NCPA - National Center for Policy Analysis


August 17, 2009

Politicians tend to like high tax rates because they believe it yields more revenue for them to redistribute. Yet the perverse incentive effects of high rates tend to limit the increase in revenue, since the higher the rates, the more worthwhile are tax avoidance activities.  At some point it becomes better to consume than invest and play than work, since the rate of return is so low, says Doug Bandow, a senior fellow at the Cato Institute.

According to a Tax Foundation study on the economic cost of high tax rates:

  • Consider the combined effect of Obama's proposal to raise the top tax rate from 35 percent to 39.6 percent and the new surtax; this means high-income households will receive 54 cents rather than 65 cents from every dollar they earn.
  • That is, the after-tax reward from earning income falls by 17 percent.
  • Based on the research mentioned above, with such large increases in tax rates, we can expect taxpayers facing the top tax rates to reduce their reported incomes by nearly 7 percent.

Overall, simulating the effect of the higher tax rates in 2011 shows that the federal government can expect to raise at most only 60 cents on the dollar.  Moreover, this is a cautious estimate; thus, we might expect an even faster shrinkage of the federal tax base from these tax increases, says the Tax Foundation.

President Barack Obama wants Americans to believe that they can enjoy all of his proposed programs without paying for them because "the rich" will cover the cost.  But taxing "the rich" will only be the start.  To get real money, the big spenders are going to have to tax the middle class as well, says Bandow.

Source: Doug Bandow, "The Price We All Pay for High Tax Rates," Cato At Liberty, August 13, 2009; based upon: Robert Carroll, "The Economic Cost of High Tax Rates," Tax Foundation, Fiscal Fact, No. 182, July 29, 2009.

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