Taxes Do Make a Difference (II)

A comparison of Europe and the United States suggests that our conclusion about the importance of taxes is correct. European nations, on average, have imposed higher marginal tax rates on their citizens than has the United States. Estimates of the size of the underground economy are that it is twice as large in Europe as a share of the economy as it is in the United States.
About 10 percent of total economic activity in the United States appears to be underground, but the number is over 20 percent for Europe. There is one thing we can be confident of for the United States. If marginal income tax rates rise compared to what they were during the period 2003–2010, the relative size of the underground economy will grow.
This is just one reason why, when government officials make their calculations of increased tax revenues due to new higher tax rates, they are consistently wrong. The officials fail to take into account the movement into the underground economy that is induced by higher marginal tax rates, and thus overestimate the amount of increased tax revenues from the higher rates.

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