Studies have found that Biden’s tax plan will destroy the economy – here’s why

Joe Biden’s tax plan has been touted as fair by the people who prefer progressive tax systems, saying it will only affect the rich and corporations. However, numerous analyses of the tax plan show this is not so; the tax will affect the whole economy and all workers. In fact, the Tax Foundation, in their analysis of the Biden tax plan, found the following potential outcomes:

  1. GDP would decline by 1.47 % in the long run
  2. After-tax income would decline by 6.5% for the top 1%, but it would decline by 1.7% for all taxpayers on average, by 2030
  3. A 2.54% decline in the capital stock
  4. A 517,800 loss of full-time equivalent jobs
  5. A 1.04% fall of the wage rate

A new study by economists from the Hoover Institution also found the tax plan would, in the long run, reduce employment, the amount of capital in the economy, real GDP, and consumption.

Tax incidence

One thing that helps us understand why this would be so is the concept of tax incidence. Tax incidence tells us who ultimately bears the burden of the tax regardless of whom the tax is levied upon. Tax incidence tells us how the burden of the tax is shared among shareholders. And in the end, tells us how best to design taxes that present the least damage to all shareholders involved.

The best way to understand tax incidence is to see what happens when a tax is levied on a good in the market. Who bears the burden of a sales tax depends on how responsive demand is to price changes, also known as price elasticity of demand.

When the demand for a good is inelastic (graph 1), a unit increase (decrease) in price results in less than a unit decrease (increase) in quantity demanded. In this case, when the sales tax increases, sellers have more wiggle room to raise prices before they can start to see demand for their goods go down. And this enables them to pass the majority to the entire burden of the tax to consumers through higher prices.

On the other hand, if demand is elastic (graph 2), that is a unit increase (decrease) in price results in more than a unit decrease (increase) in quantity demanded, sellers are warier of raising prices. Therefore, they tend to leave prices the same or increase them just slightly when taxes are raised. Sellers in this case tend to bear the majority or entire burden of a tax increase. The level of elasticity for a particular good determines how the tax burden (incidence) will be shared between a seller and buyer.

The corporate tax

Using tax incidence on corporate taxes helps us understand why research suggests that labor, not capital, bears the majority of the corporate tax burden. Capital is generally highly mobile (therefore, more elastic as represented by graph 2 above), unlike labor. Therefore, owners of capital easily pull their capital once they see a decrease in their rate of return. This minimizes the burden that they bear. Workers on the other hand incur big costs to moving so they are forced to stay in an economy where the rate of return to production has been decreased. They are forced to suffer lower wagers due to (1) the fact that capital has decreased, decreasing demand for labor (2) output or growth in output has decreased due to lower productivity which stalls wages.

Some research has also shown evidence that corporate taxes can be passed on to consumers through higher retail prices. And as shown this is especially true for goods that have an inelastic demand. The concept of tax incidence ultimately explains how progressive taxes even, though they do not fall on low-income individuals present a burden to low-income individuals through low investment and stunted economic growth.

It is through this distortion of economic behavior that taxes present a cost to low-income individuals. Generally, high-income individuals make their money through investments and businesses. And raising taxes on that group of people reduces their willingness to invest (effectively lowering the demand for capital and labor) and instead increases consumption. In the long run, the economy shrinks as it is working on lower and lower capital.

What this means

Defining fair tax can be very subjective. But what we can’t do is analyze taxes by looking at who the tax is levied upon. And that is usually what progressive tax supporters tend to do. As we have seen, who wins or loses (and by how much) when it comes to taxes rests on who really pays the tax in the end. And that is not always the person legally required to pay the tax.

Tax systems designed to advance ‘fairness’,  i.e. highly progressive tax codes that tax high-income earners and corporations heavily, are harmful not only because they disperse high costs on individuals paying them, but because they also distort behavior so much they end up stalling growth and shrinking the economy.