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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.

Suggested Citation

  • Martin Feldstein, 2006. "The Effect of Taxes on Efficiency and Growth," NBER Working Papers 12201, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12201 Note: PE
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    File URL: http://www.nber.org/papers/w12201.pdf
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    References listed on IDEAS

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    6. Steven Gjerstad, 2004. "Risk Aversion, Beliefs, and Prediction Market Equilibrium," Microeconomics 0411002, EconWPA.
    7. Jeff Dominitz & Charles F. Manski, 2004. "How Should We Measure Consumer Confidence?," Journal of Economic Perspectives, American Economic Association, vol. 18(2), pages 51-66, Spring.
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    Citations

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    Cited by:

    1. Barreix, Alberto & Roca, Jerónimo, 2007. "Strengthening a fiscal pillar: the Uruguayan dual income tax," Revista CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), August.
    2. Andreas Bergh & Magnus Henrekson, 2011. "Government Size And Growth: A Survey And Interpretation Of The Evidence," Journal of Economic Surveys, Wiley Blackwell, pages 872-897.
    3. Steven J. Davis & Magnus Henrekson, 2010. "Economic Performance and Market Work Activity in Sweden After the Crisis of the Early 1990s," NBER Chapters,in: Reforming the Welfare State: Recovery and Beyond in Sweden, pages 225-252 National Bureau of Economic Research, Inc.
    4. 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, vol. 1(2), pages 31-52, August.
    5. James R. Hines Jr., 2007. "Taxing Consumption and Other Sins," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 49-68, Winter.
    6. Mathur, Aparna & Morris, Adele C., 2014. "Distributional effects of a carbon tax in broader U.S. fiscal reform," Energy Policy, Elsevier, vol. 66(C), pages 326-334.
    7. 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 563-594, September.

    More about this item

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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