The Real Cost of Higher Taxes


Dan Mitchell of the Center for Freedom and Prosperity writes:

A column in the Wall Street Journal explains how certain tax cuts generate additional growth and thus lead to some degree of revenue feedback to the Treasury. The authors point out that higher taxes, by contrast, would impose harsh costs on the economy for every dollar collected by the IRS:

…a recent study by Gregory Mankiw, an economist at Harvard…concluded that a $1 tax cut on dividends would reduce government revenue collections by about 50 cents, after taking into account taxes on $2 of additional economic growth induced by the tax cut. A $1 tax cut from an across-the-board rate reduction would cost the IRS about 77 cents, after taking into account taxes on the 95 cents of additional economic growth induced by the tax cut. …If Congress is willing to forego 50 cents of revenue, the economy would grow and people would have $2 more income. If given the choice, most people would take the $2. Now apply the conclusions of the Mankiw study in reverse — to tax increases. The results illuminate the high costs of providing the government with an additional $1 to spend. A purported $1 tax increase on dividends only nets the Treasury 50 cents — but costs Americans $2 in lost income, plus 50 cents in tax. When a higher rate is levied on all forms of income, an attempted $1 tax increase yields only 77 cents — but costs Americans 95 cents in lost income plus 77 cents in tax. If the government were to kick up the tax increases enough to collect a full additional $1, the cost to the public would be between $2.25 and $5, counting both tax paid and income lost. A May 2006 study by Harvard’s Martin Feldstein, “The Effect of Taxes on Efficiency and Growth,” confirms the disproportionately large economic losses associated with tax increases. blockquote> (subscription required).


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