While I sometimes make moral arguments against the current tax system (because it is corrupt, because it doesn’t treat people equally, because it provides unearned wealth for insiders, etc), my main arguments are based on economics.
High tax rates on workers and entrepreneurs discourage productive behavior.
Double taxation on income that is saved and invested discourages capital formation.
Tax preferences and other loopholes bribe people to use resources inefficiently.
These are the principles that explain why I like tax reform, why I promote the Laffer Curve, and why I advocate for tax competition.
Maybe it’s time, however, for a back-to-basics primer on taxes and behavior. That’s why I’m very glad that Professors Tyler Cowen and Alex Tabarrok of George Mason University (and the Marginal Revolution blog) are producing videos on various economic principles.
And I particularly like a video they produced which uses supply and demand curves to show how taxes reduce economic output.
But before we watch that video on taxes and “deadweight loss,” here’s a video on how supply and demand curves interact.
Feel free to skip this video if you feel confident in your understanding of these economic concepts (and also feel free to watch this video on the demand curve and this video on the supply curve if you don’t have any background knowledge and need to start at the beginning).
Now let’s look at their first-rate video on how taxes lead to less economic output and foregone value for both buyers and sellers.
Very well done. I particularly like the closing example showing how the so-called luxury tax backfired.
Here are a few of my thoughts to augment Professor Tabarrok’s analysis.
1. The video looks at how taxes affect the equilibrium level of output for an unspecified product. Keep in mind that this analysis applies to “products” such as labor and investment.
2. It should go without saying (but I’ll say it anyhow) that ever-higher tax rates impose ever-higher levels of deadweight loss.
3. The point about avoiding taxes on goods where there is high “elasticity” has important lessons for why it is foolish to impose class-warfare tax rates on people who have considerable control over the timing, level, and composition of their income.
4. This analysis does not imply that all taxes are bad. Or, to be more precise, the analysis does not lead to the conclusion that all taxes are counterproductive. If government uses money to provide valuable public goods, the overall effect on the economy may be positive.
P.S. I’ve shared a couple of tests that allow people to determine their philosophical/political leanings, including the libertarian/anarchist purity quiz, the circle test to see where you are on the spectrum from socialism to voluntarism, and a candidate affinity test.
I’m a sucker for these quizzes, even when they don’t make sense.
And if you like these tests (particularly one that does make sense), then you’ll enjoy this quiz from David Boaz’s new book, The Libertarian Mind: A Manifesto for Freedom.
You’ll be shocked to learn I got a perfect score. Which is probably a good thing since David is one of my bosses.
The Princess of the Levant will snicker at the thought of me being described as “cosmopolitan,” but I’ll tell her that even a rube can have a cosmopolitan vision of society.
And remember, libertarians also have the self confidence to enjoy self-deprecating humor, so we must be good folks.
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[…] I discuss class-warfare tax policy, I want people to understand deadweight loss, which is the term for the economic output that is lost when high tax rates discourage work, […]
[…] I discuss class-warfare tax policy, I want people to understand deadweight loss, which is the term for the economic output that is lost when high tax rates discourage work, […]
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[…] use economic jargon, “deadweight losses” grow exponentially as tax rates are […]
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[…] Such as the observation that taxes hinder prosperity by reducing economic output (what economist refer to as deadweight loss). […]
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[…] high measure of elasticity means a large “deadweight loss” since taxpayers are choosing to earn and/or report less […]
[…] high measure of elasticity means a large “deadweight loss” since taxpayers are choosing to earn and/or report less […]
[…] high measure of elasticity means a large “deadweight loss” since taxpayers are choosing to earn and/or report less […]
[…] tried to justify extortionary tax rates. Simply stated, high tax rates hinder the economy, create deadweight loss, and don’t produce revenue […]
[…] can sympathize with their skepticism. When I was first learning about public finance and studying supply-and-demand curves showing deadweight loss, I also wondered about the supply-side claim that marginal tax rates mattered. Even after I started […]
[…] Such taxes still drive a wedge between pre-tax income and post-tax consumption, so they do result in less economic activity (what economists refer to as “deadweight loss“). […]
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[…] a visual from an excellent video tutorial by Professor Alex Tabarrok. It shows that government grabs a share of private output when a tax is […]
[…] entry was posted on 09/02/2018 Three years ago, I shared two videos explaining taxation and deadweight loss (i.e., why high tax burdens are bad for […]
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[…] core principle is that taxes create distortions by reducing demand and supply. Which is why it’s not a good idea to impose high tax rates on […]
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[…] lawmakers did move in the right direction when looking at the key principles of good tax reform (reducing tax rates, reducing double taxation, and reducing distortionary preferences). Final grade […]
[…] think there’s value in my approach (if people grasp an underlying principle, that can impact their understanding of both current and future policy fights). But there’s […]
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[…] of which can be illustrated using supply and demand curves, for those who prefer something […]
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[…] of this should be a surprise. We know taxes impact the decisions of high-income, high-productivity people, everyone from entrepreneurs to […]
[…] bottom line is that people respond to incentives. When tax rates climb, there’s more “deadweight loss” in the economy. So when tax rates fall, output […]
[…] don’t realize (or prefer not to acknowledge) that changes in tax rates alter incentives to engage in productive behavior, and this leads to changes in taxable income. Which leads to changes in tax revenue, a relationship […]
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[…] Don’t they understand the basic economics of supply and demand? […]
[…] And you’re more likely to get a better-performing economy when marginal tax rates are reasonable. […]
[…] And you’re more likely to get a better-performing economy when marginal tax rates are reasonable. […]
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[…] i) Less economic output? […]
[…] MRU videos are great tutorials about economics. In prior posts, I’ve shared videos explaining how taxes destroy economic value, highlighting the valuable role of market-based prices, and revealing the destructive impact of […]
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[…] The MRU videos are superb tutorials. In prior posts, I’ve shared videos explaining how taxes destroy economic value and highlighting the valuable role of market-based prices, and they’re all worth a few […]
[…] few days ago, we used supply-and-demand curves to illustrate how taxes reduce economic […]
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[…] By Dan Mitchell […]