The Effect of Taxes on Efficiency and Growth
Posted: 6 May 2006
This report 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 collects only about two-thirds of the revenue implied by a static calculation, according to this report.
Feldstein explains that tax on investment income brings a deadweight loss even if household saving does not respond to taxes and the net rate return. What matters is the response of future consumption. The tax on investment income is also effectively a tax on labor supply, he explains, 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. Finally, he discusses the various ways in which capital income taxes distort economic activity.
Suggested Citation: Suggested Citation