The US tax code is a complicated mess, and the country can learn a lot from other countries about how to fix it. That’s the premise of reporter T.R. Reid’s new book A Fine Mess: A Global Quest for Simpler, Fairer, and More Efficient Tax System.
The US last passed significant tax reform in 1986. Difficult as it is to imagine given today’s polarized politics, the sweeping simplification of the tax code was considered a grand bipartisan success. But since then, the number of tax breaks in the country’s code have more than doubled. The size of the breaks for mortgage interest (pdf) and health insurance premiums have soared. There is a bipartisan consensus that another round of reform is needed. Like other presidents before him, Donald Trump campaigned on a desire to revamp the system (pdf).
The US has fallen behind the rest of the world in its approach to taxation. Reid’s book looks to other countries to understand what works, and what doesn’t. He suggests eight lessons from eight countries that Trump’s team should heed as it tries to tackle tax reform.
1. New Zealand: Broaden the base and lower the rates
The consensus among tax policy experts is that taxing lots of actions at a low rate leads to the fewest economic distortions and simplest tax code. Economists call it BBLR, for “broader bases and lower rates.”
New Zealand is a world leader in BBLR. In the 1980s, the country killed off nearly all major deductions and write-offs in the tax code. The reforms were politically challenging, says Reid, but eventually popular because they led to the “lowest rates on average workers of any developed nation.” Although New Zealand collects more tax as a percentage of GDP than the US, the median Kiwi wage earner pays about half as much in income tax as their American counterpart.
2. The Netherlands: Limit the deduction for charitable contributions
The tax deduction for charitable contributions is perhaps the most popular tax break in the US. It’s a bad idea.
Reid estimates that the US loses $50 billion in revenue every year from charitable deductions, and that the benefits from this break go mostly to the wealthy. People in the top income brackets are most likely to donate large sums by check or in kind, and thus get the most benefit from this break. Cash contributions, the most common type of giving for lower-income Americans, don’t count. Reid contends that the deduction doesn’t even have a major impact on giving, though other researchers disagree.
In the US, up to 50% of a household’s income can be deducted for charitable giving. In the Netherlands, the maximum is 10%. If the US reduced the charitable giving level to where it is in the Netherlands, the government could lower rates on the poor.
3. Estonia: Beware the flat tax
After the fall of the Soviet Union, the new governments in former Soviet states had to figure out how to fund themselves. Estonia’s first post-Soviet prime minister, Mart Laar, had a radical idea. Influenced by the ideas of American free-market economist Milton Friedman, Laar wanted to introduce a flat tax.
Against the advice of his finance minister, Laar implemented 26% flat rate on personal income and corporate profits. Over the next decade, the Estonian economy took off, and the simplicity of its tax system received a lot of the credit. Observing Estonia’s success, many other Eastern European countries followed suit. Reid argues that the flat tax worked well, in part, because there were so few rich people in post-Soviet countries, which made taxing everyone equally relatively uncontroversial.
But this wouldn’t last. Since the 2008 financial crisis, cash-strapped Eastern European countries that once had flat taxes have ditched them and imposed higher rates on the rich, like in most other countries. Estonia, which has kept its flat tax, has instead raises revenue through higher sales taxes and employment levies—revenue generators that are more distortionary and regressive than raising rates on the highest earners.
4. France: Don’t soak the rich too much
France’s government spends more as a percentage of GDP, 57%, than any other developed country. It finances its generous state expenditure by taxing the rich. Income tax rates in France for the highest earners have long been among the highest in the world.
In 2012, president François Hollande ran on a promise to hike those rates even further. He proposed a 75% tax on incomes above €1 million (US$1.07 million).
Wealthy French people threw a fit. Actor Gerard Depardieu moved to Belgium. The country’s professional soccer clubs threatened to go on strike. More importantly, tax revenue declined, which some economists attributed to the top rate rising to a point that discouraged economic activity, a point along a continuum known as the “Laffer Curve” (pdf).
In 2015, Hollande scrapped the 75% tax rate bracket. “The whole experiment seemed to demonstrate clearly that there is a limit to how high any government—even in France—can raise tax rates,” writes Reid.
5. Japan: Automate tax collection
Japan’s tax agency completely automates the process of paying taxes for about 80% of households, explains Reid. Based on withholdings throughout the year, the agency calculates exactly how much an individuals owes, or how much the government owes the individual. Then, the agency automatically deposits or withdraws the amount owed.
The US Office of Management and Budget estimates that it takes the average American over 10 hours to complete their individual tax return every year. Zero hours sounds better.
6. Slovakia: It helps if lawmakers to impose a higher rate on themselves
In 2012, the Slovakian government wanted to introduce a progressive income tax rate. At the time, Slovakia levied a flat rate of 19% on incomes (see the entry about Estonia above). The leftwing government in power at the time proposed to raise rates to 25% for income earned above about €35,000.
The backlash from businesses and conservative politicians was severe. In order to smooth the passage of the elevated rate, the act included a provision that members of the Slovakian parliament and the prime minister’s cabinet would pay a rate 5% higher than all other citizens. The act passed.
7. Almost every other country in the world: Introduce a value-added tax
According to Reid, 175 of the world’s 200-odd countries imposed a value-added tax (VAT) in 2016. VAT accounts for 20% of all government revenues worldwide. The US is the only rich country in the world not to adopt such a tax.
The main advantage of VAT is that it gives an incentive to companies to report transactions. In a VAT system, a tax is imposed in every stage of a product’s creation. For example, with a 10% VAT, if a retailer buys car tires from a wholesaler, the retailer must pay a 10% tax. When that retailer sells the tires to a customer, it also charges a 10% tax, but then deducts the tax paid to wholesaler from what is due to the government. Under this system, everybody needs a receipt that shows what they paid for goods or services as they pass along supply chains.
Economists and tax collectors around the world love VAT. It’s easy to collect and, as a consumption tax, doesn’t distort the economy the way employment-based taxes do.
8. Chile: Adopt a cuddly mascot for the tax collection agency
The Internal Revenue Service is not well loved among Americans—in fact, in some surveys it is the most unpopular federal agency of all. In many other countries, the national tax agency is held in high regard. The Swedish Tax Agency (the Skatteverket), Reid points out, is the country’s most respected arm of the government.
In order to educate the public about the role of tax collection, the Chilean tax agency adopted a rapping chinchilla named Ivo as its mascot. Other countries’ tax agencies have used songs, slogans, and banners to celebrate the importance of their role. People are more motivated to pay their taxes (pdf) if they think the money pays for useful services. Getting a cute mascot to deliver that message could be worth a shot—Iris the IRS iguana?—since whatever else the IRS is doing, it isn’t working.