tax, leaving her with $64,504 of personal income, 65.9 percent of her total earnings. A similar worker in the EU–OECD pays $18,797 in income taxes, $27,955 in payroll taxes, and $4,956 in VATs, leaving her with $48,292, 48.3 percent of her total earnings. (See Chart 2.)
In Belgium and Germany, upper-middle-class workers pay average tax rates of 62.4 percent and 55.6 percent, respectively. Well more than half of every dollar earned by someone making $100,000 a year in these high-tax countries is taxed away.
Workers earning above the average wage pay even higher marginal taxes, topping 50 percent in 13 of the 23 EU–OECD countries. The United States had the second-lowest marginal wage tax of 41 percent, behind Poland (37 percent) in 2018. Three countries have marginal taxes above 60 percent, and Sweden’s top rate is just shy of 70 percent for workers earning 167 percent of the average wage.
As is clear when looking at the European fiscal model, large welfare states cannot be sustained by primarily taxing any narrow segment of the population. Everyone must pay for big government. The cost of high taxes is more than the direct costs; all taxes have economic costs, even if they are turned into widely available benefit programs. Across Europe, for example, workers work fewer hours, spend more time on vacation, and are less entrepreneurial. Even those people who want to work or earn more are discouraged because high average and marginal taxes directly undercut any personal benefit from more effort.
The European welfare state, financed by high taxes, is not inevitable in the United States. Americans still have a choice. To secure a future where taxes can stay relatively low, Congress must:
- Reform the largest drivers of future deficits—Medicare, Medicaid, Obamacare, and Social Security. The Heritage Foundation’s 2020 Blueprint for Balance presents one road map to balancing the budget without raising taxes by 2029.
- Adopt a firm budget for the U.S. government to prohibit sustained deficit spending.
- Reject the $100 trillion progressive tax-and-spend agenda, including Medicare for All, taxpayer-funded college, a national job guarantee, paid family and medical leave, and the Green New Deal.
Big government is costly, and those costs are largely shouldered by the middle class through higher taxes and fewer economic opportunities. The progressive agenda cannot be funded without raising taxes on typical Americans.
If an American worker earning $40,000 were to move to Europe, her taxes would increase by 15 percentage points, or almost $6,000. Someone making $100,000 a year would pay more than $16,000 if they were taxed in Europe. If current U.S. spending growth is not slowed down, European level taxes are inevitable. There are no other sustainable options. Not adding any new spending and reforming existing programs is the only way to avoid significantly higher taxes on all Americans.
Adam N. Michel is Senior Policy Analyst in Fiscal Policy in the Grover M. Hermann Center for the Federal Budget, of the Institute for Economic Freedom, at The Heritage Foundation.