It is clear that high rates of taxation lower the rate of
economic growth, and that states that lower their tax burdens are rewarded with
an enhancement in their economic growth. Income taxes levied on individuals and
corporations are particularly detrimental to growth, more so than consumption
based taxes or user charges that do not reduce incentives to work or form
capital. Progressive taxation not only lowers the rate of economic growth
compared with proportional or regressive taxation, but in the process hurts the
very persons that progressive taxes are designed to help: the poor.
– Richard K. Vedder 1981
The government needs tax revenues
to operate: to provide law and order, to provide for the common defense, and
for the general welfare. Beyond that,
many people have urged, with some success, that taxes should redistribute
income, “spread the wealth around”, punish those who earn too much, support
those who earn little or are unemployed, and direct behavior of individuals and
corporations into desired occupations.
For these reasons, the US Tax Code has become very long, very complex
and very costly for those who have to comply with it.
In 2010 the U.S. tax code was 71,684
pages in length. The Congress adds a few thousand pages every year. Filling out Federal tax forms costs US
residents more than $300 billion per year. Every year it costs more, because
Congress adds more regulations.
Taxes have become a drag on our
economy and have resulted in unemployment.
To understand how taxes had affected American life, let’s contrast the
effect of taxes on a typical American family in the past with a similar one
The early pioneers in
America had lots of work to do. They had to clear the trees, brush and rocks
off the land so that they could plant. They needed houses to live in, and barns
to store the grain, and protect their tools and livestock from the winter. It
was hard work. Most of them were very poor. But they were free, independent,
and proud of what they accomplished.
What little they were able to save, they invested in farm machinery and
livestock to make their lives more productive. William and Lydia Brewster
living in 1811 were one of these families.
There were tax
collectors, of course, even in the early days. But they didn’t collect much
from these rugged pioneers. The government was very small. To improve their
lives, William and Lydia had to put many hours each week into investments in
their farm which did not result in food on the table at the time: draining
swamps, erecting fences, building roads. Each of these activities, however,
made their future life more productive. After thirty years of hard work, they
had a good income from their farm, a comfortable house, and eight healthy
children most of whom had married and started families of their own.
Much of the increased productivity came from capital goods that
they bought in the village: a plough, two strong work horses, a farm wagon, a
milk cow and a bull, some chickens, plus picks, shovels, a wheelbarrow and a
manure spreader. To earn the money for these capital investments, William and
Lydia had to sell cash crops in the village: potatoes, corn, eggs, milk, plus
wild blackberry jam and honey that Lydia canned herself.
On the thirty year struggle from poverty to affluence,
William and Lydia had to invest more than a third of their time and income
every week on long term investment activities. The rest they used for feeding
and clothing their large family. Fortunately, when they earned money, they were
able to invest it in capital goods right away. Their income increased as a
result. In the money of their day, the value of their output per year went from
$200 in the year when they were first married, to more than $4,000 per year
(equal to about $120,000 today) when they had their thirtieth wedding
Modern Families Lots of Taxes
Contrast William and Lydia with their modern counterparts
Jim and Mary Anderson trying to make a go of it on the same farm, two hundred
years later, in 2008. They have advantages that William and Lydia did not have:
a good education, good roads, and high tech capital equipment that they could
buy in the village. But they had one big disadvantage: taxes that took about
28% of everything that they earned. There were Federal, State and County taxes.
Jim and Mary worked just as hard as their ancestors, but their income did not
rise. They saved a quarter of everything that they were able to earn, but taxes
took away all of that, and more. They started out with high hopes. They were
able to earn $28,000 from the produce of their farm in the first year. After
paying for food, clothing, utilities, gasoline and payments on their farm and
car, they had almost $8,000 saved up for purchase of a tractor and some modern
farm equipment. When they got the tax bills, they found that they owed $9,770
– a combination of social security taxes, federal and state income taxes, and
local property taxes. They borrowed $1,770, and postponed the purchase of the
The next year was even worse. Without more capital goods,
their income was the same: $28,000. But this time, in addition to the $9,770 in
taxes, they had to pay $800 in payments and interest on their last year’s debt.
They had to borrow $2,500 more. On top of that Mary was pregnant. The next few
years were a slow slide from high hopes to poverty. They finally realized that
they could not succeed in farming. They sold the farm. Jim got a job in the
village, pumping gas, and Mary applied for food stamps to feed the children.
How taxes are used
Jim and Mary feel that taxes make it impossible for them to
duplicate the experience of their ancestors: to build a life of affluence by
hard work, saving, and investment. But the officials running the government see
it differently. Look at the situation from their point of view:
The government has a steady income from taxes, which they
use for the public good. They have put millions of people to work maintaining
roads, and parks, building public housing, and land reclamation projects. They
support millions through generous and caring social security and welfare
programs. They provide free medical care for the poor and the elderly. They run
a vast public school system, and keep a modern police force busy combatting
drugs and crime. They have social welfare workers in every community helping
people like Jim and Mary to apply for the food stamps and other benefits to
which they are entitled. What’s wrong with that?
What Taxes Do
The fact is that the taxes that Jim and Mary paid reduce
their saving and investment. While some taxes reduce consumption, most of them
reduce saving: for the simple reason that for most people, saving is something
you do with your extra income, after your basic consumption needs are met. So
the vast majority of tax dollars reduce saving and investment.
Profits come from savings that are invested through
financial intermediaries with entrepreneurs who start and run businesses. These
businesses employ workers, and return profits to the Intermediaries and to the
consumers who started the process off by saving. Taxes that reduce saving reduce the investment
in business, resulting in reducing employment and profits.
What does that mean for society today? It means that we
have fewer rags-to-riches stories like William and Lydia Brewster and more
welfare stores like Jim and Mary Anderson. Of course, you can say that Jim and
Mary were wrong to try farming on their own. If Jim and Mary had gone to work
for a large corporation, they might have done all right. Many people do.
But, on the whole, high taxes reduce the rate of growth of
our output, reduce productivity, reduce
the possibilities of our becoming wealthy and increase unemployment.
Richard K. Vedder, “State and Local Economic Development Strategy:
A Supply-Side Perspective”, U. S. Congress, Joint Economic Committee,
October 1981 Page 340.