Prescott and Ohanian on US taxes

High tax rates—on both labor income and consumption—reduce the incentive to work by making consumption more expensive relative to leisure, for example. The incentive to produce goods for the market is particularly depressed when tax revenue is returned to households either as government transfers or transfers-in-kind—such as public schooling, police and fire protection, food stamps, and health care—that substitute for private consumption.

In the 1950s, when European tax rates were low, many Western Europeans, including the French and the Germans, worked more hours per capita than did Americans. Over time, tax rates that affect earnings and consumption rose substantially in much of Western Europe. Over the decades, these have accounted for much of the nearly 30% decline in work hours in several European countries—to 1,000 hours per adult per year today from around 1,400 in the 1950s.

U.S. growth is currently weak, and overall output is 13.5% lower than what it would be had we continued on the pre-2008 trend.

The economy now faces two serious risks: the risk of higher marginal tax rates that will depress the number of hours of work, and the risk of continuing policies such as Dodd-Frank, bailouts, and subsidies to specific industries and technologies that depress productivity growth by protecting inefficient producers and restricting the flow of resources to the most productive users.

If these two risks are realized, the U.S. will face a much more serious problem than a 2013 recession. It will face a permanent and growing decline in relative living standards.

Source: The Wall Street Journal.

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8 Responses to Prescott and Ohanian on US taxes

  1. H B Bear

    “…subsidies to specific industries and technologies that depress productivity growth by protecting inefficient producers and restricting the flow of resources to the most productive users.”

    The “destruction” of creative destruction is highly under-rated.

    How much wealthier would all Australians now be if Japanese imports were allowed to swamp the Australian car manufacturing industry in the 1970s? Just yesterday Stephen Smith was releasing a report on one of the greatest industrial failures, Bomber’s Collins Class submarines, while laying the groundwork for another $35bn spend to save a couple of South Australian marginals.

    The “too big to fail” argument also served to protect vast numbers of bankers and capital that should have been liquidated for more valuable uses.

  2. blogstrop

    I thought the US would be stuffed after one term of Obama, and it’s so far in debt that may still be true. Two terms and they certainly are.

  3. H B Bear

    The only person in the US who gets up in the morning and makes a decision between going to work and going to the golf course is The Magic Negro. For everyone else the decision is between working your arse (or ass) off and being unemployed/broke.

    Tax rates are much more likely to influence things like do I go exploring for minerals in Australia or Africa, where do I stick my next car assembly plant. European labour hours worked are as likely to be a function of restrictive labour supply laws (unfair dismissal, holidays etc) leading to a substitution of capital for labour where possible, than whether Fritz puts in more overtime at the BMW plant based on his marginal tax rate.

    For all that Europe is more stuffed than the US. They are both stuffed.

  4. Elizabeth (Lizzie) B.

    Agree, H B Bear. High marginal tax rates are disincentives to individuals (although sometimes people carry on regardless because they want to do so or because they don’t have much option to do otherwise). The impact of labor laws on the hiring and investment decisions of firms are probably more important, as you note. Firms don’t just replace labour with investment in high tech capital, they shift labour costs elsewhere (which Fritz has found OK because it’s all in the Euro for him; I found out that many Audi cars are made in Spain and it is still cost effective to ship them back to Germany for final quality control before shipping ex-Europe – a lesson the Italians learned long ago with the north/south divide in Italy for their Alfas).

    Running this discouraging tax and investment policy agenda at the same time as encouraging and expanding the nature and range of public sector spending is, eventually, buying into a Greek solution.

    America, once land of the free is now land of the free stuff. In other words, turning into the land of an economy free to get stuffed.

    All to end in tears of some sort of another.

  5. Pedro

    Why this is all nonsence. Picketty and Saiz proved the optimum top rate is 110% and I’ll bet those euro govts were merely responding to a unanimous desire from the electorate to force the workaholics to get a life.

  6. Rococo Liberal

    The problem is that Government in the US (and here to a large extent) has got so complex that the average voter doesn’t really understand it.

    As Mark Steyn has stated, this means that voters are motivated by tribal allegiances rather than political decisions when voting. Thus 95% of blacks go for Obama, as do the rest of the Rainbow coalition. They don’t know or care about political issues such as Benghazi or the economic fuck-up caused by Obama. No, it’s all about voting for the cool guy whose face or feelings match the voter in question.

    America is a socialistic mess that is far worse than Europe, because it is in denial about how nannyish and staist it is.

    After all, don’t all the rubbishy left-wing ideas about discrimination, equality of outcomes and global warming hysteria all stem from the US? Europeans are just amateurs at being nanny statists in comparison to the Democrat controlled cities from the US.

  7. Elizabeth (Lizzie) B.

    The boomer generation’s ‘revolution’ in thinking about their country’s proud hereitage of authority, work, savings, investment and family (thinking about them by rejecting them in favour of ‘communal’ ideologies of redistributive privilege) is a cancer that America has yet to conquer. It has grown and taken over much of that was once America’s pride: the cultural and economic institutions, the government apparatus, even the army.

    Vale (for the time being) the US.

  8. Eyrie

    reduce the incentive to work by making consumption more expensive relative to leisure, for example.”"

    Yep, kind of hard to tax a day off work.

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