Recent data from the Organisation for Economic Cooperation and Development (OECD) show that the United States has the second-most progressive tax system among OECD countries, with the rich paying a larger share of taxes relative to their share of income. At the same time, our tax system is smaller than in other countries. Federal, state, and local taxes in the United States amount to 25.4 percent of GDP, compared to the OECD average of 34.2 percent.
Our choice of a small progressive tax system has important policy implications. The relatively steep progressivity of our tax system tends to reduce income inequality by redistributing income from rich to poor. But the small size of our tax system pushes in the opposite direction, limiting the amount of redistribution that it can induce.
Faced with these tradeoffs, Republicans have focused on reducing the size of government, promising tax cuts for everyone. Democrats have focused on increasing progressivity, demanding that the rich pay their “fair share.” The resulting compromise, as we recently discussed in two Tax Notes articles (part 1, part 2), is our small but progressive tax system. As it turns out, even though our tax system is among the most progressive in the OECD, our fiscal system induces less redistribution than most other OECD countries due to our smaller taxes and benefit payments.