Arnold Kling  

The Cost of High Taxes

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Richard Rogerson writes,


In 1960, hours of work were actually higher in Germany, France, and Belgium than they were in Canada, the United States, and Australia. That is, 50 years ago the relative work levels of these countries were reversed. This evidence seems inconsistent with the view that Europeans work less because they either value leisure more or do not care so much about consumption.

Read the whole thing. What we call a European welfare state would perhaps be better termed a welfare-reducing state. People get driven out of market activities and into home production. If the U.S. had higher tax rates, we might not end up with any higher revenues. Instead, we would spend more time mowing our own lawns, cooking our own meals, doing our own household repairs, and so on.


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CATEGORIES: Fiscal Policy



COMMENTS (11 to date)
liberty writes:

"This evidence seems inconsistent with the view that Europeans work less because they either value leisure more or do not care so much about consumption."


This is not a bad argument - but it isn't perfect. What if they valued consumption up to a certain level of income, and then the marginal value of additional earnings stopped being worth the additional work. Perhaps at a certain point the marginal value of leisure began to exceed the marginal value of material consumption, and would have regardless of the tax rate.

Now, this might seem like a funny coincidence - only those countries with high taxes began to value leisure above consumption - and it is easy to see a correlation. But there are also two possible endogenous effects that might need to be considered:

(1) Those countries tending to value leisure at the margin above consumption might vote more for higher taxes because they would rather the money go e.g., to help the poor, because, recall, they do not value marginal consumption that much. In other words: correlation is not causation, and the value system might have caused the taxes.

(2) In countries with lower taxes and higher consumption, consumption may be valued higher by an individual because others are consuming more - and in countries with more leisure people may value leisure more because they can go on holiday together, or to parties, the pub, etc. In other words, these values feed on the environment: so the correlation is natural regardless of which came first, and they may have really sort of come about together.

Just some food for thought.

GU writes:
If the U.S. had higher tax rates, we might not end up with any higher revenues. Instead, we would spend more time mowing our own lawns, cooking our own meals, doing our own household repairs, and so on.

There has been much research devoted to figuring out people's responsiveness to taxes (vis-à-vis their labor decisions). The standard finding is that primary wage earners are very non-responsive to taxes—they will keep working. It is secondary wage earners that tend to drop out of the labor market or "downgrade" their labor efforts in response to tax increases. Also, wealthy people are sensitive to taxes, but they also have the most options for reducing their tax burden.

The people with the highest effective tax rates are what most would call upper-middle class, who have high incomes but not have enough assets to play tax avoidance games (or quit working in response to tax increases).

We are not anywhere near the downward sloping side of the Laffer Curve. It would be more responsible to say "if the U.S. had far higher tax rates, we might not end up with any higher revenues". I'm all for spending (i.e. entitlements plus military adventures) cuts, but the suggestion that a top marginal rate of 35% or 40% is anywhere near the precipice of disaster is untenable.

The efficiency costs of waiting to address the fiscal gap need to be factored into tax analysis; viz., we need to count both the deadweight loss from tax increases today and the efficiency gains from closing the fiscal gap.

Mr. Econotarian writes:

This paper argues that European labor market regulations better explain the US/Euro hours worked differential than tax rates:

In this paper, we argue that European labor market regulations, advocated by unions in declining European industries who argued "work less, work all" explain the bulk of the difference between the U.S. and Europe.


agnostic writes:

"Instead, we would spend more time mowing our own lawns, cooking our own meals, doing our own household repairs, and so on. "

That's good for your moral fiber because it keeps you in touch with the real world, rather than insulating yourself from it and thereby becoming more fragile to your eventual encounter with it.

Plus when a person's phoney-baloney knowledge economy job evaporates, they'll actually have practiced something of a trade for long enough that they can support themselves rather than lay about or go on the dole -- or ask for a bailout.

If those losers working for AIG, Citibank, etc., knew how to mow lawns, cook a good meal, and repair houses, the collapse of their house of cards would not have been as painful for them and especially for the rest of society.

David N. Welton writes:

> cooking our own meals

If you had some of my Italian mother in law's cooking, you might come round to the European way of thinking!

Cooking your own meals would likely be a healthier alternative for many Americans, who are, in many cases, quite overweight.

Chris Koresko writes:

GU: We are not anywhere near the downward sloping side of the Laffer Curve... the suggestion that a top marginal rate of 35% or 40% is anywhere near the precipice of disaster is untenable.

I'm very curious how one determines this sort of thing. From historical data?

Rob writes:

"People get driven out of market activities and into home production. If the U.S. had higher tax rates, we might not end up with any higher revenues. Instead, we would spend more time mowing our own lawns, cooking our own meals, doing our own household repairs, and so on."

The perils of self-sufficiency writ large are massive indeed, but somewhat higher marginal tax rates don't mean that Europe is some kind of autarkic backwater. You genuinely made home production sound like a harbinger of the apocalypse. More time spent with the children - gasp! No McDonald's for din dins - shock and horror! Gimme a flippin' break.

andy writes:

The graph that seems to provide 'clear negative relationship' seems to me to be a random scatterplot with a correlation line put through it....

rpl writes:

Rob wrote:


You genuinely made home production sound like a harbinger of the apocalypse. More time spent with the children - gasp!

More time with the children? Not really; you still have to do all that home production, remember? And it will take you longer to do it yourself than it would have taken to earn the money to pay someone else to do it; that's how specialization works.

No McDonald's for din dins - shock and horror!
Believe it or not, some of us find ways to outsource food preparation without resorting to fast food. For example, most good grocery stores sell fresh food that is pre-prepared, so all you have to do is pop it in the oven. If you're not good at slicing and chopping, it can be a real time saver.

andy wrote:


The graph that seems to provide 'clear negative relationship' seems to me to be a random scatterplot with a correlation line put through it....

Really? It looks to me like a reasonable relation with one notable outlier (the upper-rightmost point). Would have been nice if the author had given us a proper measure of significance, though.

Hyena writes:

What's funny is that this may lie at the heart of lower European birth rates. Increased home productions is generally "increased home production by women"; insofar as this reinforces traditional gender roles, it will tend to reduce fertility. Research suggests that the dichotomy of gender-progressive markets and gender-regressive homes pushes women away from motherhood.

GU writes:

@Chris Koresko

Sorry for the late response. See the article below for opinions of economists on the "revenue maximizing marginal tax rate," i.e. the peak of the Laffer Curve.

http://voices.washingtonpost.com/ezra-klein/2010/08/where_does_the_laffer_curve_be.html

There are links to papers in the article. I would start with the Slemord paper if you're interested. Slemrod is a non-partisan, straight shooter. A book edited by Slemrod, but with essays by many different scholars, called Does Atlas Shrug: The Economic Consequences of Taxing the Rich offers many perspectives on responses to tax increases (and implicitly on what side of the Laffer Curve various policies fall).

The works referenced explain their methodology.

Of course, as Martin Feldstein points out in the article referenced above, we might ask whether it matters where the Laffer Curve bends. I don't think the goal of tax policy is to maximize (government) revenue, but I also don't think the moderate tax increases that are on the table now will result in lower revenues. Clearly, most experts on the issue don't think so either.

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