If Prices Are Signals, Are Taxes Noise?

Below is a letter I wrote to the Wall Street Journal that was printed in the April 30, 2007 edition:

"Stephen Moore did a great job explaining how complicated our tax code is and how high taxes have gotten relative to what was originally promised in 1913 ("Those April Blues," page A12, April 13). One other way to see the insidiousness of taxes is to realize that they are just as much the "noise" in the economy as prices are the "signals." The income you get paid is the price for your services and therefore signals the value of those services. But taxes reduce the clarity of that signal (hence, they are noise) by reducing how much of your pay you actually get to keep. As taxes increase, the noise-to-signal ratio in the economy increases even more, meaning distortions, and the mis-allocation of resources they cause, increases disproportionately. For example, if the income tax rate is 10%, you keep 90% of your income. The noise-to-signal ratio is .111 (or .1/. 9). But if the tax rate goes up by .10 or to 20%, the noise-to-signal ratio goes up even more, by .15 to .25 since you keep 80% of your income. The .25 comes from .20/.80 equaling .25. Another .10 increase in the tax rate increases the noise-to-signal ratio by .179 from .25 to .429. Then going from a 30% tax rate to a 40% tax rate makes it go up by .238, from .429 to .667. Every tax increase causes increasing damage to the economy's ability to efficiently allocate resources."

To read more about why this makes sense and what the theoretical foundation is go to If Prices Are Signals, Are Taxes Noise?