Does Cutting Taxes Sap Productivity?
Big government is associated with high worker productivity.
Posted Oct 12, 2017
Republicans pursue a long-held objective of cutting taxes. They argue that doing so is best for the economy. Empirical evidence suggests the opposite. The bigger the government, the more productive the workers.
The Cross-National Evidence
According to orthodox right-wing economics, big government is bad because it takes money away from the private sector where capital can be more efficiently deployed in generating economic activity.
If this reasoning were correct, then countries with big government and high personal taxation would have feeble economies with unproductive workers.
Most previous research analyzed the impact of taxation rates on annual growth rates but the findings were contradictory, possibly because annual growth rates are noisy. They do not give an accurate picture of how prosperous a country really is.
So, the mere fact that India has a growth rate three times that of the U.S. does not mean that Indian workers are three times as productive, for instance. Poor countries may also grow rapidly without seeing a huge increase in standards of living because they start from such a low base.
I investigated the relationship between taxation rates and World Bank productivity in (constant) dollars per hour for all the countries for which data were available.
The result was that countries having high taxation levels (expressed as a proportion of national gross domestic product) are much more productive.
Startling as this result seems, a more important question to ponder is why high taxation might yield more productive workers. I approached this problem by asking whether workers in high-taxation countries are likely to work harder than their counterparts in low-taxation regimes.
Even asking this question is problematic for many economists. Most like to consider labor simply as an expense of doing business, no more interesting in itself than the price of soybeans. There is a strange internal contradiction in this approach because workers in underdeveloped countries typically have low productivity. Despite low labor costs industrialists struggle to make their plants yield any profit (1).
The Human Element: Worker Motivation
Clearly, there is a human element in business productivity albeit one that is ignored in mainstream statistical models of economic growth.
Arguably there are at least four critical inputs to work motivation. These include, good health, good nutrition, parental investment, and male competition over brides. For the sake of brevity, I will simplify these topics and take them as self-evidently true, as all have clear supportive empirical evidence.
Four Spurs to Work
1 Improved Health and Reduced Burden of Infectious Diseases.
Populations with relatively poor health and low life expectancy are less interested in working hard for two reasons. First, people who suffer from chronic illnesses, such as malaria, have less physical energy and need to rest more. Second, life expectancy is lower, so that people live in the moment rather than accumulating money to be enjoyed later in life. They “discount the future” (1).
2 Improved Nutrition
Economic development is characterized by a steady increase in availability of food that has striking consequences for productivity. Better nourished mothers give birth to larger babies that are healthier and subsequently score higher on IQ tests (2). More intelligent children do better in school, are more ambitious, acquire more human capital, and earn more, thereby boosting the economy (Case and Paxon, 2008).
3 Collapse of Extended Families
Having a large extended family can be a disincentive to hard work. If income is shared: the worker's own quality of life is not noticeably improved by earning more wages. Sharing income in a traditional three-generation family would also discourage workers from accumulating savings that work against entrepreneurship.
With increasing urbanization over time, average household size declines and children acquire greater human capital.
4 Men Competing for a Spouse or Romantic Partner
With improved health, males are surviving at higher rates than ever before and this intensifies competition over women. Men appeal to women by establishing high social status or having good earning capacity. This is true even in the modern world where women are economically independent (4).
How Taxes Boost Worker Motivation
In unpublished research, I found that these four spurs to working harder account for all of the relationships between taxation and productivity. Simply stated, big government makes workers more productive because it creates conditions under which they are motivated to work harder.
What might governments do that accounts for this boost in productivity?
Big government improves health through public health programs that improve sanitation and root out many serious infectious diseases. Improved health increases the number of males around thereby enhancing male competition over money. Reduced child mortality also helps to reduce fertility and brings down household size and increases parental investment per child.
Nutrition programs in schools increase learning capacity of children. Improved prenatal nutrition even boosts children's IQ and ambition (3).
Big government plays a major role in infrastructure development so that the US interstate highway system greatly enhanced the productivity of American workers after World War II when the country came into its own as the preeminent industrial power.
The safety net provided by a welfare state may also help individuals to feel more secure so that they feel freer to take the risk of starting a business, as illustrated by high entrepreneurship in Scandinavian countries.
1 Clark, G. (2007). A farewell to alms: A brief economic history of the world. Princeton, NJ: Princeton University Press.
2 Floud, R., Fogel, R. W., Harris, B., & Hong, S. C. (2011). The changing body: Health, nutrition, and human development in the Western world since 1700. Cambridge, England: NBER/Cambridge University Press.
3 Case, A. & Paxon, C. (2008). Stature and status: Height, ability and labour market outcomes. Journal of Political Economy, 116, 491-532.
4 Hitsch, G., Hortacsu, A., & Ariely, D. (2010). What makes you click? - Mate preferences in online dating. Quantitative Marketing and Economics, 8, 393-427.