Why some people pay more tax and others less

You have to hand it to the Danes. They are the world’s highest taxpayers, but they have no sense of being wronged by a rapacious government.

Their tax-GDP ratio is a whopping 50%, which means for every krone of income earned, the government swipes half a krone as tax. In Sweden, the government robs you of 49.7%.

In most of Scandinavia and western Europe, taxation levels are spine-chilling, with collections usually in the range of 40-50% of GDP. Even gangsters are kinder to the rich.

India and China are less into extortion, with tax-GDP ratios in the range of 17-18%. Even Uncle Sam is more demanding at 28.2%. In contrast, the lowest taxation levels are in the Gulf, with the United Arab Emirates at a meagre 1.4%. Saudi Arabia nicks you for 5.3%. At these levels, citizens are essentially participating in charity. You don’t need a taxman to collect 1-5% of your income. Most people would be willing to put these piffling amounts in a publicly-placed collection box.

The tax divergence is as wide between countries as within. In India, the salaried upper classes pay the highest rates; companies pay very little. A study by the finance ministry in 2007-08 showed that companies paid an effective corporate tax of 22.24% when the actual rate is 33.99%. The bigger the company, the lower the effective tax rate.

Why are some taxpayers in some ountries willing to pay so much when others are willing to pay so little?

Here are some guesses.

The first element is trust. In high-trust, homogeneous societies, there is a greater willingness to pay tax because everybody knows that money paid today ultimately comes back to you and your kin.
Denmark is a high-trust society, and its citizens know that most of the money will be paid out as social security — for the old, the unemployed, medicare, et al. Since there is strong social identification with these groups, taxpayers may grumble at high rates, but they do not see it as money going down the drain.

In India, where social groups are extremely suspicious of one another, we have a low-trust society. If we had high tax rates, very few people would pay them for we wouldn’t know where the money went. We will never have a 50% tax-GDP ratio because we are anyway paying more taxes privately — through bribes. Bribery and speed money are taxes you pay to private parties to ensure that you get what you want. The poor pay private taxes to get their ration cards or NREGA payments; the rich pay to get their licences or favoured deals.

The second element that determines how high your taxes can be is governance and the ability to enforce rules.

Countries with high levels of governance can ask for higher taxes; those with militaristic, oligarchic or feudal systems will tend to have lower rates, since these countries are, by definition, run for the benefit of the few. It’s no surprise that Burma’s tax-GDP ratio is 4.9%, or that even Bangladesh (8.5%) and Pakistan (10.6%) have low ratios. All of them have had many spells of army rule. The only category to have both low rates and good governance is trading countries like Taiwan or Singapore. India, which tends to have moderate levels of governance, cannot hope to raise the tax-GDP ratio till it can enforce the rule of law and stamp out corruption.

The third element is collectibility. In low-trust societies, what matters is how easily you can collect your tax, and how difficult it is to evade it. VAT works well because it is self-reinforcing. Indirect taxes work well because taxes are collected at factory-point or port of entry. One-time fees work well (car registrations) because you can’t buy something without paying upfront. Cesses also work because they are collected like excise duties. Tolls are easy to collect in a corrupt society because they work exactly like a bribe: you pay to get past a barrier.

In India, we should look to tax expenditures, not incomes. We should raise specific purpose taxes like tolls and cesses to raise resources, so that people can see taxes doing some good. Else, we will continue to have a system that is inequitable in practice. Some people will always pay more, some less.

(Note: The tax-GDP data has been sourced from the Heritage Foundation’s study on economic reedom, updated to around mid-2008. The figures may be a bit outdated, but good enough as
approximations of current reality).