Are taxes too high? This question features in political debates everywhere, and in 2024 was a source of debate in the French, U.K., and U.S. elections. The U.K. Chancellor of the Exchequer (Finance Minister) wrote: ‘The most dynamic economies tend to be places with lower taxes. The lesson is clear: supporting businesses with competitive taxes – not more government spending – is the way to growth.—Mail Online, 20 January 2024
What are the tax levels in France, the U.K., U.S. and other advanced economies?
In 2024, taxes in advanced economies ranged from a low of 30.5 percent of income in the United States to a high of 52 percent of income in France. The United Kingdom came close to the middle of this range at 39.5 percent of income.
Figure 1 shows the tax levels in seven economies since 2001.
The Nordic economies (Denmark, Finland, Iceland, Norway, and Sweden) with generous social welfare programs have had the highest taxes for many years, but France caught up and on average overtook them after 2013. Germany and Italy have the second-highest taxes at around 45 percent of income. Japan’s tax level has increased most.
Do high taxes bring slow economic growth?
If “the most dynamic economies tend to be places with lower taxes”, those with lower taxes will have grown to the highest income levels. So, we would expect to see a negative correlation between income and taxes.
Figure 2 shows the relationship between income per person and the average level of taxes in our seven economies.
It is a scatter diagram with the average tax rate on the x-axis and real GDP (income) per person on the y-axis. The economy with the lowest taxes (US) does have the highest income. But the economy with the second-highest income (Nordic) has the highest taxes. And the correlation across the seven economies is close to zero.
Do high taxes bring low labor productivity?
Economies with lower taxes and lower income might have more productive labor and be taking more leisure. So, do we see a negative correlation between taxes and labor productivity?
Figure 3 answers this question.
It shows the relationship between output per hour worked and the average level of taxes in our seven economies. It is a scatter diagram with the average tax rate on the x-axis and output per hour worked on the y-axis. The relationship between these two variables is the opposite of what would be expected. The correlation across the seven economies is positive. The economy with the highest taxes (Nordic) has the highest productivity, and the economy with the second-lowest taxes (Japan) has the lowest productivity.
So, don’t taxes affect productivity and economic growth?
We cannot say that taxes have no influence on economic growth.
Correlation does not imply causation, and the absence of correlation does not imply the absence of causation.
Real GDP growth is driven by the growth of labor productivity, which in turn results from choices that bring capital accumulation, both human and physical, and technological change. Marginal tax rates on labor and capital income influence these choices. We must look deeper into these choices to isolate how they are influenced by taxes.
Now take a short quiz to ensure you understand what you just read.