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Economic Effects of Taxation:
Some Stylized Facts
Jon Bakija
Department of Economics
Williams College
[email protected]
Government has both benefits and costs
•
Benefits
– Some show up in GDP. Example:
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Government fixes a market failure (e.g., imperfect information in credit markets) that otherwise would
prevent people from making productive investments in education
– Some (mostly) do not. Some examples:
•
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Protection from risk through social insurance
Improving social welfare by helping needy
A cleaner environment
Costs
– When taxes are related to ability-to-pay, this inevitably reduces the incentive to earn income,
which has a cost
– Example:
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•
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A person is deciding whether to do some extra work that would earn $100.
The forgone leisure is worth $80 to the person.
In the absence of taxes, person chooses to do the work, gets net benefit of $20.
With a 30% income tax, the work is not done, the person loses $20 net benefit, and government gets
no revenue from it.
Conclusion: cost of tax is larger than the revenue raised by the government (in this example, by $20).
•
The evidence discussed in this presentation tells us something about the costs of
taxation, and possibly about some of the benefits that show up in GDP.
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But it leaves out the benefits that don’t show up in GDP, so it is not itself decisive,
just one ingredient we’d need to help make the decision
Figure 1 -- GDP per capita in thousands of dollars, versus
government revenue as a percentage of GDP, 2007
QAT
70
GDP per capita
60
50
SGP
y = -1.29 + 0.60x
KWT NOR
(SE=0.12)
USA
40
IRL
HKG
CHE
CAN
AUS
DEU
30
ESP
KOR
20
TTO
CZE
NLD
AUT
SWE
DNK
GBR
BEL
FIN
FRA
ITA
SVNGRC
NZL
ISR
PRT
CYP
SVK EST
HUN
LVALTU POL HRV
CHL RUS
MYS TUR
BGR
URY
ROM
IRN BLR
KAZ
LBNBRA
SRB
ZAF
MKD
COL
TUN
DOM
PER
DZA
JAMUKR
THA
BIH
SLV
NAM
CHN ARMGEO EGY
JOR
GTMPHL
PRY
BOL
LKAIDN HND
MAR
IND
MDA MNG
NIC
PAK KEN
LAO
KGZ
NGA
KHM
BGD
ZMB
BFAGHA
UGA
NPL
MDG
MLICIV
AFG
TGO
SLE
NER
10
0
0
10
20
30
40
LSO
50
60
70
Central government revenue excluding grants, as a % of GDP
Source: World Bank World Development Indicators. Includes all countries with population > 1 million and available
data. GDP per capita is in thousands of constant year 2005 dollars, adjusted for purchasing power parity.
80
50
Figure 2 -- GDP per capita in thousands of dollars, versus taxes as a
percentage of GDP, rich countries, 2009
NOR
GDP per capita
45
USA
40
AUS
35
IRL
CHE
NLD
AUT
CAN
GBR
30
BEL
SWEDNK
FIN
FRA
JPN
ESP
25
DEU
ITA
GRC NZL
y = 31.45 + 0.025x
PRT
20
20
(SE =0.179)
25
30
35
40
45
Total government tax revenue as a percentage of GDP
Source: author's calculations based on OECD data. GDP per capita is in thousands of constant year 2005 dollars,
adjusted for purchasing power parity. Includes tax revenue of both central and sub-national governments. Includes
all OECD countries with populations over 1 million in 2009, and GDP per capita (in 2005 PPP dollars) over $8,000 as
of 1970.
50
Figure 3 -- Annual percentage growth rate in real GDP per capita,
1970-1985 and 1985-2010, versus taxes as a percentage of GDP
(average over each period), rich countries
IRL
6
y = 2.273 + 0.009x
(SE=0.017)
Growth rate (%)
5
4
3
2
1
0
English-Speaking, 1970-1985
English-Speaking, 1986-2010
European Core, 1970-1985
PRT
JPN
ESP GBR
AUS
European Core, 1986-2010
NOR
NLD AUT FIN
FIN
AUT
GRC IRL
FRA NOR
BEL
DEU
USA ITA
PRT
DNK
BEL
FRA
JPN CAN CAN DEU
GRC USA
NZL
SWE
CHE
ITA
ESP AUS
GBR
NZL
NLD
CHE
SWE
European Periphery, 1970-1985
European Periphery, 1986-2010
DNK
Japan, 1970-1985
Japan, 1986-2010
Scandinavia, 1970-1985
Scandinavia, 1986-2010
Regression Line
20
25
30
35
40
45
50
Total tax revenue as a percentage of GDP, average over period
Source: author's calculations based on OECD data. GDP per capita is adjusted for inflation and purchasing power
parity. Includes tax revenue of both central and sub-national governments. Includes all OECD countries with
populations over 1 million in 2009, and GDP per capita (in 2005 PPP dollars) over $8,000 as of 1970.
Change in growth rate (%)
3.5
Figure 4 -- Change in growth rate of real per capita GDP, 1970-1985
to 1985-2010, versus change in taxes as a percentage of GDP, 1970 to
1985, rich countries
y = 0.772 - 0.025x
IRL
(SE=0.074)
3.0
2.5
2.0
AUS
NLD
PRT
GBR
1.5
ESP
SWE
1.0
NZL
0.5
USA
0.0
DEU
CAN
GRC
CHE
BEL
AUT
FIN
DNK FRA
-0.5
JPN
NOR
ITA
-1.0
-2
0
2
4
6
8
10
12
Change in total tax revenue as a percentage of GDP, 1970 to 1985
Source: author's calculations based on OECD data. GDP per capita is adjusted for inflation and purchasing power
parity. Includes tax revenue of both central and sub-national governments. Includes all OECD countries with
populations over 1 million in 2009, and GDP per capita (in 2005 PPP dollars) over $8,000 as of 1970.
Econometric cross-country evidence on taxes and growth is mixed
• The graphs above suggest no effect of overall level of taxes on growth
– The final one does suggest a small negative effect, but not statistically significant
• Problems: reverse causality, omitted variable bias, and “bad control”
– Increased income increases demand for government (“Wagner’s law”)
– Recessions cause tax revenues to decline relative to GDP automatically (e.g., people fall
into lower tax brackets).
– Governments often enact tax cuts at bottom of recession. Subsequent recovery results
from response to Keynesian stimulus which only applies when economy is below
capacity, the effects of central bank policy, etc. Doesn’t tell us anything about long-run
effects of having a big government, since different issues are involved.
– And of course, many other factors influence growth.
– The “bad control” problem: controlling for a variable that is partly an outcome of the
causal effect you are trying to estimate can bias your estimates.
• Example: spending more on civil service and education may help reduce corruption,
which in turn improves growth. In that case, controlling for corruption may absorb
some of the positive effects of government on growth, biasing the estimated effect
of size of government (as measured by tax / GDP) towards negative.
• Slemrod (1995) critiques the literature
Econometric cross-country evidence on taxes and growth is mixed
• Bergh and Henreksen (2011) survey the recent literature.
– They conclude that for rich countries, increasing taxes by 10% of GDP reduces
annual growth rate by 0.5%-point to 1%-point.
– But estimates are very sensitive to reasonable changes in set of control
variables, which can produce an estimate of zero effect of taxes on growth
(e.g., Bergh and Karlssson 2009)
– Their preferred method, which leads to their main conclusion above,
estimates lots of regressions with different small subsets of control variables,
and constructs an average estimate weighted by R-squared (overall forecasting
accuracy) of each regression.
• But this does not really solve the reverse causality, omitted variable bias,
and “bad control” problems discussed on previous page.
• They concede that they have not really established causality with any
confidence.
– They also concede that Scandinavian countries have clearly achieved high
growth with high taxes, and try to understand why.
• Well-designed policy, good institutions?
• Culture and trust?
Effects of taxes on hours worked
• Much prior research suggests hours worked are
not responsive enough to incentives to affect
aggregate labor income very much
– See, e.g., See Alesina, Glaeser, and Sacerdote (2005)
• Example: Moffitt & Wilhelm (2000): hours
worked by rich did not go up when 1986 tax
reform cut top rate from 50% to 28%.
• Those arguing taxes have a big impact on labor
supply point to cross-country evidence.
Figure 5 -- Annual hours worked per person aged 15-64,
versus tax rate on labor, 1997-2006 averages
1500
1400
Hours worked
1300
CHE
USA
JPN CAN
AUS
1200
GBR
SWE
AUT FIN
1100
y = 1492 - 8.34x
1000
ESP
NLDITA
DEU
900
(SE =2.43)
FRA
BEL
800
700
20
25
30
35
40
45
50
Average tax rate on labor
55
60
Source: author's calculations based on an updated version of data used in Ohanian, Raffo, and Rogerson (2007). Tax rate data
is from McDaniel (2009) and includes income, payroll, and consumption taxes. Hours worked is the product of average
annual hours worked among workers from The Conference Board (2010), and employment-to-population ratio for those aged
15-64 from Nickel and Nunziata (2001) updated by the author using data from OECD.
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Change in hours worked
Figure 6 -- Change in annual hours worked per person aged
15-64, versus change in tax rate on labor,
200
1960-1969 to 1997-2006
100
USA
AUS
0
CAN
SWE
-100
-200
y = -106 - 8.33x
ESP
NLD
CHE
JPN
AUT
-300
ITA BEL
(SE = 11.50)
FIN
-400
GBR
-500
DEU
FRA
-600
0
5
10
15
20
25
Change in average tax rate on labor between 1960-69 and 1997-2006
Source: author's calculations based on an updated version of data used in Ohanian, Raffo, and Rogerson (2007). Tax rate data
is from McDaniel (2009) and includes income, payroll, and consumption taxes. Hours worked is the product of average
annual hours worked among workers from The Conference Board (2010), and employment-to-population ratio for those aged
15-64 from Nickel and Nunziata (2001) updated by the author using data from OECD.
Taxes and Hours Worked: Discussion
•
The graphs imply:
– A 10% increase in tax rate (e.g., from 30% to 33%) would reduce hours worked by 1.7%.
– It would need to reduce hours worked by 10% to put us on the wrong side of the Laffer curve,
so this implies we’re nowhere close to that.
– At recent U.S. levels of taxation and hours worked, the graphs imply that a 10% increase in
after-tax wage is associated with about a 4% increase in hours worked.
•
•
Blomquist and Simula (2010) calculate that this would imply that the economic cost of rasing an
additional $1 of revenue from an uniform across-the-board tax rate increase in the U.S. would be
about $1.44.
But many other factors could explain this relationship
– Unions pushing for mandatory vacations and shorter work weeks in Europe for reasons
unrelated to taxes
– Other government policies such as unemployment insurance, pensions
– “Income effects” of technology (higher wages and incomes -> people choose more leisure)
– See Alesina, Glaeser, and Sacerdote (2005)
•
Ohanian, Raffo, and Rogerson (2007) find an effect about twice as large
– But that is driven by time series variation common to all countries (not larger declines in hours
for countries with larger tax increases).
– They do not control for time fixed effects (so they are not doing a “difference-in-differences”
comparison)
– Maybe biased due to common technological change across countries leading to common
income effects?
Figure 7 – Do rising top income shares imply progressive taxes on
the highest incomes are especially harmful to the economy?
Source: reproduced directly from Saez, Slemrod, and Giertz (2012). Income excludes
capital gains.
Figure 8 -- Outside the top 1%, there was a much
smaller change in income despite tax cuts
Source: reproduced directly from Saez, Slemrod, and Giertz (2012). Income excludes
capital gains.
Figure 9 -- Larger cuts in top tax rate are associated with larger
increases in top income shares across countries
Source: reproduced directly from Piketty, Saez, and Stantcheva (2011). Income excludes
capital gains.
If the cross-country relationship between tax
cuts and top income shares shown above were
entirely driven by real economic responses (e.g.,
working harder):
– The economic cost of raising $1 more tax revenue
from a top-bracket taxpayer would $1.55
– The peak of the Laffer curve would be at a top tax
rate of 57%
• But there are other possible explanations for rising top
income shares
–
–
–
–
–
Skill-biased technical change
Globalization
“Superstar” theory
Executive compensation issues
Pay (e.g. stock options) tied to booming financial market
asset prices
– Shifting of income from corporate to personal tax base
– Changes in tax avoidance and evasion
• Costly, but can be addressed by tax reform and enforcement
• To the extent these other factors contribute, the
previous slide overestimates the unavoidable costs of
progressive taxation
High top marginal tax rates have not been associated with
lower growth in U.S.
Figure 12 -- Top marginal tax rates and economic
growth are uncorrelated across countries
Source: reproduced directly from Piketty, Saez, and Stantcheva (2011). Income excludes
capital gains.
Jobs of top earners suggest importance
of non-tax explanations
Figure 13 -- Percentage of national income (excluding capital gains) going to the top 1
percent of the income distribution, by occupation
18
Other
16
Computer, math, engineering,
technical (nonfinance)
14
Business operations (nonfinance)
12
Real estate
10
Medical
8
Arts, media, sports
6
Lawyers
4
2
Financial professions, including
management
0
Executives, managers, supervisors,
entrepreneurs (non-finance)
1979
1993
1997
1999
2001
2002
Source: Bakija, Cole, and Heim (2012).
2003
2004
2005
Income growth of top earners differed greatly by
occupation, yet all faced similar tax cuts
Figure 14 -- Percentage of national income (excluding capital gains) going to top 1 percent
by occupation, relative to 1979
3.5
Real estate
Financial professions, including
management
3.0
Business operations (nonfinance)
Computer, math, engineering, technical
(nonfinance)
2.5
Arts, media, sports
2.0
Medical
Executives, managers, supervisors,
entrepreneurs (non-finance)
1.5
Lawyers
Other
1.0
1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
Source: Bakija, Cole, and Heim (2012).
References
Alesina, Alberto, Edward Glaeser, and Bruce Sacerdote. 2005. “Work and Leisure In The U.S. and Europe: Why So Different?”
NBER Macroeconomics Annual, Vol. 20 Issue 1. (Link to freely accessible working paper version:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=706982).
Bakija, Jon, Adam Cole, and Brad Heim. 2012. “Jobs and Income Growth of Top Earners and the Causes of Changing Income
Inequality: Evidence from U.S. Tax Return Data” Working Paper, Williams Colllege
(http://web.williams.edu/Economics/wp/BakijaColeHeimJobsIncomeGrowthTopEarners.pdf).
Bergh, Andreas, and Magnus Henrekson. 2011. “Government Size and Growth: A Survey and Interpretation of the Evidence.”
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(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1610090)
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(http://www.conference-board.org/economics/database.cfm).
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through 2008 on 10/18/2009. (http://www.caramcdaniel.com/tax-files/mcdaniel_tax_update.xls?attredirects=0).
References
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Shrug? The Economic Consequences of Taxing the Rich, Joel Slemrod, ed., New York: Russell Sage Foundation and
Harvard University Press ,pp. 193-234. (Link to freely accessible working paper version:
http://www.nber.org/papers/w6621).
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(http://cep.lse.ac.uk/pubs/download/data0502.zip).
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