The Deadweight Loss of Taxation
With all the talk of increased taxation in the coming years, e.g., the budget passed in the House earlier this year would raise taxes by more than $3,000, according to this letter from the National Taxpayers Union, it time to take a look at the economic costs of taxation. A research report (requires Adobe) issued this month by Congress’ Joint Economic Committee does that.
The report begins by defining just what is “excess burden” or deadweight loss of taxation.”
“The overall burden of taxation is much larger than the tax receipts that government collects each year because taxes distort the behavior of individuals and firms. (emphasis added) These distortions reduce potential output or economic welfare. Economists refer to this reduction as the excess burden or deadweight loss of taxation, (emphasis in the original) which is usually expressed as a percentage of tax collections either on average or at the margin (the last dollar of tax collected).”
In its conclusion, the report says:
“Given the enormous size of the excess burden from the existing federal tax system, policymakers should pay greater attention to the effects of proposed changes on the efficiency and international competitiveness of the U.S. economy when shaping federal tax policy.”
In reporting on the JEC study, Jeff Dircksen and Dan St. John note at Government Bytes, the blogsite of the National Taxpayers Union, that economist Martin Feldstein:
"looked at the effect a 1 percentage point increase in all federal taxes. He found that the cost of raising an additional dollar to spend is $1.76. Continuing this though, Feldstein concluded that the hypothetical tax increase would only pull in 57% of its potential."
By federal standards, the report is short – only four pages. With the potential of adding $3,000 annually to the tax burden, Congress should be looking to cutting spending rather than adding to the tax burden. Moreover, it's quite readable.