Working Papers

The Real Costs of Taxation

Ross Gittins is criticising the budget tax cuts by appealing to the seemingly common sense notion that the rich do not need an incentive to work.  Yet high marginal tax rates do not need to have a negative effect on labour supply to be costly.  The welfare costs associated with high marginal rates have more to do with distortions to decision-making.  These distortions can be costly simply by changing the way in which labour is supplied, they do not need to have a negative impact on supply per se.  This applies not just to decisions about labour supply, but also saving and investment, tax avoidance and evasion.

Gittins contradicts himself in making this argument, since he has been at the forefront of those arguing that the concessional treatment of capital gains has been a major culprit in the investment property boom and house price inflation.  Of course, Gittins sees this as an argument against the concessional treatment of capital gains, rather than one in favour of lowering high marginal rates, but he readily accepts the notion that taxes can have a significant distortionary impact on decision-making when it suits him.

The literature suggests that behavioural responses to changes in marginal tax rates are concentrated at the top end of the income scale, where most revenue is collected, which is why the welfare costs of taxation are so high (see Alex Robson for some US estimates in this regard).

posted on 19 May 2005 by skirchner in Economics

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This implies that the privileges granted to well-heeled investors in high gaining assets by the concessional Capital Gains Tax are economicly equivalent to the punishments meted out to well-heeled earners by the progressive High Income Tax. Presumably I-E would favour a flat tax on income derived from all assets - whether intellectual, industrial or real capital. That would stop efficiency distortions alright, although it would be inequitable.

Posted by Jack Strocchi  on  05/19  at  04:13 PM

pure rubbish from gittins:

“will gain a tax saving of up to $6 a week, while the remainder gain savings rising to a maximum of $42 a week (plus a further $45 in July next year) for the 3 per cent of taxpayers earning $125,000 or more.”

lets measure tax cuts in absolute terms, but happily tax people at progressive rates!

what hypocrisy.

Posted by .(JavaScript must be enabled to view this email address)  on  05/19  at  04:49 PM

More to the point, what is the basis for Robson’s claim that progressive taxation inhibits economic efficiency? There is little evidence that high progressive tax rates have inhibited the overall supply of labour or capital. The tax law may encourage distortions but it is more likely that loop-holed deductions, rather than progressive impositions, deflect investment and income from its most valued destination.

Posted by Jack Strocchi  on  05/20  at  11:33 AM

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