NCPA - National Center for Policy Analysis

NCPA Study: Lower Growth Is A Hidden Cost Of Taxation

July 1, 1998

Taxes for a certain amount of public goods and services -- such as infrastructure, protection of property and education -- can make private economic activity more productive, says economist Gerald W. Scully. But beyond some point, especially when taxes are used mainly to redistribute income, they reduce incentives enough to lower the rate of economic growth.

Using an economic model, Scully determined the tax rate that will maximize economic growth. For the 46-year period from 1950 through 1995, he found:

  • The growth maximizing tax rate for the United States is 21 percent of gross domestic product (GDP); this tax rate would have produced average annual real economic growth of 4.8 percent.
  • However, taxes took 24.2 percent of GDP in 1950 and kept rising, so the actual growth rate over the period averaged only 3.4 percent.
  • The additional 1.4 percentage points of growth would have resulted in workers now producing (measured in 1992 dollars) $107,900 in per capita output instead of $54,100.

This means the average person would have twice the real income he or she has today. And the resulting increase in revenues could have paid for all government programs and left the nation debt-free!

Most other industrial nations have taxes well above the optimal rate for their economy, says Scully. For example, he estimates:

  • On the average, the growth-maximizing tax rate is about 20 percent of GDP among developed countries -- ranging from 16.6 percent for Sweden to 25.2 percent for the United Kingdom.
  • Current levels of taxation, however, range from 34.1 percent in the United Kingdom to 51.6 percent in Denmark.

The experience of European nations that take an even higher percentage of GDP in taxes to reduce income inequality indicates the eventual result is lower economic growth, reduced job formation and increased unemployment.

Source: Gerald W. Scully (University of Texas at Dallas), "Measuring the Burden of High Taxes," Policy Report No. 215, July 1998, National Center for Policy Analysis, 12770 Coit Rd., Suite 800, Dallas, Texas 75240, (972) 386-6272.


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