When he [Lucas] is asked about Europe, he talks about the cost of high taxes. From the interview:
For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. “The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard,” says Mr. Lucas. “And it’s really hurting them.”
No doubt that (theoretically) high taxes could discourage effort but is this statement empirically relevant? Below is a chart of marginal tax rates … and the female employment to population ratio for the age range (25-54) for 2010 … (the chart looks similar if we look at a different age range or male participation rates).
Do we see more or less effort in countries with high tax rates? Not obvious. In fact, in the sample I have selected there seems to be a positive correlation, not a negative one. …. The US appears as a country with low taxes but also low levels of effort.
Antonio Fatás, “Macroeconomics: Evidence or Ideology“, Antonio Fatas and Ilian Mihov on the Global Economy, 26 September 2011.
Mr Fatás teaches economics at INSEAD, an international business school. He has an undergraduate degree (1987) from the Universidad de Valencia and a PhD (1993) from Harvard University.
This is yet another example of what I call “faith-based economics”: High taxes must discourage work, no matter what the evidence shows!