High Tax Rates Hurt the Economy

I argue that high tax rates do hurt the economy. I will employ both theoretical and empirical support for this assertion. Why High Taxes Hurt The Economy? Higher tax rates hurt the economy because they discourage productive behavior. If labor taxes were to be higher, then labor would be less desirable relative to leisure. This is because the higher taxes on labor would reduce the reward for labor. This would reduce the incentive for people to choose work over leisure. The same is true of capital taxation. If the government were to tax capital higher, the potential reward for successful investment would be reduced. This would then reduce the level of investment. Reduced investment leads to less capital reinvestment, less new jobs, less new equipment, and lower productivity. These higher tax rates would also reduce the potential reward from entrepuenership. This would mean that higher taxes would lead to less new businesses and less entrepeunerial ventures in the economy. Furthermore, taxes also deeply distort economic behavior. When tax rates are higher, the value of tax deductions are much higher. When the tax rate is 80%, there is more reason to try to avoid taxes through deductions than at a tax rate of 40%. This leads to many misused economic resources. Right now, our tax code has a full deduction for employer provided Health Plans. Due to this, 59% of Americans are on Employer Provided Health Plans. This has led to extreme distortions in our Health Care System, as it kept patients from buying individualized Health Care Plans. High tax rates also encourage tax dodging. Billions of dollars go to tax lawyers to help people avoid taxes. These are wasted resources that could go to more productive uses. If tax rates were lower, there would be less incentive to use resources to avoid taxes, meaning that more resources would go towards more productive ventures. Finally, high tax rates in one country, particularly high progressive tax rates, typically lead to a many companies and high skill workers emigrating to lower tax countries. This leads to job loss in high tax countries (as some corporations move to lower tax countries, brining jobs with them) and productivity loss, as some of the most productive and innovative members emigrate to lower tax countries. Empirical Evidence on High Tax Rates and Economic GrowthEmpirical Evidence generally supports the notion that higher tax rates reduce labor supply, and, therefore, economic output. Nobel Prize Winning Economist Edward Prescott looked at the difference in labor supply between the G-7 Countries and found that different tax rates are responsible for almost allof the difference in labor supply between countries: "Americans now work 50 percent more than do the Germans, French, and Italians. ' This was not the case in the early 1970s, when the Western Europeans worked more than Americans. This article examines the role of taxes in accounting for the differences in labor supply across time and across countries; in particular, the effective marginal tax rate on labor income. The population of countries considered is the G-7 countries, which are major advanced industrial countries. The surprising finding is that this marginal tax rate accounts for the predominance of differences at points in time and the large change in relative labor supply over time. " These results go a long way in showing that high tax rates do, in fact, reduce labor supply over time. Another common result in empirical studies is that the Corporate Tax is particularly harmful to growth. This is a common result found in numerous studies from the OECD, World Bank, Joint Comittee on Taxation, Oxford, and a number of reputable independant economists. These studies typically find that high corporate tax rates reduce investment and entrepeunership. On top of this, high corporate taxes typically send corporations to lower tax nations. High tax rates also tend to correlated with lower growth rates. One empirical study on this was published in the Cato Journal, which, after controlling for numerous factors, found that high marginal tax rates have significant negative impact on growth in US states: "This article explores the impact of tax policy on economic growth in the states within the framework of an endogenous growth model. Regression analysis is used to estimate the impact of taxes on economic growth in the states from 1964 to 2004. The analysis reveals a significant negative impact of higher marginal tax rates on economic growth. The analysis underscores the importance of controlling for regressivity, convergence, and regional influences in isolating the effect of taxes on economic growth in the states. "This study is not an exception to the rule. There are numerous studies finding that taxes have a negative impact on economic growth (look at links to see numerous other studies). Conclusion Based on both these theoretical and empirical facts, I conclude that taxes have strong negative effect on the economy. Sources. http://en.wikipedia.org...(for Prescott study on Taxation and Labor Supply) . http://www.minneapolisfed.org... (for CATO study on Income Taxes and Growth) . http://www.cato.org...(for numerous other studies that show high taxes hurting growth) . http://pirate.shu.edu...