Sunday, December 04, 2005

Empirical Evidence For the Negative Effect of Taxes

"Austrians" often maintain that it is both impossible and unnnecessary to conclusively prove economic theories with statistical evidence. Impossible because there are so many different factors -many of which is extremely difficult or impossible to quantify- working to produce a single phenonema like say GDP including for example tax rates, regulatory burden, trade policy, natural resources, cultural factors, demography, monetary policy, relative preference for non-economic priorities, innovativeness of the population etc. almost ad infinitum that there will never be a perfect empirical correlation between any sigle one factor and the phenonema it contributes to, despite the fact a causal relationship really exists. Unnecessary because we can really conclude the causal relationships with so-called aprioristic reasoning.

Like in the case of taxes, we can conclude that it will certainly lower economic activity based on the fact that 1) People desire more money 2) Taxation of productive activities means that they will get less money from productive activities. From thiose two premises we can conclude that taxes will make people less willing to engage in productive activities from which in turn we can conclude that taxes will reduce the level of productive activities.

The counter-argument sometimes used against the above reasoning is that taxes through the so-called income effect might stimulate productive activities, but this argument was refuted by me in this article.

But nevertheless, while we can conclude through aprioristic reasoning that taxes will damage the economy, we cannot conclude how much it will damage it. To find that out, statistical analysis might be necessary after all. And while for the above stated reasons, any such analysis should be taken with a grain of salt, it is still likely to give us some hint of how big the effects are.

One such study was made by Nobel Laurate Edward Prescott, and it concluded that marginal tax rate changes accounted for nearly all the differences in hours worked between the G7 countries (the United States, Japan, [West] Germany, Britain, France, Italy and Canada). A surprisingly strong finding, as I had expected working hours laws to play a bigger role, but possibly support for such laws could have correlated with tax rate changes. I presented this study already last year in a blog post at the Mises blog.

Now in a comment thread at Angrybear, the signature "Teller" presents 5 more links to empirical studies that all show how labor supply is increased if taxes are cut. The exact magnitude of the estimated effect differ somewhat, but they are all significant:

Study Nr. 1
Study Nr. 2
Study Nr. 3
Study Nr. 4
Study Nr. 5


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