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Deadweight Costs and ACC

My column at this week took on the deadweight costs of taxation. Andrew Little rightly noted that ACC’s overcharging amounts to a payroll tax, and that that payroll tax deters useful economic activity. Economists call that the “deadweight” cost of tax: it’s the cost of a tax over and above the collected revenue. Treasury recommends that we add 20% to the cost of any government-provided programme to cover the deadweight costs of the tax needed to fund it, but it’s important to remember that the deadweight costs of tax increase with the magnitude of the tax: the 0.3 percentage point difference between what ACC does charge and what it should charge will have associated deadweight costs, but the deadweight costs of substantial income tax hikes would be more than proportionately higher.

From the column, but read the whole thing:

The estimates of the extra burden taxes impose on the economy are most applicable around small changes in tax, like the 0.33% charged by ACC. A larger tax hike would have more than proportionately higher associated expected deadweight costs. A decade ago, Professor John Creedy summarised economists’ rule of thumb on the issue: if the tax rate doubles, the deadweight cost of taxation quadruples.

So the deadweight costs of a 38 or 39 percent top marginal tax rate are much higher than those of a 33 percent top marginal tax rate. That does not necessarily mean that any future Labour government should not raise the top marginal tax rate. But it does mean that the programmes that would be funded at higher tax rates have to pass a higher benefit hurdle – and especially where government consumption spending, as a fraction of GDP, is now no lower than it was at the height of the last Labour government.

Chart source: Michael Reddell

About Eric Crampton (88 Articles)
I'm Head of Research with the New Zealand Initiative.

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