The Wisdom of Prescott 2: Sales taxes=Labor Taxes
By Garett Jones
You work in the market economy to buy stuff in the market economy, either now or later.
So if sales taxes are permanently high that weakens your desire to work in the market economy. That means leisure–which government is still bad at taxing–starts looking like a better alternative. Let’s make that dinner at home rather than going out to a restaurant.
Good neoclassicals like Prescott keep an eye on sales taxes when thinking about the incentive to work. High European VATs stand between Europeans and their ability to consume market goods–and according to Prescott high VATs helps explain low European employment. Why work so much when it’s so hard to turn work into goods?
There are a lot of good things to be said about consumption taxes. After all, they’re not capital taxes, and Chamley and Judd (PDF offering counterargument) showed us that capital taxes are bad bad bad.
But Prescott reminds us that consumption taxes and labor taxes are really two sides of the same coin: They both stand between your market labor and your ability to consume market goods. So, administrative issues aside, any nice thing you’d like to say about one you need to say to the other.
This idea isn’t unique to Prescott. I’d learned and forgotten this idea many times over the years, but after reading Prescott’s model of why Americans work more than Europeans, I never forgot it again (yet).
Technical Coda: Dirk Krueger, a Prescott student, works this result out starting on page 91 (big PDF).