Monday, April 10, 2006

More Empirical Evidence on the Negative Effects of Taxes

I have previously dealt with the effects of taxes on a theoretical level, like when I here demonstrated that on a economy-wide basis the income effect will not cancel out any of the negative substitution effects from tax and spending policies (although it will cancel out some of the positive effects from tax cuts financed by higher government borrowing), so the effects of tax and spend policies on economic growth can only be negative.

Here I linked to a few empirical studies on the subject.

Now there is a new study on the issue, from Magnus Henrekson and Steven Davis. Just as one would have expected, high taxes on labor will reduce private sector employment, particularly in highly labor intensive sectors. An excerpt from the summary:

"They find that higher tax rates on labor income and consumption expenditures lead to less work time in the legal market sector, more time working in the household sector, a larger underground economy, and smaller shares of national output and employment in industries that rely heavily on low-wage, low-skill labor inputs.

The estimated tax effects are large for the authors' preferred tax measures. Cross-country comparisons in the mid-1990s indicate that a tax hike of 12.8 percentage points (one standard deviation) leads to 122 fewer hours of market work per adult per year and a 4.9 percentage point drop in the employment-to-population ratio. It also increases the size of the shadow economy by 3.8 percent of official GDP, and it reduces by 10 to 30 percent the share of national output and employment in "Retail Trade and Repairs," in "Eating, Drinking, and Lodging," and in a broader category that includes "Wholesale Trade and Motor Trade and Repair." The evidence suggests that tax rate differences among rich countries are a major reason for large international differences in market work time and in the industry mix of market activity."


Blogger Will Derwent said...

It is good to see someone who shares an interest in economics in the blogosphere, for a moment I thought I might be the only one.

It seems exasperating to have to explain that taxes are a bad thing, or for that matter that free trade can actually make people wealthier, rather than the common 'wisdom' that it will increase the gap between rich and poor.

As for negative effects of taxes, yes taxes are rotten instruments to redistribute the wealth of the nation, far more econmic damage is inflicted through cushy passive welfare laws that discourage workforce participation, especially in the elderly, youth and women. You mention Italy in other posts: Italy has one of the worst figures for workforce participation amongst 55-64 year old men (and women - who are purportedly 'looking after the family' instead of working), and worse figures for youth workforce participation than France. Reforming welfare systems and changing the alternative options to employment can do far more to economic growth than overall tax rates (though ultimately both ought to be reformed).

3:57 AM  

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