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The Effect of Taxes on Efficiency and Growth

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  • Martin Feldstein

Abstract

This nontechnical paper discusses the adverse effects of high marginal tax rates on labor income and on investment income. It explains that the deadweight loss of a tax on labor income depends on the response of taxable income and not just the change in labor supply. An across the board increase in personal tax rates involves a deadweight loss of 76 cents per dollar of revenue and only collects about two-thirds of the revenue implied by a %u201Cstatic%u201D calculation. A tax on investment income brings a deadweight loss even if household saving does not respond to taxes and the net rate of return. What matters is the response of future consumption. The tax on investment income is also effectively a tax on labor supply because current work effort produces income that will be spent on future consumption and the tax on investment income reduces the future consumption that results from more work today. An appendix shows for a simple log utility case that the tax on labor income has a smaller deadweight loss than a tax on investment income with the same present value of revenue. There is a further discussion of the various ways in which capital income taxes distort economic activity.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12201.

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Date of creation: May 2006
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Publication status: published as Feldstein, Martin. "The Effect of Taxes on Efficiency and Growth." Tax Notes (May 8, 2006).
Handle: RePEc:nbr:nberwo:12201

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Cited by:
  1. Raj Chetty, 2009. "Is the Taxable Income Elasticity Sufficient to Calculate Deadweight Loss? The Implications of Evasion and Avoidance," American Economic Journal: Economic Policy, American Economic Association, American Economic Association, vol. 1(2), pages 31-52, August.
  2. Bergh, Andreas & Henrekson, Magnus, 2011. "Government Size and Growth: A Survey and Interpretation of the Evidence," Working Paper Series, Research Institute of Industrial Economics 858, Research Institute of Industrial Economics.
  3. James R. Hines Jr., 2006. "Taxing Consumption and Other Sins," NBER Working Papers 12730, National Bureau of Economic Research, Inc.
  4. Mathur, Aparna & Morris, Adele C., 2014. "Distributional effects of a carbon tax in broader U.S. fiscal reform," Energy Policy, Elsevier, Elsevier, vol. 66(C), pages 326-334.
  5. Steven J. Davis & Magnus Henrekson, 2010. "Economic Performance and Market Work Activity in Sweden After the Crisis of the Early 1990s," NBER Chapters, National Bureau of Economic Research, Inc, in: Reforming the Welfare State: Recovery and Beyond in Sweden, pages 225-252 National Bureau of Economic Research, Inc.
  6. Ferede, Ergete & Dahlby, Bev, 2012. "The Impact Of Tax Cuts On Economic Growth: Evidence From The Canadian Provinces," National Tax Journal, National Tax Association, vol. 65(3), pages 563-94, September.

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