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ECONOMIC POLICY 39: Celebrate: you're tax free! Showing the real size of the tax burden The problem: the tax burden is unclear Taxes are complicated, and everyone pays different amounts depending on their earnings, wealth, and what they buy. How to give the public a clear impression of the size of the tax burden they are carrying? The solution: calculate Tax Freedom Day One answer is to show the total tax burden in terms of the proportion of the year for which people are working to pay off their taxes. And then mark the 'tax freedom day' when they finally stop working for the national treasury and can at last start working for themselves. The United States led the way in presenting the tax burden in this clear way. In 1948, a Florida businessman, Dallas Hostetler, came up with the idea of Tax Freedom Day, copyrighted it, and calculated it each year for the next two decades. In 1971, he retired and transferred the copyright to the Tax Foundation in Washington DC. The Tax Foundation has calculated Tax Freedom Day for the United States ever since, and in 1990, began calculating the specific Tax Freedom Days for each individual state. What Tax Freedom Day means Tax Freedom Day shows the total tax paid each year by a taxpayer on average income (including indirect taxes, local taxes and payroll taxes) as a percentage of that average individual's total income. The date is calculated by comparing the government's total tax take against the nation's total earnings, and expressing the result as a percentage. That result is then converted into days of the year, starting from 1 January. Thus if taxes take just 25% of a nation's total earnings, Tax Freedom Day falls a quarter of the way through the year, at around the end of March. If the tax burden is 50% of earnings, Tax Freedom Day falls roughly at the end of June. The tax side. All genuine taxes are included in the tax take total. This includes direct taxes, such as income tax, capital gains tax, estate tax and corporate taxes (which ultimately are paid by the owners and customers of each business). It also includes all kinds of indirect taxes, such as sales taxes, duties on petrol, alcohol and tobacco, stamp duty, vehicle taxes, property taxes and so on. Government income from various fees and charges is not included (because they represent a payment for goods or services, which would still be due even if they were supplied by the private sector). Government interest and dividends received are similarly excluded (because they are pure business income, which is not levied by legislative force). The income side. Most people might naturally turn to Gross Domestic Product (GDP) statistics as the right measure of a nation's earnings to use in the Tax Freedom Day calculation. However, both the Tax Foundation in the United States nd the Adam Smith Institute in the United Kingdom use Net National Income (NNI) instead. The reason is that NNI excludes capital consumption, which is an expense and not part of net income, while it includes net property income from abroad. NNI is thus the closest macroeconomic equivalent to personal income on the individual level. Government borrowing. Of course, the amount of tax we pay is not the same as the amount which the government spends: because the government is also a big borrower. While governments may aim to keep in current balance, the heavy borrowing of previous years will still have to be paid back in the form of higher taxes and/or a weaker economy later on. Since the standard Tax Freedom Day calculation measures taxation only, public-sector borrowing (which can be said to be a form of deferred taxation) is not included until the time actually comes to repay the debt. This is in a sense unfair. It will make a squander-bug government, which borrows instead of raising taxes, look virtuous: while its fiscally more responsible successor, which attempts to pay off the public debt, will look like a high-tax government. Therefore the Adam Smith Institute further refines its calculations by adjusting for public borrowing, adding or subtracting days from the raw figure as appropriate. International comparisons. The Adam Smith Institute publishes league tables of Tax Freedom Day in various countries. A problem in such comparisons is that capital consumption data are notoriously unreliable, and require an assumption that the relationship between Net National Income and Gross Domestic Product is roughly equivalent, at least in the industrialized countries. The Institute's chart shows that Tax Freedom Day in the United Kingdom falls about three weeks later than it does in the United States. The citizens of the Euro area, however, have to work around four weeks more than Britons before they have paid off their taxes. Within the same country, however, comparisons between different regions can be revealing. The Fraser Institute calculates separate Tax Freedom Days for each of the provinces of Canada. The Tax Foundation, similarly, calculates Tax Freedom Day in each of the US States, and these dates are taken up with enthusiasm by public policy institutes such as the Buckeye Institute in Ohio, and by politicians such as Governor Frank Keating in Oklahoma. For further information:
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Copyright 2002: Adam Smith Institute
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