One of my pet peeves has long been the fact that most people seem to have no idea how much they pay in taxes.  The reason for this is obvious:  many of the taxes we pay, by design, are hard to keep track of.  In this category are sales taxes, utility taxes, taxes on gas, etc.  (This does not include the taxes paid by corporations and other businesses (they do not pay taxes, they collect taxes) that are passed on in higher prices for the products and services that we purchase, or in the social security share of employees paid by employers that effectively reduce the wages that employers pay employees.)  In the Wall Street Journal we find that the average worker has a tax rate of approximately 40 percent:

But tax rates are already high—much higher than is commonly understood—and increasing them will likely further depress the economy, especially by affecting the number of hours Americans work.

Taking into account all taxes on earnings and consumer spending—including federal, state and local income taxes, Social Security and Medicare payroll taxes, excise taxes, and state and local sales taxes—Edward Prescott has shown (especially in the Quarterly Review of the Federal Reserve Bank of Minneapolis, 2004) that the U.S. average marginal effective tax rate is around 40%. This means that if the average worker earns $100 from additional output, he will be able to consume only an additional $60.

Research by others (including Lee Ohanian, Andrea Raffo and Richard Rogerson in the Journal of Monetary Economics, 2008, and Edward Prescott in the American Economic Review, 2002) indicates that raising tax rates further will significantly reduce U.S. economic activity and by implication will increase tax revenues only a little. Continue reading →