Deadweight loss caused by taxes

Income taxes are an important source of government revenue, but do have negative consequences. Previous US estimates have stated that for every dollar raised in tax revenue, there is an efficiency loss of 2.5 percent. However, a recent study says these previous estimates do not consider the effect of tax rates on tax avoidance - that is, engaging in legal non-taxable behaviour such as accepting health benefits instead of salary, taking more leisure time, and being less productive. As tax rates rise, tax avoidance becomes more severe.

The study estimates that:

  • The efficiency loss from current income taxes is more than 30 percent.

  • If Social Security taxes are included, there is a 50 percent efficiency loss.

  • A 10 percent increase in taxes would raise revenue by only $21 billion, while reducing efficiency by $44 billion.

    The study finds that these conditions are aggravated because of the progressive tax structure of the USA tax code.

    Source: NCPA Policy Digest / "The Deadweight Loss of Income Taxes," Economic Intuition, Spring 2000. Based on: Martin Feldstein, "Tax Avoidance and the Deadweight Loss of the Income Tax," Review of Economics and Statistics, November 1999.

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