Measuring the Burden of High Taxes

Studies | Taxes

No. 215
Wednesday, July 01, 1998
by Gerald W. Scully


We have shown that tax rates in the United States, as well as in nations with more aggressive welfare programs, are substantially higher than the rates that would maximize growth. Thus we have proved that the marginal cost of taxation is high. By the standard of maximizing per capita output (another way of saying economic growth), Americans are overtaxed by about 50 percent. By penalizing success with taxes and subsidizing failure with transfer payments, the United States and other OECD nations have lower standards of living than they would have if tax rates were lowered. The slower rise in various social indicators and the increasing societal disorder since 1960 demonstrate the consequences of higher tax rates.

In terms of social progress, increased taxes have not bought very much for the United States. It is true that infant mortality and the overall death rate are down and life expectancy is up since the 1960s, but these gains are small compared with those of the previous 90 years, when government was smaller and tax burdens much less oppressive. Little progress has been made in reducing poverty. Criminal activity, as measured by incarceration rates, has skyrocketed.

Many European nations have gone further than the United States in efforts to reduce income inequality and establish welfare states. To reach the European level of income equality, government in the United States would have to be expanded to the point that taxes would take about 45 percent of GDP instead of the current one-third. But the price for further homogenization of incomes is even lower economic growth, reduced job formation and increased unemployment - exactly what Europe is experiencing now.

"Welfare states are failing, with fiscal policies that are simply unsustainable."

Welfare states were successful for nearly two generations after World War II. They had reasonable rates of economic growth, low unemployment and very little poverty. Sweden became the liberal utopian model. The Swedes were widely praised for their attention to jobless workers, who received 90 percent of their pay for several years while seeking new employment, and for the fact that, after taxes, university professors earned little more than bus drivers. Asser Lindbeck makes the point that such social programs may change individual behavior temporarily, but eventually - probably after more than one generation - the disincentives to productive labor become fully visible. Habits, social norms, attitudes and ethics constrain purely economic incentives. But before long, a critical mass of welfare recipients begins to undermine the old norms and the overall economy. As public benefits expand and marginal tax rates rise, the net payoff to private productivity shrinks and the demand for inclusion in welfare programs rises.22

Now welfare states are failing. Many European nations have fiscal policies that are simply unsustainable. High taxes and large deficits have sucked the marrow from their economies, and governments have been forced to scramble to pay the interest charges on huge public debts. Labor peace has been purchased with massive long-term transfers of wealth to the unemployed and a host of social programs from health care to baby-sitting. Many of these governments recognize that the size and scope of the welfare state has to be reduced or there may be an economic collapse. But shrinking the welfare state is politically difficult, unless a serious crisis arises.23 For example, France tried to modestly reduce individual entitlements and got rioting in the streets.

"Because of the burden of taxation, our standard of living is lower than we could have had now."

For the United States, the evidence points to a need to revise the structure and philosophy of taxation. Considering the deadweight loss from tax rates above the growth-maximizing level and the diminishing gains in terms of social progress from increased taxes since the 1960s, the marginal cost of taxation is far higher than the marginal benefit. Rather than improving lives, the current burden of taxation has resulted in a lower standard of living than we could have had now.


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