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How Much Does it Cost the Private Sector to Provide Government with $1 in Tax Revenue?

May 2006
By Gary Robbins

Forget about the idea that the cost of paying $1 in tax is $1. Even academics on the left now acknowledge that taxes do have some dynamic effect on economic performance. When taxes go up by $1, it is not just the private sector's after-tax income that goes down; its pre-tax income goes down as well. Thus, when the question is, "How much does it cost the private sector to provide government with $1 in tax revenue?" -- the answer is $1 plus the amount by which taxpayers' incomes go down because of the negative effect the tax has on the economy.

Because of that negative effect, there is general agreement that an attempt by the government to increase tax collections by $1 will, in the long run, net only $0.68 -- but the effect on government tax receipts is only part of the story and the least important part at that. The important story is that the government "lost" the $0.32 in anticipated extra tax revenue and ended up with only $0.68 because the taxpayers "lost" $1.07 in income that otherwise would have been produced and would have been taxed at an assumed average rate of 30 percent ($1.07 x 30% = $0.32).

Up to this point in the story, the private sector has lost $1.07 in income and paid $1 in tax for a total cost to it of $2.07 -- but the government has on net collected only $0.68.

For the government to actually receive a full $1 net addition to tax revenue, the total cost to the private sector would be $2.57.

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