Working Paper: NBER ID: w12201
Authors: Martin Feldstein
Abstract: This nontechnical paper discusses the adverse effects of high marginal tax rates on labor income and on investment income. It explains that the deadweight loss of a tax on labor income depends on the response of taxable income and not just the change in labor supply. An across the board increase in personal tax rates involves a deadweight loss of 76 cents per dollar of revenue and only collects about two-thirds of the revenue implied by a "static" calculation.\nA tax on investment income brings a deadweight loss even if household saving does not respond to taxes and the net rate of return. What matters is the response of future consumption. The tax on investment income is also effectively a tax on labor supply because current work effort produces income that will be spent on future consumption and the tax on investment income reduces the future consumption that results from more work today. \nAn appendix shows for a simple log utility case that the tax on labor income has a smaller deadweight loss than a tax on investment income with the same present value of revenue.\nThere is a further discussion of the various ways in which capital income taxes distort economic activity.
Keywords: No keywords provided
JEL Codes: H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| High marginal tax rates on labor income (H31) | Substantial deadweight losses (H21) |
| High marginal tax rates on labor income (H31) | Changes in taxable income (H29) |
| Changes in taxable income (H29) | Substantial deadweight losses (H21) |
| Tax on investment income (H24) | Deadweight loss (H21) |
| Tax on investment income (H24) | Future consumption (E21) |
| Future consumption (E21) | Labor supply (J22) |
| Higher taxes (H29) | Reduce effort and human capital investments (J24) |
| Reduce effort and human capital investments (J24) | Diminished overall productivity (D24) |
| Decrease in marginal tax rate from 40% to 30% (H29) | 16% increase in taxable income (H29) |