An Ode To Taxes

I have been on Money Twitter for about a year now. It fascinates me to see how everybody in the community sees taxes as a bad thing. When given the opportunity everyone tries to minimize their tax rate.

As a Dutch citizen I have found out – partially thanks to Money Twitter – that I pay a relatively high share of my income in taxes. Sometimes it made me even dream about living abroad because of the chances for a lower tax rate.

Imagine the money you would have left to spend if your tax rate would be reduced by 10% or even 20%. Life would be much better, wouldn’t it?

Yet there is a good reason why we as citizens once accepted a society – the social contract – where taxes are charged over our wealth and income. That is why I decided to write this blog post: to put the importance of paying your taxes into perspective.

Why We Hate Taxes

I understand why paying taxes is something to avoid as long as it stays within the legal boundaries. The money will still be yours and you can do with it as you please, while it would otherwise disappear in the deep pockets of the state.

When we pay taxes, we see one stream of cash that annoys us a lot: it flows out of our bank account as one big lump sum into a very, very vast cash pool owned by the government.

Additionally, lower tax burdens are generally perceived to be beneficial to the economy. When you have to pay less taxes, you can spend more, which increases economic activity.

If the economy grows fast enough, the government’s income can even stay constant at a lower tax burden as the difference is made up by an increase in the number of transactions.

The other way around, higher taxes can decrease economic activity and cause a recession, which will not solve any problems (neither for you nor the government). Through this (very simplistically laid out) reasoning there is a fine balance between a government and its citizens on how large the tax burden can and should be.

Why We Pay Taxes

The government has a budget. Just like you and me. A government, as the traditional theory goes at least, cannot borrow infinite amounts of money. In the long term, a government needs to pay its debts. So when it is operating with a deficit today, it has to earn money at some point to pay off the newly created debt in the future (alternatively, it could break-even at a stable debt load). Because we generally trust governments, their debt securities are seen as some of the safest investments in the world.

The image below is taken from the publication of the Dutch 2019 government budget. As you can see, expenses (‘uitgaven’) have been higher than income (‘ontvangsten’) as the economy recovered from the financial crisis in 2008. From 2017 onwards, when the economy was growing and doing well, the government was able to save some money again. The pattern where governments spend more in bad times, and spend less in good times, is a key component in Keynesian Economics.

Countries in the European Union have budget agreements, known as the Stability and Growth Pact. For example, the deficit is not allowed to be larger than 3% of GDP (Gross Domestic Product) and the national debt is not allowed to be higher than 60% of GDP. Not all countries currently comply with these rules, which causes some internal debates. However, these limits are deemed necessary to prevent unfair competition between member states and to maintain stability of the Euro.

Simply put, if the members of the European Union would not have these agreements, competition between the states and the stability of the Euro could be put at risk more easily. Think about the Euro crisis, where Greece defaulted on its loans (check out this video by the Plain Bagel explaining this in more detail). The Euro should be able to depend on its member states, which is vital for the currency to succeed (I stop here to prevent the long discussion as to how viable this ambition is). Likewise, it would be unfair for competition between the member states if one country spends beyond its means, while another has its debt in control.

The United States

Let’s shortly extend this view to the United States. The United States has the most trusted currency: the reserve currency known as the US Dollar. But would they be allowed into the European Union? Let’s see.

The image below shows the historical revenues and outlays. The average revenues were 17.4% of GDP and average outlays were 20.3% of GDP (both from 1968 to 2017). The average difference of 2.9% implies they just make the cut. However, when this is the long-term average, the national debt is likely not in check.

There is this famous website giving real time insight in the United States’ National Debt: usdebtclock.org. According to this website, the current debt to GDP ratio of the United States is 128.14%. By this metric, the United States would not be let into the Euro.

This might surprise you, but for the United States this high debt level matters a lot less than for European countries. Why? Simply because their debt is denominated in US Dollars and almost all external transactions are denominated in US Dollars.

European countries, businesses and citizens need to exchange Euros into US Dollars to buy, for example, oil. The United States does not need to do so, as their currency is the benchmark. They can simply issue more debt, which will be bought by investors or the Federal Reserve (who prints more US Dollars to do so). This system works as long as the confidence in the United States’ institutions (and likewise the US Dollar) is maintained.

A further point in favor of the United States is that by far not all countries in the European Union currently comply with the national debt limit rule either. The image below comes from the same Dutch government publication, showing that as of 2018 (when strictly looking at this sample) only Germany (‘Duitsland’) and the Netherlands (‘Nederland’) complied with the 60% limit. I guess the entire ‘developed world’ needs to put debt management on the agenda.

Comparing Countries?

A government’s income is largely driven by taxes paid by its citizens. For example, 20.2% of the Dutch government’s income for 2019 was budgeted to come from wage and income taxes, 19.5% from VAT income, 36.9% from national, healthcare and employee insurance contributions, and 10.1% from corporate income taxes and dividend taxes. This already covers 86.7% of the total budgeted income and still excludes items like import taxes, gift and inheritance taxes and – in the case of the Dutch government – income from natural gas. Total income of the Dutch government stands (as the image above shows) between 38% and 40% of GDP.

The expenses in 2019 were largely budgeted for social security (27.7%), healthcare (27%), education, culture and science (13.1%), and municipality, provincial and VAT contribution funds (11%). These four cover 78.8% of total government expenses, with the rest going to other ministries and areas such as infrastructure and water management (3.2%) and defense (3.4%). The expenses for 2019 were budgeted around 38% of GDP, leading to a surplus of around 1% for the year.

The structure of the government budget of the United States is – on a high level – the same, as shown by the image below. Income is largely made up by income taxes, and expenses are largely related to social secuity and healthcare. However, the deficit for 2019 is 4.6% – in economically good times. You could criticize the large defense spending at 3.2% of GDP, or you could say that taxes should simply be raised to better cover the planned expenses.

With a strong economy you would think this should be easily attainable for the United States, just like the Dutch government is currently doing. Yet, it is not right to simply compare countries like that. The structure of the economy and the political history can differ so much that it is very hard to bring change to the structure of the government’s income and expenses.

A number that expresses this difference, for example, is the income as a percentage of total GDP. Whereas the total income of the Dutch government is between the aforementioned 38% and 40% of GDP, the total revenues of the United States’ government is (only) 16.3% of GDP. The Netherlands has a post-war history where a social state was created, with quite some influence in every day life and thus a larger share in taxes from, and contributions to, its citizens. The United States is more liberal and simply intervenes less in the daily life of its citizens.

The thing we can say from these numbers, in my opinion, is that a country should manage its own situation well enough to keep its debt within realistic measures. When this does not happen, the ever so stable government can turn less stable when debt and interest payments become due. It is our responsibility as citizens to keep the government accountable. So whenever the monetary management becomes unsustainable, change might be needed to prevent future generations from having to pay the price for us living beyond our means today.

Why (Should) We Love Taxes(?)

As long as you have an accountable government and as long as you are able to live and work in a safe country with a prosperous economy you may want to think again about your stance on paying taxes.

I will not agree with every decision the government makes on the allocation of the tax income in their budget. But I am proud that I am able to pay them my fair share so that they can – in return – provide a stable society where I can continue to do so.

The next time you drive on a nice and crisp asphalt road, the next time you send your kid to school, the next time the police helps you out, the next time you get healthcare for which you paid less than the actual cost, or the next time you visit your grandparents that receive money from the government to make the best of their old days, remember it is all possible because people pay their taxes.

In times where the economy is not in your favor, like it is right now with covid-19, the government has your back and takes care of the people in need until they can safely take care of themselves again (if the government wouldn’t, they might be asking you for help directly if you were not directly influenced by covid-19).

Whenever you hear your friends or neighbors talk about working in the shadow economy, or when people do not want to be open about their tax administration, hold them accountable. Every tax penny paid less by them, is a tax penny you will (eventually) have to pay instead. Or worse, it is a tax penny due to be paid by your children in the future.

Likewise, whenever your government is not accountable, make them accountable. Whenever your government is wasting tax money where not only you, but also your fellow citizens worked hard for, hold them accountable. But when you do, remember you are building a country together.

Wrap-up

To summarize my stance on taxes, I can only say that I am proud that I am able to pay them and that my government – at least on a high level – spends it wisely. I am happy with the country I live in, which is largely made possible because my (grand)parents paid taxes. I am going to pay my fair share, so that the future generations can say the same.

What do you think? Do you hate to see the money go to the government, or did I manage to make you a little bit more proud when you realize what it is used for?

One thought on “An Ode To Taxes

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