The decrease in after-tax income makes less wealth available for investment, thereby discouraging capitalization and further lowering productivity and wages. Investment and productivity are further diminished if interest, dividends, and capital gains are taxed, since taxpaying investors receive less compensation for the disutilities of time preference and risk. If the currency is depreciating because of inflation, investors are even taxed on the nominal profits resulting from that depreciation, so that the combined effects of taxes and inflation may result in a negative rate of return. Both the tax burden and the effects of currency depreciation are compounded over time, generating a kind of "negative compound interest" effect. Consequently, high marginal tax rates have a devastating effect on long-term growth and prosperity.

Furthermore, under a graduated income tax, the computation of income on an annual basis (income-tax averaging was eliminated in the United States in the early 1980s) is especially discouraging to high-risk investment. The high-risk investor may realize zero net income or even net losses in most years, but a much higher income in occasional years. As a consequence, her long-range income may be roughly comparable to other investors, but the vast majority of it is earned in a much higher tax bracket. The assumption of high risk is thus heavily penalized and strongly discouraged under such a system. Yet this kind of risk-taking is vitally important to long-term economic growth, particularly to the development of new goods or production methods. A decreased availability of innovative products, such as new lifesaving medicines, may lead to diminished competition and higher prices in those markets.