Monday, June 18, 2012

Higher Taxes Correlate with Prosperity

Taxes are one of three pillars of prosperity.   From Marginal Revolution:
In a recent book Besley and Persson 2011 argue that fiscal capacity is strongly correlated with economic performance across countries (see also here and here). They cite important historical work by Mark Dincecco who has shown that across Europe, between 1650 and 1900, higher taxes were associated with both limited government and economic growth (see here). The following graph is from Dincecco (2011) which contains similar figures for other European countries.

MR eyes this a bit warily, saying the correlation might be due to selection bias and incomplete data:
Modern states did not emerge out of nowhere.  They replaced pre-existing local systems of taxation, patronage, and rent seeking. ... There is plenty of evidence that these local systems imposed large deadweight losses [so] an increase in the measured size of central government need not have been associated with an increase in the total burden of government.  Rather the total deadweight loss of all regulations and taxes could have gone down in the 18th and 19th centuries, even as the tax rates  imposed by the central state went up. 
I am not sure but think this means that MR thinks that revenues could have been higher in the local system period than the data suggest?  Then MR adds a note about what caused revenues to increase:
Note: the increase in per capita revenues in England depicted in the figure is largely driven by higher rates of taxation (notably the excise) and more effective tax collection and not by Laffer curve effects (although the growth of a market economy during the 18th century did make it easier for the state to collect taxes).
So higher rates and better tax collection led to more revenues to be collected.  The Laffer thesis more or less says that low rates lead to more tax revenues since low rates produce more growth and more growth increases the base to be taxed, while higher taxes drive people out of the market and end up lowering revenues.  Leaving aside the evidence (or lack thereof) for the accuracy of this thesis in practice,  I take it that MR wants us to understand that revenues did not rise as a result of increased growth producing a bigger base and therefore more revenues at the same low rate as before, but rather England raised its tax rates and collected more taxes as a result.  Laffer doesn't seem to have played any role so I'm not sure what the point is of bringing him into this at all.  All in all I am finding MR more than usually confusing the point with this note, but I appreciate that they alerted me to the book.  Better just to read that, I think.

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