The impact of tax policy on economic growth, income distribution, and allocation of taxes

Social Philosophy and Policy

Volumn 23, Issue 2, 2006, Pages 28-52

  Gwartney, James D ^a   Lawson, Robert A ^a  

^a NONE

Author keywords

[No Author keywords available]

Indexed keywords

EID: 33745654320     PISSN: 02650525     EISSN: 14716437     Source Type: Journal    
DOI: 10.1017/S0265052506060158     Document Type: Article

References (19)

1. The elasticity of labor supply is equal to the percent change in the number of hours worked divided by the percent change in the wage rate. Thus, if a 10 percent reduction in wages led to a 1 percent reduction in hours worked, the elasticity of labor supply would be 0.1 (1 percent divided by 10 percent). For empirical estimates of the elasticity of labor supply, see Thomas MaCurdy, David Green, and Harry Paarsch, "Assessing Empirical Approaches for Analyzing Taxes and Labor Supply," Journal of Human Resources 25 (Summer 1990): 415-490;
2. Robert Triest, "The Effects of Income Tax Deductions on Labor Supply When Deductions are Endogenous," Review of Economics and Statistics 74 (January 1992): 91-99;
3. and Thomas J. Kniesner and James P. Ziliak, The Effects of Recent Tax Reforms on Labor Supply (Washington, DC: American Enterprise Institute, 1998).
4. Prescott concludes: "I find it remarkable that virtually all of the large difference in labor supply between France and the United States is due to differences in tax systems. I expected institutional constraints on the operation of labor markets and the nature of the unemployment benefit system to be more important. 1 was surprised that the welfare gain from reducing the intratemporal tax wedge is so large." See Edward C. Prescott, "Richard T. Ely Lecture: Prosperity and Depression," American Economic Review, Papers and Proceedings 92, no. 2 (May 2002): 1-1.5, at p. 9.
5. The Laffer curve is used to show that increases in tax rates will, after a point, result in reduced tax revenues. See James M. Buchanan and Dwight R. Lee, "Politics, Time, and the Laffer Curve," Journal of Political Economy 90, no. 4 (1982): 816-19;
6. and James M. Buchanan and Dwight R. Lee, "Tax Rates and Tax Revenues in Political Equilibrium: Some Simple Analytics," Economic Inquiry 20, no. 3 (1982): 344-54.
7. The original source of the marginal tax rate data is Price Waterhouse Coopers, Individual Taxes: A Worldwide Summary (Hoboken, NJ: John Wiley and Sons, various years). The top marginal tax rates reported here include rates that apply at the subnational level if applicable.
8. The data for the United States illustrate why it is important to consider both the top rate and the income threshold at which it applies. The top marginal tax rate and the income threshold at which it begins to apply (in both current and 2004 dollars) are shown below for the United States for various years since 1963. Note that in 1963 the top marginal rate in the U.S. was 91 percent, but that rate only applied to incomes in excess of $2.46 million (measured in terms of 2004 prices). Thus, very few people confronted this rate. The top rate was cut to 70 percent by 1965, where it remained until 1980. By 1980, the income threshold for the top rate was much lower (about $494,000 in terms of 2004 prices), and far more taxpayers faced the top rate than in the early 1960s. A lower top marginal rate can be more restrictive than a higher one if the lower rate begins to apply at a substantially lower income threshold.
9. James Gwartney and Robert Lawson, Economic Freedom of the World, 2004 Annual Report (Vancouver, BC: Fraser Institute, 2004). Initially published in 1995, this report presents data on thirty-eight different variables designed to measure the consistency of a nation's institutions and policies with economic freedom. The report covers over 120 countries.
10. Other researchers have used similar techniques in an effort to hold other things constant. For example, when analyzing the impact of changes in the top state income tax rates on income growth, Holcombe and Lacombe compared the growth of per-capita income in counties on state borders with income growth in adjacent counties across the state border. This border-matching technique made it possible for them to hold constant many factors such as climate, culture, and proximity to markets that might also influence the growth of income. Their findings indicate that over the thirty-year period from 1960 to 1990, states that raised their top income tax rates more than their neighbors had slower income growth and, on average, a 3.4 percent reduction in per-capita income. See Randall G. Holcombe and Donald J. Lacombe, "The Effect of State Income Taxation on Per Capita Income Growth," Public Finance Review 32, no. 3 (May 2004): 292-312.
11. A t-ratio is a statistic that allows one to estimate the probability that a statistical result has simply occurred by chance. A "high" t-statistic indicates a low probability (p-value) that a given result is by chance, and, in such a case, the result is said to be "statistically significant." How high the t-statistic has to be is somewhat subjective, but t-ratios with corresponding p-values under 10 percent are generally considered statistically significant. A t-ratio of 7.0 (given the sample size in the model) would correspond with a p-value of essentially zero-meaning we are virtually certain that the result is not the product of chance alone.
12. The average annual growth rate of per-capita GDP for the Democratic Republic of the Congo was minus 2.0 percent during the 1980s and minus 7.2 percent during 1990-2002. The latter figure was, by far, the worst growth record of any country in our study. Because Congo also maintained a high (60 percent) marginal tax rate throughout the period, it exerted a strong impact on the marginal tax rate coefficients of the regression.
13. Neither the initial (1990) per-capita GDP nor the marginal tax rate prior to the change (1985) in marginal rates was significant in this model. To the extent that low per-capita GDP and high marginal tax rates influence growth, the effects would be present in the 1980s as well as the 1990s. Thus, the insignificance of these variables merely indicates that they did not influence growth in the 1990s, over and above their impact on growth during the 1980s.
14. The United Kingdom and the United States are not included among the countries of table 4 because they had two major tax reductions since 1980 and one of them occurred prior to 1985. The United Kingdom reduced its top rate from 83 percent to 60 percent in 1980 and then sliced it to 40 percent in 1988. The top marginal rate in the United Kingdom has remained at 40 percent since 1988. The United States cut its top rate from 70 percent to 50 percent in 1981, and then reduced it to approximately 30 percent in 1987-1988. The top rate in the U.S. has been both increased and decreased modestly since 1988, but it has remained below 40 percent during all of this period. New Zealand's major tax change occurred during 1988-1989, when the top rate was cut from 66 percent to 33 percent, and the rate has remained below 40 percent since that time.
15. Several factors reduce the comparability of income distribution data across countries and time periods. Sometimes the underlying figures are based on income, and in other cases they are based on consumption expenditures. Sometimes the income figures are for households, and in other cases they are for individuals. Sometimes the figures are derived from national samples, while in other instances they only reflect figures for urban (or rural) dwellers. Some data are after-tax and some are before-tax. Thus, extreme care must be exercised in this area.
16. For information on the linkage between trade openness and income inequality, see Gary Burtless, "International Trade and the Rise in Earnings Inequality," Journal of Economic Literature 33, no. 2 (June 1995): 800-816;
17. and the symposium on "Income Inequality and Trade," Journal of Economic Perspectives 9, no. 3 (Summer 1995).
18. All countries in these two categories for which comparable household income distribution data could be obtained are included here.
19. Many tax filers actually received funds on net from the IRS as the result of the Earned Income Tax Credit, a program adopted in 1975 that provides a subsidy to the working poor. The tax share data of table 8 reflect only tax liability; they do not include income transfers resulting from tax credits. If these payments to taxpayers were taken into consideration, the net taxes paid by the bottom half of income recipients would have been less than 1 percent in 2002. Thus, the data of table 8 actually understate the reduction in the net share of taxes paid by the bottom half of income recipients during recent decades.