Saturday, May 20, 2006

Lazear on Taxes

CEA Chair Eddie Lazear gave a nice talk to the National Tax Association on Thursday. He laid out some principles of good tax policy:
First, an efficient tax system should not favor current consumption over future consumption....Second, all focus of capital investment should be treated similarly....Third, the tax system should not push any particular form of corporate governance....Fourth, the tax system should not discourage investment in human capital, which is so essential to economic growth.
A majority of economists would applaud these principles. Here is a passage that will likely prove more controversial:
To further investment in human capital, it is necessary that the progressivity of the tax system not become too pronounced. If high incomes are taxed at too high a rate relative to lower incomes, the incentives to invest in human capital decline. One can see the effects of tax created impediments to human investment in countries where salary compression was highly pronounced, such as the Eastern European economies around 1990. Many highly skilled individuals chose to drive taxis for tourists rather than to use their skills because the wages were higher in the tourist industry than they were in the professional occupations. Had that pattern persisted into the long run, it would imply chilling effects on investment in education. Indeed many of the professionals in those countries migrated to the West in order to take advantage of the higher wages associated with high skills.
The principle here is clearly right. Where economists disagree is over elasticities--that is, on the size of these incentive effects.

One topic missing from the talk is some ways to raise tax revenue without raising tax rates. Last November, the President's Advisory Panel on Federal Tax Reform (of which Eddie was a member) offered several good suggestions for base-broadening. In particular, they proposed eliminating the deductibility of state and local taxes and scaling back the mortgage-interest deduction. Both are good ideas.