Taxes and Economic Growth

Studies | Economy | Taxes

No. 292
Tuesday, November 21, 2006
by Gerald W. Scully


Why Have Voters Allowed Such Private Wealth Destruction?

One might ask why citizens have allowed this destruction of private wealth through excessive taxation and why politicians have given up $61.9 trillion in revenues since 1950. There are several explanations.

"Most people don't know their total tax bill."

First, and perhaps foremost, people generally are cognizant only of their actual earnings, not their potential earnings. They do not miss the lost 2.6 percentage points of average annual growth in real output because they never had it. Also, many are ignorant of the intimate link between taxation, incentives and economic efficiency. Moreover, politicians have been ingenious in hiding taxes. Because most taxes on earned income are deducted from wages before the workers receive them, many are unaware of their actual tax burden. People also pay a host of other taxes (property taxes, sales taxes, excise taxes and so forth), but most do not know how much of their total income they pay in taxes because so many taxes are hidden or are a small portion of an individual transaction.

Second, the theory of government growth is still being developed. As mentioned above, government has grown at times by distinct jumps (World War I and World War II each yielded a permanent 50 percent or so increase in the tax burden) and at times incrementally (for example, the Roosevelt years, 1932-40, and during Johnson's Great Society of the 1960s). Patriotism silenced objection to higher tax rates and expansion of the tax base during the wars. The Great Depression conditioned people to the idea of a larger role for government. New and expanded government redistribution programs tend toward what might be called creeping incrementalism. For example, the food stamp program began in the early 1960s as a modest $175 million effort and now costs $36 billion.13 Another discrete jump in the size of government is on the horizon if it assimilates the $1.7 trillion health care industry. Proposals for national health insurance, if passed, would push taxes as a percent of GDP above the 40 percent level.

Third, politicians face a different set of priorities than do other citizens and often fail to appreciate how the world works. Most politicians are lawyers. The function of lawyers is to redistribute income between plaintiffs and defendants. Thus, politicians tend to view taxpayers and voters as the functional equivalent of plaintiffs and defendants. They often misunderstand how productive activities occur and how their decisions affect such activities. For example, for 200 years politicians have been told the benefits of free trade, yet with a couple of exceptions (such as Britain in the 19th century and the United States after World War II), protectionism has been preferred by politicians and generally favored by the public. For 200 years, politicians have been warned that excessive taxation promotes inefficiency and discourages compliance (from Adam Smith's observations about tariffs and smuggling to the supply-siders' observations about marginal tax rates). The deleterious effect of massive regulation on productivity is well known, yet the burden grows.14 Henry Manne, dean emeritus of the law school at George Mason University, has suggested that the amount of law, mainly statutes, is 100 to 1,000 times greater today than in 1933.15


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