Taxes Are Already Higher Than You Think

From Edward Prescott and Lee Ohanian, at the Wall Street Journal:

President Obama argues that the election gave him a mandate to raise taxes on high earners, and the White House indicates that he won't compromise on this issue as the so-called fiscal cliff approaches.

But tax rates are already high—much higher than is commonly understood—and increasing them will likely further depress the economy, especially by affecting the number of hours Americans work.

Taking into account all taxes on earnings and consumer spending—including federal, state and local income taxes, Social Security and Medicare payroll taxes, excise taxes, and state and local sales taxes—Edward Prescott has shown (especially in the Quarterly Review of the Federal Reserve Bank of Minneapolis, 2004) that the U.S. average marginal effective tax rate is around 40%. This means that if the average worker earns $100 from additional output, he will be able to consume only an additional $60.

Research by others (including Lee Ohanian, Andrea Raffo and Richard Rogerson in the Journal of Monetary Economics, 2008, and Edward Prescott in the American Economic Review, 2002) indicates that raising tax rates further will significantly reduce U.S. economic activity and by implication will increase tax revenues only a little.

High tax rates—on both labor income and consumption—reduce the incentive to work by making consumption more expensive relative to leisure, for example. The incentive to produce goods for the market is particularly depressed when tax revenue is returned to households either as government transfers or transfers-in-kind—such as public schooling, police and fire protection, food stamps, and health care—that substitute for private consumption.

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Actually, other economic research says tax rates are considerably higher than that, particularly in California. See: "Ezra Klein: Yesterday's Revenue Can't Support Tomorrow's America."