When it comes to taxes, Americans don’t shoulder as heavy of a burden as those in other advanced countries. But that kind of tax relief doesn’t come without compromises.
Overall, total taxes collected in 2023 made up 25.2% of US gross domestic product, or GDP. That’s lower than the 33.9% average for countries in the Organization for Economic Cooperation and Development (OECD) and far lower than the more than 40% tax-to-GDP ratio found in nine European countries.
On a per-person level, workers who earned the average wage across 22 European countries pay $11,676 more in taxes each year than they would in the US, according to the Cato Institute, a libertarian think tank. A family of four pays $21,546 more.
“The US is a low-tax country relative to other large and relatively high-income economies,” said Alan Cole, senior economist at the Tax Foundation. “There are few countries in our ballpark.”
A big reason for the discrepancy is that more than 170 countries worldwide employ a value-added tax, or VAT, at the federal level, a tax tool that President Donald Trump railed against last week in his speech at the World Economic Forum. A VAT is a consumption tax levied on the value of goods and services. In the US, such a tax doesn’t exist, with our federal government primarily relying on income tax.
“So really at most levels of income, in most circumstances, you’re just going to have a lower tax burden as a percentage of your income as an American,” Cole said. “It’s kind of surprising that it works at all relative to what European countries have.”
Lower taxes don’t come without big trade-offs, though, mainly a reliance on states to administer large elemental programs and an overall smaller safety net for US citizens.
The easiest way to think of VAT is a very broad sales tax at the federal level. Not only does the tax apply to goods that you buy in a store, similar to a state-level sales tax here, but it also applies to services.
Take a contractor who does a home repair. You wouldn’t normally pay sales tax on that in most states, but in Europe, that repair would be subject to a value-added tax. A VAT can also be more complicated than a flat sales tax. For instance, if a company buys an intermediate good from another, both companies will pay a part of the VAT.
So, a value-added tax is applied “to everything in the economy,” Cole said, with these countries charging a VAT up to 20% to 25%, much higher than the sales tax that US states typically assess.
“The result of that is just that they raise a lot of money,” Cole said.
Some nations may levy reduced VAT rates on certain goods and services to help lower-income people who spend a bigger share of their take-home pay on food and transportation. Other countries may exempt lower-income citizens from paying income taxes, another tax revenue source in advanced economies, to offset the burden from the value-added tax.
This photo shows the Internal Revenue Service (IRS) headquarters building in Washington, April 13, 2014. (AP Photo/J. David Ake, File) ·ASSOCIATED PRESS
Instead of a VAT, our federal government relies heavily on income taxes, which makes up about half of all US revenue. This includes 44% from taxes on personal income, profits, and gains as well as 7% from taxes on corporate income and gains, according to the OECD.
Income taxes in the US are also progressive. Americans in the two lowest tax brackets pay just a 10% and 12% rate on their earnings, much lower than the VAT rates. Even those who earn more and pay a higher tax rate can often reduce their overall tax burden through tax credits and deductions.
For instance, the average effective tax rate for those making $200,000 to less than $500,000 was 16.6% in 2018, according to an analysis from the Pew Research Center. And some of the poorest Americans end up paying no income tax and instead receive money from the federal government in the form of refundable tax credits.
One reason this can occur is because of the sheer number of affluent Americans. Incomes in the US at the very top are unusually high compared with other countries.
“We have like more than a million people who make more than $500,000 a year. That’s almost unheard of in other countries,” Cole said. “That’s still a small minority, but they contribute a lot of income tax revenue, while sparing a lot of ordinary people from paying much in tax.”
On top of that, the US is home to many more highly profitable corporations that also contribute to the income tax base. Those lucrative income sources make the US system work, Cole said, “even though they don’t have this workhorse tax that Europeans do.”
In this photo illustration, a 1040 U.S. Individual Income Tax Return document is seen on a desk on April 15, 2024 in North Haledon, New Jersey. (Photo illustration by Michael Bocchieri/Getty Images) ·Michael Bocchieri via Getty Images
Another key difference between the US tax system and the rest of the developed world is the role of state and local taxes. US federal taxes make up about two-thirds of the total tax burden an American faces. The rest comes from states.
US states and localities depend on income taxes, sales tax, and property taxes. Taxes on goods and services make up about 16% of an American’s total tax burden and property taxes contribute 10%, said Thomas Brosy, a senior research associate at The Urban-Brookings Tax Policy Center.
“The US is typically higher than most countries when it comes to property taxes,” Brosy said. The OECD average is 5%.
Some other European countries, such as the UK, Switzerland, and Germany, have more quasi-state distinctions that have more taxing authority. But for the most part, the US is unique in its decentralized tax system.
“We have unusually robust states,” Cole said. “You get that from the name of our country, the United States. We make a big deal of the fact that we’re these multiple jurisdictions put together.”
The Uncle Sam balloon, right, and other participants in the 85th Annual Macy’s Thanksgiving Day Parade make their way down New York’s Sixth Avenue Thursday, Nov. 24, 2011. (AP Photo/Tina Fineberg) ·ASSOCIATED PRESS
The reason that states need so much revenue is because they foot the bill for two huge expenditures: schools and police, which are often covered by the federal government in other countries. While this provides state residents more control over these necessary programs, the structure also allows bigger discrepancies to arise among states, especially education.
That also gets to the trade-offs when it comes to lower taxes. The fact that the US has a smaller federal government helps to offset the lower revenue — percentage-wise — it takes in versus its European counterparts.
“Some of the countries with the largest share of GDP collected as tax revenue are countries that have much more generous and wide social safety nets,” Brosy said.
Even though the US collects taxes specifically to pay for its Social Security obligations, the percentage it collects is “slightly below average” compared with other countries, according to Brosy. Some of those other countries, especially the Scandinavian ones, also fund things like universal healthcare, higher education, parental leave, and child and elderly care.
These are all pricey expenses that Americans are left to pay for on their own — ostensibly from their tax savings.
Janna Herron is a Senior Columnist at Yahoo Finance. Follow her on X @JannaHerron.
