Europe: High Individual Taxes Impede Innovation, Growth and Reduce Competitiveness

While it should be obvious to everyone, high individual taxes hinder investment and innovation and diminish wealth creation – which can create benefits for all. The flipside to high taxes is a central authority that provides more social services, or entitlements, to the population while making centralized investment decisions. The question is, which holds better economic benefits, and which costs more?

A recent report by the Tax Foundation highlights the impact of high individual takes on high earners and how it affects the European economy. The report states that there is a campaign for even higher taxes on wealthier individuals, but high tax policy tends to impede investment and undermine innovation. Entrepreneurial innovation is vital for job creation and fostering a prosperous society.

While some believe a soak-the-rich policy will not harm middle and lower earners and may be a path to addressing “inequality,” these policies come with “economic consequences” that penalize efficient investment, having a serious impact in the long run, according to the report.

The document states:

“High taxes on capital and high incomes can have negative impacts on key economic variables such as investment and innovation. High-net-worth individuals and businesses often invest in high-risk, high-reward projects such as new companies and startups or new technologies. An overly burdensome tax regime could deter these investments, which, in the long term, would negatively affect economic growth and job creation. Therefore, it is crucial to balance the need for revenues with maintaining an environment conducive to growth, investment, innovation, and business development.”

Some European countries also levy a “Wealth Tax” that the Tax Foundation claims “collects little revenue and creates legal uncertainty” while disincentivizing entrepreneurship and harming long-term growth.

Higher taxes on the wealthy can compel these individuals to vote with their feet and migrate to a lower tax jurisdiction. You can easily see this happening in the US as the states with no or lower income taxes have seen a massive influx of new residents and businesses. Meanwhile, the high tax locales have experienced an exodus of the people who tend to pay the highest taxes covering the  cost of government benefits and programs.

The report states that taxes vary greatly in the various European countries, and harmonization or a “race to the top” – raising taxes – will stifle “economic dynamism” and “incentives for investment.”

The report points to a “negative correlation between higher tax rates and the proportion of high-quality foreign investors located in a country as well as the proportion of high-quality domestic inventors who remain in their country.”

While high tax advocates believe high taxes are a good tool to redistribute wealth and address inequalities, the report states that “empirical evidence suggests that the actual impact on inequality reduction can be very limited.” Limited resources shifted to government projects means less for private sector investment, which tends to be more efficient. High taxes can reduce capital available for risky ventures and the entrepreneurs that need growth capital to build the next big thing. And then there is the fact that the very wealthy have the ability to mitigate high taxes – it tends to be the middle that ends up shouldering the burden.

The authors believe that policymakers should “consider the broader implications for economic incentives and growth” as superficial assessments can lead to less optimal returns for all.

In Europe, equity ownership, or riskier assets, is on the rise. However, compared to the US, equity ownership is around 62% of households today, and Europe has more to go. An article in Bloomberg earlier this year noted that “shunning stocks and hoarding cash is harming European wealth. This author claims that the savings habits of Europeans increase inequality. Just 13% of European households hold mutual funds, and only 11% directly hold shares. Perhaps a tax policy that encourages share ownership and supports private firms and capital formation would help drive innovation in Europe. The next Google, Apple, Microsoft is just around the corner.

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