How Capital Taxes Harm Economic Growth: Britain Versus the United States

To finance expenditures on goods and services and government programs, governments levy taxes on many different economic activities. Large countries tend to raise much of their revenue by taxing income. For example, in the United States, taxes are levied on capital income, such as profits and interest, and also on labor income, such as wages and salaries. Taxes on income affect economic activity, since they change the incentives individuals and enterprises have to produce, consume, save, and invest. Taxes on capital income have potentially important implications for economic growth, since they change the incentives to accumulate capital goods. For example, increasing taxes on capital income reduces the rate of return to capital investment. A decline in the rate of return may lead to less investment and, consequently , slower growth in a nation's stock of productive capital. Slower growth in the stock of capital means fewer new factories, office buildings, computers, and other types of equipment and structures available to produce output , which can lead to slower economic growth. This argument suggests that an important factor in setting capital taxes is the sensitivity *Lee Ohanian is an assistant professor of economics at the University of Minnesota and has been a visiting scholar in the Research Department of the Philadelphia Fed. This article is available on the Internet at "http://