How Tax Rates Affect Revenue

How Tax Rates Affect Revenue

How Tax Rates Affect Revenue

As Congress and the administration debate the need for tax increases in the debt deal, economist Antony Davies wonders if the goal of raising revenue to shore up our budget problem is actually met by raising rates. 

“Historically, altering the top marginal income tax rate has had no effect on tax revenue as a fraction of GDP,” said Mercatus scholar Antony Davies. “The same is true for the average marginal tax rate, Social Security and Medicare tax rates, the effective corporate tax rate, and the capital gains tax rate.”

“There are a variety of reasons that may explain this,” said Davies. “It could be the Laffer Curve, maybe people are good at shifting the sources of their income in response to tax-rate changes, maybe people expend more effort looking for loopholes as tax rates rise, or maybe Congress plays a shell game – raising tax rates while exempting more income from taxes.”

“However, the evidence remains – the government can only set tax rates, it has little control over tax revenue,” he said. “Since, regardless of tax rates, tax revenue is a relatively constant 18 percent of GDP, this suggests that the solution for raising tax revenue is to adopt a tax policy that causes GDP to grow more quickly.”

 

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