Interesting op-ed in today’s Wall Street Journal by Edward C. Prescott (Senior Monetary Adviser at the Federal Reserve Bank of Minneapolis, Professor of Economics at the W.P. Carey School of Business at Arizona State University, and 2004 Nobel Laureate in Economics), "Stop Messing With Federal Tax Rates":

That our current tax system is complicated and burdensome and absorbs unnecessary amounts of our limited resources is well accepted by most everyone, and this issue was a primary concern of the Advisory Panel on Federal Tax Reform that recently released its recommendations. This problem deserves to be seriously addressed, but we could take a big step in the right direction if we just stop messing with federal tax rates. Maybe Congress should take a cue from the Federal Reserve, which learned a long time ago that oversteering with its policy corrections wreaks havoc with market expectations and impedes economic growth. Just as the Federal Reserve has made it clear that it will strive to maintain low inflation, which has allowed businesses and consumers to invest and plan accordingly, Congress should establish good tax rates and walk away. The people will take it from there.

So what are good tax rates? It’s useful to begin with consideration of a simple principle: Taxes distort behavior. From this powerful little sentence comes the key insight that should inform our thinking about setting tax rates. Any tax, even the lowest and the fairest, will cause people to consume less or work less. Taxes that are inordinately high only exacerbate this reaction, and the aggregate accumulation of these individual decisions can be devastating to an economy.

Good tax rates, then, need be high enough to generate sufficient revenues, but not so high that they choke off growth and, perversely, decrease tax revenues. This, of course, is the tricky part, and brings us to the task at hand: Should Congress extend the 15% rate on capital gains and dividends? Wrong question. Should Congress make the 15% rate permanent? Yes. (This assumes that a lower rate is politically impossible.) These taxes are particularly cumbersome because they hit a market economy right in its collective heart, which is its entrepreneurial and risk-taking spirit. What makes this country’s economy so vibrant is its participants’ willingness to take chances, innovate, acquire financing, hire new people and break old molds. Every increase in capital gains taxes and dividends is a direct tax on this vitality.