The Effect of Taxes on Efficiency and Growth

Martin Feldstein

NBER Working Paper No. 12201
Issued in May 2006
NBER Program(s):   PE

This nontechnical paper discusses the adverse effects of high marginal tax rates on labor income and on investment income. It explains that the deadweight loss of a tax on labor income depends on the response of taxable income and not just the change in labor supply. An across the board increase in personal tax rates involves a deadweight loss of 76 cents per dollar of revenue and only collects about two-thirds of the revenue implied by a “static” calculation.

A tax on investment income brings a deadweight loss even if household saving does not respond to taxes and the net rate of return. What matters is the response of future consumption. The tax on investment income is also effectively a tax on labor supply because current work effort produces income that will be spent on future consumption and the tax on investment income reduces the future consumption that results from more work today.

An appendix shows for a simple log utility case that the tax on labor income has a smaller deadweight loss than a tax on investment income with the same present value of revenue.

There is a further discussion of the various ways in which capital income taxes distort economic activity.

download in pdf format
   (100 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w12201

Published: Feldstein, Martin. "The Effect of Taxes on Efficiency and Growth." Tax Notes (May 8, 2006).

Users who downloaded this paper also downloaded* these:
Feldstein w5055 Tax Avoidance and the Deadweight Loss of the Income Tax
Engen and Skinner w5826 Taxation and Economic Growth
Auerbach w12307 The Choice Between Income and Consumption Taxes: A Primer
Feldstein w13745 Effects of Taxes on Economic Behavior
Metcalf and Fullerton w8978 The Distribution of Tax Burdens: An Introduction
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us