Why We Care About Taxes
May 9, 2005
Who cares about tax policy? If you ask an economist, she’ll say taxes matter because they affect the prices of almost everything. That means tax changes can cause dramatic social changes, ranging from the kinds of cars we drive to the way we spend our free time.
One of the most striking examples of how taxes affect culture comes from studies of work habits in the U.S. vs. Europe in recent years. Thanks to Europe’s vastly higher labor taxes—which shift people away from work and toward leisure—Europeans on average work far less than their U.S. counterparts. From a recent NBER study:
Taxes on labor income and consumption spending encourage households to shift away from work in the legal market sector and toward untaxed uses of time such as leisure, household production, and work in the shadow economy…
Cross-country comparisons in the mid-1990s indicate that a tax hike of 12.8 percentage points leads to 122 fewer hours of market work per adult per year and a 4.9 percentage point drop in the employment-to-population ratio. It also increases the size of the shadow economy by 3.8 percent of official GDP …
The evidence suggests that tax rate differences among rich countries are a major reason for large international differences in market work time and in the industry mix of market activity.
The lesson? Culture is driven partly by economics. When tax policy penalizes work we’d generally expect less of it. And the European experience confirms that. For more on the economics of marginal tax rates, be sure to check out the Tax Foundation’s “Primer on the Economic Implications of Marginal Tax Rates.”