DO LOWER TAX RATES MAKE PEOPLE WORK HARDER?

In arguing for cuts to the top marginal tax rate from 50% to 30%, Greg Hywood (The Age, 3/10/04) posed the rhetorical question “What better incentive to work than keeping two thirds of the extra you earn, not a half?” Rhetorical questions are supposed to answer themselves. However, I do not think it is at all clear that lower tax rates lead people to work more or harder.

Imagine a family currently struggling to meet mortgage repayments on a house they cannot quite afford, or sending their kids to a private school. The father takes extra jobs on the side while the mother might take part-time work, in both cases to meet payments to sustain their lifestyle target. Surely it is possible that putting extra dollars in their pocket from a tax cut could lead them to cut back on extra and part-time work.

Imagine a 50 year old middle income earner who thinks she needs k$500 to retire. Might she not retire earlier if there are major tax cuts, since the nest egg is accumulated more quickly? In my own case, if the government reduced my tax to zero, I firmly expect that I would move to half time work as soon as my kids are through school. It is not that I do not like my job, but I would like to do other ‘less productive’ things before I die.

Broadly speaking, those who are striving to meet a pre-defined financial goal would work less if tax rates were lowered. Those with unlimited desires might work harder. But my experience is that what separates those who work 80 hours per week from those who work 35 is their individual level of ambition and engagement with their job, rather than the marginal tax rate.

While it is true that a 100% tax rate would almost certainly be a disincentive, it is reasonable to assume that many people would actually slow down and take life a little easier if there were 0% tax. Most people’s tax-work curve would be hill shaped with the top of the hill located at different positions for different people. The chart on the left is for a low value worker who worked hardest at 40% marginal tax rate. The right chart is for a high value worker who works hardest with zero tax. The relationship between tax and work for the economy as a whole would be the accumulation of these curves over all these different people – an income weighted functional integral.

I do not know whether work would increase or decrease with tax rates. The point is – it is an empirical question and, like so many things in economics, can not be decided by naive common sense assertions such as “lowering tax rates increases incentive.” Dissecting the incentive argument a little further, where is it written that the aim of economic policy is to make us work harder? I thought the aim was to produce more, or was it to consume more, or was it to be happy…..I have forgotten what it was now, as has the rest of the world. But I sure recognise a Presbyterian plot when I see one! And “What better incentive to work, than keeping two thirds of the extra you earn?” sure sounds like the old Protestant work ethic to me.

I am not necessarily against tax cuts. What I am against is bullshit. This is largely why I became an academic – to hunt out and expose bullshit in all its varied forms. The “incentives” argument is indeed the worst kind, namely self serving bullshit. The main effects of tax cuts are to redistribute wealth. People who argue for tax cuts are mainly arguing for redistribution from the poor to the rich relative to the status quo, the effects on the economy as a whole being unclear. One can make a coherent and reasonable argument that the rich currently pay too much tax, compared to say 10 years ago. Indeed, I would make it. There is no need to pretend that I am trying to incentivise everyone for the good of all.