Economic Consequences of Income Taxes

Should five percent appear to small
Be thankful I don't take it all
--The Beatles

Debates on the morality of income taxes, particularly those taken on a progressive scale, are rarely definitive. As Mises observed, the decision of whether to implement socialistic mechanisms like a progressive income tax system is ultimately a political one. If that political decision is based on democratic process, then voters will be tempted to revise their morals in a manner that helps them get what they want.

Less debatable are the economic consequences of a progressive income tax system. They are less debatable because they are grounded in natural laws that do not drift with the wind.

In this compilation, Hazlitt reminds us of two economic consequences of progressive income taxation. One is that appropriation of income on a progressive scale increases the chances that income destined for savings will be taken from private hands. When savings are reduced, there is less capital. When there is less capital, there will be less investment. Absent investment, productivity does not improve. Without productivity improvement, standard of living stagnates or declines.

Stated differently, progressive income tax systems invite capital consumption. When capital is consumed, there is less chance of productive investment that drives durable wage and job growth.

A second economic consequence of income taxation is that it reduces incentive to produce. ECON 101 tells us that taxing a behavior results in less of that behavior. Higher incomes are taxed at marginally higher rates in progressive tax systems. As such, progressive income taxes penalize high levels of production. Producers are therefore discouraged from being highly productive.

Once again, the result is less wealth produced. Less wealth means lower general standard of living.