The United States Collects Less Tax Revenue Than Other G7 Countries
Countries rely on a variety of mechanisms for collecting revenues to fund government activities. In the United States, those include income, payroll, property, sales, and excise taxes. Similarly, other countries in the Group of Seven (G7) — an informal group of industrialized democracies including Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States — employ the same revenue-raising tools, while also utilizing a value-added tax (VAT). Tariffs, or customs duties, are an additional source of revenue used by all.
With the U.S. debt growing faster than ever before — driven by a structural mismatch between spending and revenues — this piece looks at how the American tax system differs from the tax systems of other advanced democracies. The comparison could be used by U.S. policymakers to consider options for narrowing the nation’s large and persistent deficits.
How Do Sources of Tax Revenue Differ for the United States?
Individual income taxes are the largest source of revenue for the United States. Similarly other G7 countries rely on either individual income taxes as their largest or second-largest source of tax revenue. However, the United States relies on individual income taxes to a much greater extent. A key difference between the tax system in the United States and those in other industrialized democracies is the imposition of consumptions taxes. While all other G7 countries have a national VAT, the United States does not impose a nation-wide consumption tax. However, forty-five out of fifty states impose a sales tax. National VATs are the third-largest source of revenue for all other G7 countries (except for the United Kingdom, where it is the second).
How Competitive Is the U.S. Tax System?
In a globalized economy, the competitiveness of a country’s tax system can be a factor in the success of that nation’s economy. The rate and structure of a tax system can determine economic decisions such as how much taxpayers spend or save, how many hours individuals choose to work, and how much capital businesses and stakeholders decide to invest. Countries compete for international business and trade and can optimize their tax systems to incentivize business investment. According to the Tax Foundation, the United States ranks second among G7 countries for overall tax competitiveness, with a tax competitiveness index score behind only that of Canada.
The U.S. Tax System Helps Businesses Stay Competitive
Taxes on corporate profits play an important role in a country’s economy, as they affect the after-tax return on capital investment. Countries with a competitive corporate income tax rate and adequate business cost recovery and investment incentives can help their domestic businesses thrive while also attracting the business of multinational corporations. The U.S. statutory corporate income tax rate is in line with other G7 countries: 26 percent compared to an average of 27 percent. However, most other G7 governments offer corporations capital allowances that reduce their tax liability, resulting in an effective average tax rate (EATR) that is lower than the statutory rate. The U.S. tax code offers large enough capital allowances, such as deductions or credits, to maintain an EATR that is slightly lower than the average of other G7 countries.
Many countries offer incentives for business research and development (R&D), which can be delivered to businesses both through direct funding and tax support. According to the OECD, tax-based incentives for research and development have been increasingly used by governments to promote business innovation and help drive economic growth. U.S. expenditures on business R&D are above the average of other G7 countries as a share of GDP, with relatively equal expenditures from direct funding and tax support.
In the United States, tax support for R&D investment does less to lower the tax burden on R&D investment compared to non-R&D investment than in other G7 countries. Nonetheless, more corporations in the United States may be able to take advantage of tax expenditures for R&D investment than in other G7 countries. For example, the tax discount for R&D investment is lower in the United States than Germany and Italy, yet U.S. expenditures on tax supports are higher as a share of GDP than those same countries.
The U.S. Tax System Places a Lower Tax Burden on Workers
Just like taxes on corporations, taxes on labor play an important role in a country’s economy. Tax laws can have a great impact on individuals’ choices, such as when and how much to work, whether taxpayers spend or save, and even how many children to have or when to get married. Among G7 countries, the United States has one of the lowest tax burdens on labor, which is the ratio between the amount of taxes paid by the worker (including income and payroll taxes) and their total compensation. In fact, the United States has a lower tax rate on labor for the average earner in all four household types analyzed by the OECD compared to most other G7 countries. The tax burden on labor is an important measure for policymakers, as a higher tax rate on labor is associated with a higher unemployment rate.
Conclusion
The U.S. tax system collects less tax revenues compared with other G7 countries, and that lower level of revenues is a key driver of the national debt. Understanding how other advanced economies structure their tax systems is critical for policymakers exploring fiscal solutions to rising debt. While maintaining a competitive tax system that supports economic growth and encourages work is an important policy objective, there are many fiscal solutions available that can help fix the structural imbalance between spending and revenues while promoting a thriving economy.
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Further Reading
Energy Tax Policy Under the OBBBA
As part of the OBBBA, lawmakers rolled back existing energy tax incentives in order to partially offset the bill’s deficit impact.
What Are Refundable Tax Credits?
The cost of refundable tax credits has grown over the past several years, with the number and budgetary impact of the credits increasing.
The Six Largest Corporate Tax Expenditures
Relative to the size of the economy, the U.S. collects less revenues than many other advanced countries. Tax breaks are a contributing reason.