Divide and Deal: The Politics of Distribution in Democracies

3 The Politics of Tax Structure

72 Chapter 3 The Politics of Tax Structure Steffen Ganghof Governments that wish to redistribute through budgetary policy do so mostly on the spending side and not on the taxing side of the budget. The taxing side is nevertheless important, partly because less-efficient tax structure seems to be associated with lower taxation and spending levels . Hence, political struggles over spending levels may partly be fought as struggles over tax structure (e.g., Przeworski 1999: 43). A recent example of this logic is the Wall Street Journal editorial (20 Nov. 2002) that complained about the low income tax burden of a U.S. taxpayer earning twelve thousand dollars a year. These “lucky duckies” benefit so much from the progressive income tax structure that they pay little in income tax: “It ain’t peanuts, but not enough to get his or her blood boiling with tax rage.” If much less progressive income taxation could somehow be entrenched, so the argument goes, this would increase voters’ overall resistance to taxation and thus reduce tax levels. In this example tax-structure “efficiency” refers to the electoral costs of taxation (cf. Hettich and Winer 1999), but the general logic extends to economic and administrative costs. In continental European welfare states, for instance, which suffer from a high tax burden on low-skilled labor, progressive taxation of wages may be a matter of economic efficiency (Scharpf 2001). Similarly, the vertical distribution of the tax burden is only one dimension of tax equity and efficiency. The other dimension, the horizontal, has to do with the relative tax burdens on different types rather than levels of income. Along this dimension it is widely believed that moderate tax burdens on (certain types of) capital are efficient, both in general and within the income tax system (e.g., De Long and Summers 1991; Przeworski and Wallerstein 1988; Lindert 2004). For example, the The Politics of Tax Structure 73 “social democratic” welfare states of Finland, Norway, and Sweden operate so-called dual income taxes (DITs), which discriminate against wages in very systematic and visible ways: whereas capital income is taxed at a uniform low and proportional rate of 25–30 percent (or even lower), wages are taxed progressively up to top rates of almost 60 percent. Many observers find this system difficult to square with those countries’ traditional redistributive ambitions. The former Conservative prime minister of Norway, Kaare Willoch (1995: 179), for instance, laments that whereas “social democrats once felt that financial income should be taxed more severely than income from work, they have now changed their minds”; and he is puzzled that the new tax policy goes together with continuing “demands for a large public sector.” But these two observations may be causally linked rather than contradictory. For if moderate capital taxation increases the overall (i.e., electoral, economic, and administrative) efficiency of tax structure, it also tends to increase the level of public spending. In this chapter I explore the politics of tax structure in comparative perspective, drawing on both quantitative and historical evidence. My focus is mainly on advanced EU and OECD countries and on the potential tradeoffs between vertical and horizontal tax-structure efficiency. These tradeoffs seem most salient in income tax policy: if horizontal efficiency does indeed require moderate and proportional taxation of (some) capital income, whereas vertical efficiency (and equity) considerations require progressive taxation of wages, the resulting tax rate differentials will give high-income taxpayers great incentives to transform highly taxed income into lowly taxed income. Trying to avoid this circumstance is difficult and costly in administrative terms, which in turn tends to decrease political support for tax-rate differentiation. Finding a balance between horizontal and vertical tax-structure efficiency is thus inherently difficult. I will explore the tradeoffs involved and show that this exploration can inform and connect a number of separate literatures on the political economy of taxation. Moreover, I will analyze how corporate tax competition has exacerbated domestic tradeoffs and how political institutions figure in the domestic politics of income tax structure. In the next section, I clarify some basic concepts. Then I treat differentiated income taxation as an implication of the more general need to moderate the tax burden on capital income. Next I highlight basic tradeoffs in income taxation and interpret the tax reforms of the 1980s and 1990s as efforts to find systematic and efficient forms of differentiated income taxation . I then show how tax competition has exacerbated the economic and [3.138.113.188] Project MUSE...