Taxes, Government Spending & Marginal Effects

The economic case against taxes centers primarily on how it produces negative marginal effect. By reducing the net income you gain from productive activities it will mean less of these productive activities.

Yet the link between taxes and marginal effects is not as clear cut as it would seem at first for two reasons. First of all, legislators often decide to reduce tax revenues in ways which do not reduce the negative marginal effects. Examples of this are when for example mortgage interest payments and charitable gifts are made deductible.

And secondly, sometimes spending can also produce negative marginal effects. This really applies to all means tested spending programmes, including for example welfare and unemployment benefits.

Tyler Cowen now gives us another potential future example: namely the provision in the planned U.S. health care reform that will attempt to compensate people with low income for the damage that the health insurance mandate inflicts on them, they will receive subsidies. Yet as these subsidies are faced out, this will produce negative marginal effects similar to those that taxes produce. And of course, ultimately these subsidies will have to be financed by higher taxes.

Because of the way taxes and spending are designed now (and even more so how they will likely be designed in the future) in America , the negative marginal effects of these policies are at many income levels relatively high, even though tax revenues aren't particularly high.