from – Forbes- by Tim Worstall
This will perhaps be a contentious claim to some, that Obamacare, or the Affordable Care Act as it is more formally known, will reduce long run GDP in the US by 5%. But it shouldn’t actually be all that contentious: the basic idea most certainly has merit even if the exact calculation might be a little out. The point comes from Greg Mankiw and he’s insisting that we all recognise that this is a very rough indeed estimate. But, as I say, the basic underlying economics is sound:
The Affordable Care Act added “about six percentage points to the marginal tax rate faced, on average, by workers in the economy.” So estimates the University of Chicago economist Casey Mulligan.
Given that labor income was already taxed by income and payroll taxes, that figure indicates the return to working fell by about 10 percent. If we apply a plausible aggregate labor supply elasticity of 0.5, this in turn suggests a decline in labor supply of about 5 percent. In the long run, as the capital stock adjusts, a fall in labor supply leads to a proportionate fall in output. So we end up with a 5 percent fall in long-run potential output.
The basic insight is that all taxes have deadweight costs. Simply the act of taxing, taxing anything at all, means that a certain amount of economic activity does not take place. A useful rule of thumb is that taxation of $1 means that 20 cents of economic activity just never happens. And at the sort of marginal taxation rates in a modern economy an extra dollar leads to perhaps 30-35 cents of activity that just never materialise.
This is true however wonderful the things that that tax money is spent upon. It’s also true that some of the things that we spend tax money upon are worth much more to us, individually and collectively, than that 20 to 35% loss from having raised cash in taxes. The existence of a criminal justice system for example. Diversity advisers might not quite pass that test.
So, we might try to argue against Mankiw’s point by insisting that poor people getting better health care as a result of the spending of this tax money will make up for that deadweight loss of the taxation itself. That would be a tough one to sell really, given the size of the loss. We could also say that it’s a moral issue so who cares if we’re all a little poorer in the future? Which could even be true but that’s not an economic argument.
We could also argue that the situation is worse than this: for one of the tax rises is on investment income and we know very well that deadweight costs are higher on investment income than they are on labour income.
I take this to be a great example of the basic maxim of economics, that there are no solutions, only trade offs. Maybe health care reform is worth making the future less rich than it could be, maybe it isn’t (and I’ve no doubt that some reform was necessary even if I wouldn’t have chosen this one) but there’s no doubt at all that the increased taxation is going to make that future somewhat less rich than it would be without the taxation to pay for the health care reform.