Who Pays for Social Services? Comparing US and European Tax Systems
When people talk about life in Europe, they often highlight the generous public services-universal health care, generous paid family leave, free or low-cost college, and so on. And many of them want the US to set up a similar system.
Today, I want to talk about how Europe pays for its generous social services. The short answer is, of course, taxes. But the devil is in the details.
You might think that all those social programs in Europe are funded by taxing the rich. But here’s an important fact: Europe’s tax systems are actually much less progressive than the one in the US. Let’s unpack that.
In the US, federal income taxes are very progressive, which means that the more you earn, the higher your tax rate is. Yes, some rich individuals exploit loopholes and pay a much lower rate, but the majority do not. In 2020, for example, the top 1% of earners paid over 42% of federal income taxes, even though they earned about 22% of total income. Meanwhile, the bottom half of earners paid just 2 to 3%.
What about the European tax system? European countries rely much more on taxes that a large share of the population pays. A key example is Value-Added Taxes, or VATs. These are basically national sales taxes that apply to nearly everything people buy, from restaurant meals to furniture. In most of Europe, VAT rates hover around 20% or more, and everyone pays, no matter their income level. And because lower-income households spend a larger share of their income on consumption, VATs are regressive-they hit the poor harder, as a percentage of income.
To consider another example, social insurance contributions in Europe-essentially payroll taxes that fund things like health care and pensions-are often a constant percent of income and apply to a much wider base than in the US. That means middle-income workers in Europe contribute a lot toward the social safety net. In other words, Europe’s generous safety net isn’t just paid for by taxing the rich-it’s funded by taxing almost everyone.
There are other parts of the system that make the total tax burden in the US less progressive than when we only consider the federal income tax. Taxes that fund Social Security and Medicare are much less progressive, and the payroll tax, which funds Social Security, is actually regressive because it doesn’t apply above a certain income level. Some states have their own income taxes, some of which are flat, and there are also state and local sales taxes, excise taxes, and property taxes. That means the progressivity of taxes depends in part on which state you live in.
So here’s the key takeaway: Yes, European countries offer more public services-but they’re paid for by taxes that hit the middle class and working poor, such as the VAT. This is not necessarily a bad thing. Economists often favor a broad tax base-where taxes apply to more people and more types of activity. Why? Because broad taxes are harder to avoid, more stable, and less distortionary. A tax system that spreads the burden across more people and economic activity can often raise more revenue with lower rates-and without discouraging work, saving, or investment as much.
Now you might ask, could the US go a different route than Europe and just tax the rich? That would be a risky and likely unsustainable endeavor. For one thing, the math doesn’t work. Even taxing the top 1% far more aggressively wouldn’t raise enough revenue to cover the cost of European-style benefits. Wealthy taxpayers are also more mobile and better equipped to avoid or shift income to minimize taxes. Concentrating the burden on them makes the system less stable and more vulnerable to evasion.
So if we want reliable European-style services provided by the federal government, that would almost certainly require European-style taxes-not just on the wealthy, but on a broad base of earners and consumers.
Originally published at https://mytwocentsandcounting.substack.com.
