Common misconception about income tax discouraging work
I once heard a political commentator say something like this: “we tax cigarettes to reduce smoking, and then we tax success and we’re surprised this reduces success.”
This at least roughly corresponds to a misconception I learned from the economist Gregory Clark. He said if you ask economics undergraduates (a group with an unusual affinity for economics!) what effect a higher tax rate will have on hours worked, they almost always make the same mistake: they reflexively assume the tax hike leads people to work less hours.
They presumably make the too-hasty assumption that less income per hour automatically means less incentive to work. But the actual effect depends on the individuals preferences, specifically how they value income (or goods) versus leisure. They might increase their effort to offset the loss of income, or they may find that the new lower wage isn’t enough to justify working a single hour.
I find it interesting that Clark reported this as an extremely common mistake, even though economics students would be well versed in the model used to correct the error. Perhaps their intuitions take over when they don’t have time to draw budget constraints and indifference curves, or perhaps they have a belief about most people’s preferences, and that belief supports their answer.
When people talk about supply and demand curves, it is important to mention that work and land are exceptions. Land, because (usually) you cannot created more land, even if the market price goes up. Work, because everyone only has 24 hours a day, so if you pay them more, they may actually choose to work less, because for many people the entire point is to enjoy their remaining hours.
Which means that tax will also have a different impact on work and land. For discussions on land, see Georgism. Higher tax on work could mean that people now need to take two jobs or cannot afford to retire, i.e. more work.
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I wonder whether economics students also have their specific biases, which make them more likely to make this simple mistake. For instance, I would expect them to be rich and pro-capitalist, compared to the average population. Which means they are likely to see work as something that people choose voluntarily and rationally, rather than a desperate attempt to survive. When they think about someone making decisions about work, they probably imagine a CEO who already has a few millions in bank account but still wants more, rather than a single mother working two jobs to feed her child. The CEO might be disgusted by a tax increase and retire, but most people do not have this option.
Common misconception about income tax discouraging work
I once heard a political commentator say something like this: “we tax cigarettes to reduce smoking, and then we tax success and we’re surprised this reduces success.”
This at least roughly corresponds to a misconception I learned from the economist Gregory Clark. He said if you ask economics undergraduates (a group with an unusual affinity for economics!) what effect a higher tax rate will have on hours worked, they almost always make the same mistake: they reflexively assume the tax hike leads people to work less hours.
They presumably make the too-hasty assumption that less income per hour automatically means less incentive to work. But the actual effect depends on the individuals preferences, specifically how they value income (or goods) versus leisure. They might increase their effort to offset the loss of income, or they may find that the new lower wage isn’t enough to justify working a single hour.
I find it interesting that Clark reported this as an extremely common mistake, even though economics students would be well versed in the model used to correct the error. Perhaps their intuitions take over when they don’t have time to draw budget constraints and indifference curves, or perhaps they have a belief about most people’s preferences, and that belief supports their answer.
When people talk about supply and demand curves, it is important to mention that work and land are exceptions. Land, because (usually) you cannot created more land, even if the market price goes up. Work, because everyone only has 24 hours a day, so if you pay them more, they may actually choose to work less, because for many people the entire point is to enjoy their remaining hours.
Which means that tax will also have a different impact on work and land. For discussions on land, see Georgism. Higher tax on work could mean that people now need to take two jobs or cannot afford to retire, i.e. more work.
*
I wonder whether economics students also have their specific biases, which make them more likely to make this simple mistake. For instance, I would expect them to be rich and pro-capitalist, compared to the average population. Which means they are likely to see work as something that people choose voluntarily and rationally, rather than a desperate attempt to survive. When they think about someone making decisions about work, they probably imagine a CEO who already has a few millions in bank account but still wants more, rather than a single mother working two jobs to feed her child. The CEO might be disgusted by a tax increase and retire, but most people do not have this option.