If France were to reduce its effective tax rate on labor income from 60 percent to the U.S. 40 percent rate, the welfare of the French people would increase by 19 percent in terms of lifetime consumption equivalents. This is a large number for a welfare gain. This estimate of the welfare gain takes into consideration the reduction in leisure associated with the change in the tax system and the cost of accumulating capital associated with the higher balanced growth path. The reduction in leisure is from 81.2 hours a week to 75.8 hours, which is a 6.6 percent decline in leisure. I was surprised to find that this large tax rate decrease did not lower tax revenues.
That’s the take of Ed Prescott, one of America’s smartest economists, here is the original research paper.
Consider just how radical the flip has been:
Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s when the Western Europeans worked more than Americans.
According to Prescott, changes in marginal tax rates are the main reason for this shift. The Prescott cite is from www.2blowhards.com, a never-ending source of interesting material.
My take: Prescott’s critics like to squawk about his oversimplified models and his use of the representative agent construct. Having a background in Austrian economics, I have some sympathy for these criticisms. But on this matter, it is hard to deny that Prescott has nailed it.