CBO: Income tax hikes more damaging than others
Just recently, the Congressional Budget Office (CBO) released a study analyzing how financing increased spending (of 5 to 10 percent of GDP annually) through tax hikes would affect the economy. The CBO study specifically
focuses on how taxes on labor income, capital income, and consumption affect how much people work and save.
The findings confirm what has long been revealed by other studies. That is, income tax hikes, especially on capital, are more damaging to growth. Progressivity also worsens the damaging impact of income tax hikes.
The Tax foundation summarizes the findings of the study.
The authors find that labor taxes are less economically harmful than taxes on capital, as capital is more mobile and sensitive to taxation. For example, a labor tax-raising 5 percent of GDP in revenue would reduce GDP by 3.2 percent in 2030, while a progressive income tax would reduce GDP by 4.5 percent. Progressive income taxes are more damaging to growth because “high-productivity workers reduce their hours worked and because higher taxes on asset income reduce the incentive to save and invest relatively more than under the two flat taxes.”
The Tax foundation also found similar through their own calculations.
We find broadly similar results when using the Tax Foundation General Equilibrium model, namely that progressive income taxes are the most economically damaging of the three options. We find that a progressive income tax of 5 percent of GDP would reduce long-run GDP by 3.4 percent, shrink American incomes (GNP) by 3.8 percent, and eliminate about 3.6 million jobs. We find that a flat labor tax of 5 percent of GDP would reduce long-run GDP and GNP by 2.2 percent and eliminate about 2.4 million jobs.
Table 1: Long-Run Economic Effects of Stylized Options to Raise 5 Percent of GDP in Revenue
| Flat Labor Tax of 5% of GDP | Flat Income Tax of 5% of GDP | Progressive Income Tax of 5% of GDP | |
|---|---|---|---|
| Gross Domestic Product (GDP) | -2.2% | -2.8% | -3.4% |
| Gross National Product (GNP) | -2.2% | -3.2% | -3.8% |
| Capital Stock | -2.4% | -3.6% | -4.5% |
| Full-Time Equivalent Jobs | -2,425,000 | -3,000,000 | -3,550,000 |
Indeed all taxes are not created equal. As the CBO states, generally
the less a tax distorts people’s decisions to work, save, and invest, the smaller the economic effects are per dollar of revenues raised. As any tax rate increases, the size of the resulting economic distortion grows.
Income taxes are highly distortionary — they discourage productive economic activity to a higher margin compared to other taxes.
At American Experiment, we have argued that policymakers in Minnesota should focus on enacting policies that grow our economy if they want to boost revene. As the evidence points out, soaking the rich and corporations will likely only drag Minnesota’s lagging economy further down.