Workers in Countries with High Taxes Provide Less Labor

The Biden administration’s social spending plans are not fully articulated, but constitute a major addition to the $2.2 trillion Covid-19 pandemic relief package supported by the Trump administration a year ago.  The American Rescue Plan passed win March 2021 has already added $1.9 trillion to that total.  It provided relief funds for states, local governments, tribes and US territories.  It also provided helicopter cash to individual Americans, enlarged unemployment insurance benefits and enlarged federal housing subsidies. 

A second and third plan are in the wings waiting to be fully articulated.  The second is the American Jobs Plan, focused on a very generously-defined concept of infrastructure spending.  This plan has an estimated price tag of $2.3 trillion.  Biden has rejected the use of user charges to finance even the genuine, infrastructure projects. At the moment, his aim is to finance this catch-all program with through increased taxation of domestic and multi-national corporations.  

The third plan is the American Families Plan, with an estimated price tag of $1.8 trillion.  One trillion is direct spending and the rest likely will take the form of targeted tax credits and enlargement of the IRS.  The list of programs supported by this plan is huge, including subsidized child care, medical and family leave programs. health insurance assistance, free universal pre-school, free community college education to immigrants as well as citizens.  These would be paid for by redistributive tax levies on those with high incomes and capital gains.  

The Biden plans thus represent an increase in spending of $6 trillion   A long literature on taxes and labor supply suggests that there will be a reaction of workers to any tax levies needed to fund these plans.  However, these studies do not roll up the impact of higher taxes to the national level.  

The purpose of this post is to present an examination of the impact of higher taxes nationwide.  It uses a cross section of national data developed by the Organization for Economic Cooperation and Development (OECD).  The OECD membership is comprised of most of the major, western countries.  We use OECD data in this study to measure the national impact of increased taxation.  

Specifically, the OECD periodically measures the tax burden on the typical worker by constructing the so-called Tax Wedge—the percentage of the typical worker’s income that is usurped by government levies.  The OECD measure is based on the percentage tax exposure of a household comprised of a single individual, without children, at the income level of the average worker.  In 2011, the tax wedge ranged from 7 to 55 percent across the 33 countries for whom data is available.  

The microeconomic theory of policy impacts on individual workers postulates that the worker will withhold supplying labor services if taxed on these services. The graphic below plots, by the size of the tax wedge, the annual average number of hours that the workers will spend working.  The data used is the 2011 tax wedge and the 2018 labor hours supplied, by country. 

Figure 1.  Taxes Reduce Workers' Willingess to Supply Labor

The choice of 2018 for the work-hours data is not critical.  In general, tax policy evolves sufficiently slowly that all we need is data that is later than the year in which the tax wedge is measured.  Use of earlier years does not change the findings.  There is considerable variability in the data.  However, as the figure reveals, in general, the higher the tax wedge, the lower is the number of hours that workers offer the economy.  The experience of countries with large spending programs is that the ultimate incidence of the tax burden ends up being borne significantly by the average worker.  

The countries with the largest tax wedges tend to be European social-democratic countries.  Across all of the countries, the average annual hours worked varies dramatically.  The US worker, at 1800 hours per year, works  approximately 30 percent more that workers in the most highly taxed countries.  Statistically, for a given percentage increase in the tax wedge, hours worked decline by 20 percent of of that increase.   

Capital Gains Tax Increase: Another Bad Biden Idea, Part 2

It appears that the Biden administration has three goals in raising the US capital gains tax rate from 20 to 43 percent.  The first, of course is to punish successful people who are clever enough to acquire assets that appreciate.  As his old boss, Barack Obama once argued, it is better that everyone be poor than tolerate a policy that allows differences in standards of living, even if everyone is better off.  The goal is not to raise revenue, because his advisors, at least, know the facts that I set out in Part 1.  Raising capital gains tax rates does not generate more income.  It almost certainly generates less, especially in settings, iike the US, where individuals and firms are already paying taxes on other forms of income.  

Second, Biden seems to have a desire to simply be remembered as an extremist along the lines of FDR.  This involves doing dumb things that make him appear a big, important man in policy, and hopefully, history.  I say this with some confidence because the country with the highest capital tax in modern times has been Denmark, at 42 percent.  Thus, Biden’s odd choice of 43 percent is simply an infantile effort to stand out.  What a man.  

Third, his administration has plans, as his Secretary of the Treasury has stated, to try to create a worldwide tax cartel among other countries.  The idea is to talk them into fixing a high, minimum rate so that there cannot be “a race to the bottom” through competition in the rate levied.  In economics terms, of course, trying to fix the capital gains tax worldwide at a higher rate is actually a race to the bottom of capital investment and growth.  

Sending Secretary Yellen around the world on such a goofy mission is unlikely to be successful.  The 28 large OECD economies has a wide range of rates.  The mean rate is around 14 percent, less even than our current 20 percent.  This is due in part to the fact that nine of the countries have a zero rate.  Belgium, the Czech Republic, Korea, Luxembourg, Netherlands, New Zealand, Slovenia, Switzerland and Turkey have had zero rates in modern times.  Another 60 percent of the countries have a rate of 28 percent or lower, and only 5 are in excess of that rate.  Denmark, France, Finland, Ireland and Sweden make up this group, but if one looks closer, some of them have lower tax rates on other sources of income.  France is one country that is in the midst of tax reform and unlikely to sign on to Biden and Yellen's tax cartel.  That kind of accommodation to avoid suppression of jobs and capital appears nowhere in Biden’s plans.  

Capital Gains Tax Increase: Another Bad Biden Idea, Part 1

It was announced today that the Biden administration wants to raise the capital gains tax to 40 percent from its current, 20 percent at the federal level.  As you can imagine, he is on a hunt for a way to pay for the Sanders/D.O.C. socialist promise bomb to which he has strapped himself.  He could just have Janet Yellen (US Treasurer) and Fed chief Powell get money in the new (unproven and dangerous) Modern Monetary Theory (MMT) way.  But that would not accomplish the goals of his keepers.  

He also has to find some way to hurt those darn successful folks by getting his hands on their income.  After, who do they think they are?  Just because they work hard running businesses and pay most of everyone else’s taxes, doesn’t mean that there isn’t another way to wave the equality flag.  So, he or some of his keepers resurrected the nearly decennial idea of raising the capital gains rate.  

As you know, the capital gains tax is applied to realized capital gains that may be lurking in your investment portfolio, or real estate, or other assets else that grows in value, free of exposure to the tax.  When you sell the assets, as many retired people are doing today with the accumulated conventional IRA balances, or when they die, the Tax Man wants his taste.  It annoys whose who think they deserve to spread your wealth around to their friends, that you get to choose when the gains are realized when sold.  No matter that much of the gains may be purely embedded inflation, or that you may also have financed and managed a business.  

No matter, also, that even 25 years ago, it was known that it is not just rich that invest.  Indeed, a NASDAQ exchange survey found just those that held stock were very driverse:  43 percent of the adult population did so; 47 percent of women did so;  55 percent of those younger that 50 did so; and 50 percent weren’t even college graduates.  You know the demographics today are even more diverse.  Old gray-beards don’t try putting the short-squeeze on trades in their a compupter game stock.  The important thing is that a capital gains transaction put folks money in play, and affords Joe the opportunity to snatch-and-grab some of that.  

So, the economists Sarin, Summers, Zidar, and Zwick in 2021, crafted a paper (unrefereed) that asserts that the scoring of the revenue potential of such a move could be more remunerative than others had found.  Scoring is the review by the OMB of such aspects of fiscal efforts.  They did not report that the OMB’s revenue scoring in the 1990s, in practice, was off by a factor of 2 every year.  In this case, they had scored the effect of cutting the capital gains tax.  However, the fact that cutting the capital gains tax underestimated revenues strongly suggests that an increase in the rate is likely to have the reverse experience, and underproduce revenue and throttle investment.