The Effect of Taxes on Efficiency and Growth

27 Pages Posted: 25 May 2006

See all articles by Martin S. Feldstein

Martin S. Feldstein

National Bureau of Economic Research (NBER) (deceased); Harvard University (deceased)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2006

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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Suggested Citation

Feldstein, Martin S., The Effect of Taxes on Efficiency and Growth (May 2006). NBER Working Paper Series, Vol. w12201, pp. -, 2006. Available at SSRN: https://ssrn.com/abstract=902561

Martin S. Feldstein (Contact Author)

National Bureau of Economic Research (NBER) (deceased)

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Harvard University (deceased)

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