http://www.house.gov/jec/growth/longterm/longterm.htm
One area that has been scrutinized for several decades is the impact of taxes on long-term economic growth. The factual evidence is persuasive that high taxes are a major impediment to faster economic growth.
From one point of view, it is not apparent that higher taxes should harm economic growth. A tax increase would simply move the spending decision from the private- to the public-sector.[2] In this view, it does not matter who has control of economic resources. The main thing that matters is that there would be sufficient total demand to prevent recessions. However, this view of taxation is very narrow. This view does not recognize the fundamental axiom of taxation. Taxing an activity, any activity, will reduce the level of that activity. For example, raising the taxes on cigarettes will reduce cigarette consumption. Raising the tax on home ownership will reduce home ownership. Basic economic theories of supply and demand show that when anything rises in price, as occurs with a tax increase, less is demanded. Although economists recognize that impact varies among goods and services, the fundamental axiom still holds.
This fundamental axiom of taxation applies in the same manner with income taxes. Income taxes reduce the incentives to engage in activities that generate income, such as work, savings, and investment. Consider the simple example of a firm that is considering investment options. Suppose the firm decides that it will only consider investments that are expected to produce a 10 percent rate of return. If the government imposes a 50 percent tax rate on investment income, the firm will forego many formerly worthy projects. Now only projects that are expected to produce a 20 percent pre-tax rate of return will be considered. However, the firm will have fewer opportunities to invest when the rate of return must be 20 percent. Many formerly sound investments will no longer be sound for the simple reason that taxes are too burdensome. The same decision-making process is made when individuals determine how much to work and save.
Economic theory makes it clear that tax increases harm economic growth. However, like many economic questions, it is important to look at the historical record to confirm the theory. Economists have looked at tax reduction throughout the world. In the United States, there were two significant post-World War II periods of tax reduction: the Kennedy tax cuts of the 1960s and the Reagan tax cuts of the 1980s. A look at these episodes demonstrates that cutting taxes unleashes the creative forces of the American economy and provides incentives to work, save and invest.
Clear Air Turbulence
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