Tuesday, May 10, 2005

You Read It Here First

Nobel winner Ed Prescott's contribution to Auerbach and Hassett's, Toward Fundamental Tax Reform, seconds the FLUBA's argument that it will be impossible for Max Sawicky and Brad DeLong's dream of tax revenue of 30% og GDP to be realized:

Regarding tax policy, we have learned that labor supply is not inelastic and does, indeed, respond to changes in tax rates. This insight, so simple and yet so powerful, has implications for all sorts of tax policies, and one that would greatly benefit from its application is the U.S. Social Security tax system.

....According to the OECD, from1970 to 1974 France’s labor supply exceeded that of the United States. A review of other industrialized countries shows that their labor supplies also either exceeded or were comparable to the U.S. labor supply during this period. Jump ahead two decades, and you will find that France’s labor supply dropped significantly (as did others), and that some countries improved and stayed in line with the United States. Controlling for other factors, what stands out in these cross-country comparisons is that when tax rates of European countries and the United States were comparable, their labor supplies were comparable (Prescott 2004).

....Further, a recent study has shown that Germans and Americans spend the same amount of time working, but the proportion of taxable market time versus nontaxable home work time is different (Schettkat 2003). In other words, Germans work just as much, but more of their work is not captured in the taxable market.

....Some say that the 1993 tax-rate hike was responsible for erasing this country’s debt problems because it increased government revenues. This is false. The ratio of U.S. debt to gross national income continued to increase in the years following those rate hikes and did not fall until the fortuitous boom that occurred in the late 1990s. The high-tech boom meant that people worked more, output increased, incomes climbed, and tax revenues followed suit. You cannot tax your way to that sort of prosperity. Imagine the outcome of the late-1990s boom if tax rates had been lower.

And, by the way, lower tax rates are good for all taxpayers. We’re barking up the wrong tree if we think that “taxing the rich” will solve all our problems. You know who these rich people are? They are often families with two professional wage-earners. If you tax that family too much, one wage-earner will drop out. That’s bad not only for the income of that family but also for the output of the whole economy—and it will result in lower tax revenues.

....The important thing to remember is that the labor supply is not fixed. People, be they European or American, respond to taxes on their income. Just one more example: In 1998, Spain flattened its tax rates in similar fashion to the U.S. rate cuts of 1986, and the Spanish labor supply increased by 12 percent. In addition, Spanish tax revenues also increased by a few percent.

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