Tax Rates and Development

One of the clearest theoretical predictions in all of economics is that a high marginal tax rate on the income from an investment would depress the investment rate, and thus hinder growth or development.  Yet nobody has found much evidence across countries or over time to confirm that prediction, although many have tested it (including this author a long time ago). The lack of evidence for a theory means either bad theory or bad data. The first could certainly be a problem, and the data for comparable "effective" marginal tax rates are also notoriously bad ("effective" takes into account deductions, credits, and all the million complicated beasts lurking in every tax code).

However, a new paper by Simeon Djankov, Andrei Shleifer, and co-authors in a top economics journal (ungated here) utilizes a new standardized database on corporate tax rates by PricewaterhouseCoopers. They find that high corporate tax rates lower investment, FDI, and entrepreneurship (entry of new businesses) across countries.

Unfortunately, we are in a time of both fiscal crisis and ideological polarization, in which the stakes on this debate are high, and both sides would like to manipulate evidence. This post is addressed to the open-minded people who just want to know what the evidence is (both of you!) Will this study change any minds?