Thursday, July 30, 2009

The deadweight loss of higher taxes 

According to the Tax Foundation's new study, government has to raise taxes $1.40 to gain $1 of additional income.
Consider the combined effect of President Obama's proposal to raise the top tax rate from 35 percent to 39.6 percent and the new surtax. This means high-income households will receive 54 cents rather than 65 cents from every dollar they earn; that is, the after-tax reward from earning income falls by 17 percent. Based on the research mentioned above, with such large increases in tax rates, we can expect taxpayers facing the top tax rates to reduce their reported incomes by nearly 7 percent.
According to the SOI Bulletin from the IRS, there were 354,093 returns filed that had adjusted gross income over $1 million. Those returns sum to $1.211 trillion. 7% of that is about $85 billion, or more than 0.6% of 2006 GDP. In economics this is known as the "deadweight loss" of additional government. That is lost each and every year if we allow the Bush tax cuts to expire, and impose the high-income surtax to pay for health care.

In related news, the tax burden of the top 1% of the income distribution now exceeds that of the bottom 95%. Thanks, rich people! (Mankiw notes that this is due to "both changing tax policy and the changing distribution of income.")

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