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The Excess Burden of Taxes and the Economic Cost of High Tax Rates

3 min readBy: Robert Carroll


When it comes to taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy, the emphasis in Washington, DC, has once again turned to how to split up the economic pie rather than the effect of tax policy on the size of the pie. During the 2008 Presidential campaign, the focus on equity took the form of rolling back the Bush tax cuts—increasing the top tax rates—for those with incomes above $250,000. More recently, some policymakers have wanted to go even further by adding on a high-income surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. to partially finance health care reform, which would raise the top tax rate to more than 46 percent.

Making sure the tax burden is spread in a fair and equitable way clearly has popular and political support. But “fairness” is highly subjective. The current tax system is already highly progressive, with roughly two-thirds of all federal income taxes paid by the top 5 percent of taxpayers. Nevertheless, as income gains are not necessarily spread evenly across the population, the distribution of the tax burden is routinely adjusted through the political process.

What is surprising, however, is that the economic cost of some of the policies designed to increase progressivity—in particular, further increases in tax rates—is seemingly absent from the policy debate. High tax rates affect many decisions made by households and businesses. A basic tenet of sound tax policy is to balance distributional objectives with the distortive effects of high tax rates rather than disregarding one or the other.

This report estimates the economic cost of higher tax rates, what economists often refer to as the “excess burden” or “deadweight loss” of taxes. It represents the loss in welfare over and above what people transfer to the government as taxes. Virtually every tax creates an excess burden. Taxes distort choices and steer resources away from their best and highest use based purely on economic merit. When decisions are made in part for tax reasons, economic resources are wasted. The crucial point is that the revenue the government collects understates how much worse off an individual is because of a tax.

This report finds that the excess burden of taxes can be quite high, especially when the additional excess burden of higher tax rates is compared to the additional revenue raised.

  • The excess burden of the current individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. is not inconsequential, amounting to roughly 11 to 15 percent of total income tax revenues.
    • This means that in the course of raising roughly $1 trillion in revenue through the individual income tax, an additional burden of $110 to $150 billion is imposed on taxpayers and the economy.
  • Increased tax rates on higher-income households impose very large excess burdens that, under reasonable assumptions, nearly equal the revenue collected.
    • The combined effect in 2011 of increasing the top two tax rates and the health care surtax is an additional excess burden of $76 billion. When combined with the $88 billion in additional revenue, the total burden of these higher tax rates is $164 billion.

These findings should give pause to advocates of higher tax rates as a means of achieving additional progressivity; this policy carries considerable economic costs. If lawmakers deem new tax revenues absolutely necessary, then they should consider policies that achieve similar distributional objectives without the economic costs associated with high tax rates—policies such as broadening the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. by limiting or repealing special tax preferences.

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