Even if the public provision of services were just as efficient dollar-per-dollar at satisfying the consumer, and if the costs of accounting and enforcement could be reduced to zero, the "neutrality" argument would fail, because it overlooks the adverse effects of marginal tax rates on productivity. Suppose, for instance, that a free-market economy produces goods and services valued by consumers at $1 trillion. Assume that an income tax is then levied, taking $200 billion from this economy, and that as a consequence private-sector productivity decreases by 10%. Thus the private sector now produces only $700 million in goods and services. ($1 trillion - $200 billion - $100 billion = $700 million.) Even if the government is perfectly efficient, returning $200 million worth of "public" services, its citizens will still be $100 million poorer in total goods and services enjoyed.

Historically, income-tax law has provided for numerous exemptions and deductions. In order to minimize the marginal disutility of taxation, taxpayers and businesses often allocate their income to ends differing from those that they would pursue in the free market. As a consequence, the individual taxpayer often does not enjoy the full utility of even the untaxed portion of his or her income. Furthermore, taxpayers often find it necessary to consider tax policy in their personal decisions. Tax consequences must be assessed, along with other criteria, regarding such critical issues as place of residence, career, education, marriage, divorce, and retirement. Often, as a consequence, the optimal life choices that individuals would have pursued in a free-market society must be discarded.

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