Earlier this year, Syracuse University economists James Ziliak, Thomas Kniesner and Douglas Holtz-Eakin (now director of the Congressional Budget Office) found that the labor response to tax changes was twice the standard estimate. Their research suggests that we could increase our living standard by 20 percent if we just collected the same revenue from a flat-rate system.
In 2001, economists Marco Bianchi, Bjorn Gudmundson and Gylfi Zoega published a paper in the prestigious American Economic Review examining an interesting natural experiment in Iceland. Owing to a major tax reform, workers in that country in effect got a one-year reduction in their tax rate to zero. The economists found that during this time, there was a significant jump in the labor supply of both men and women, which fell back to its previous level when tax rates returned to normal.
In his Richard T. Ely lecture to the American Economic Association in 2002, economist Edward Prescott of the University of Minnesota concluded that almost all of the difference in living standards between the United States and France is accounted for by the impact of taxes on work. He notes that while the capital-output ratio is about the same in both countries, French workers work 30 percent less, due entirely to the much heavier French tax burden on labor. Prescott concluded that if France had the U.S. tax system, the French standard of living would immediately rise by 20 percent.
This result is confirmed by an examination of data from the Organization for Economic Cooperation and Development. I looked at total yearly work hours and taxes as a share of the gross domestic product in various countries. The data show clearly that the heavier the tax burden, the fewer the hours worked. In Mexico, the United States and Japan, where the tax burden is less than 30 percent of GDP, workers put in more that 1,800 hours a year on the job on average. In France and Belgium, where taxes take more than 45 percent of GDP, workers spend fewer than 1,600 hours on the job because it just isn't worth the effort once taxes are deducted from their pay.
Common sense tells us that people work less when their after-tax reward is reduced. It's good to see that economists finally agree.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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