High taxes increase labour costs and lower the standard of living

Americans work longer hours and have higher living standards than Europeans. The reason Europeans work less is due to higher taxes on work, concludes a new study from the U.S. Federal Reserve Bank of Minneapolis.

High taxes on labour increase the cost of each worker, encouraging the substitution of machinery for people. They also make it harder for employers to lure workers who have alternatives – such as leisure, school or retirement – by reducing the return to labour. In France, for example:

As late as the 1970s, the French worked longer than Americans – but they now work one-third fewer hours, 17.5 hours per week, on average.

Between the early 1970s and mid-1990s, the French tax rate rose to 59 percent from 49 percent, while the U.S. tax rate held at 40 percent.

The Japanese, with even lower taxes, work more (27 hours weekly) than Americans (at 25.9; Italians, with the highest taxes, work the least (16.5 hours).

However, labour costs could rise in the United States due to higher taxes and expensive benefits. For the past three years compensation has grown about 4 percent a year, largely because of soaring health-care costs. Since inflation is lower than a decade ago, the "real" cost of labour is rising twice as fast now as in the 1990s – making it harder for employers to afford to hire more freely.

Source: Gregory Ip, U.S. Can Look Toward Europe For Warnings on Work, Taxes, Outlook, Wall Street Journal, October 20, 2003; see Edward C. Prescott, Why Do Americans Work So Much More than Europeans? Staff Report 321, September 2003, Federal Reserve Bank of Minneapolis.

For text (WSJ subscription required) http://online.wsj.com/article/0,,SB106659451760545300-search,00.html

For study text http://minneapolisfed.org/research/sr/sr321.pdf

For more on the Effects of Taxes http://www.ncpa.org/iss/tax/

FMF Policy Bulletin\28 October 2003