Scott Sumner on taxes

Scott Sumner has a reply to a BV piece of mine in which I suggested that the labor disincentive effect of income taxation is relatively modest right now in the U.S.

Scott:

The required number of hours worked is itself endogenous.  In Europe, required yearly hours are less than in the US, due to higher taxes. 

This assertion might be true. If Scott has evidence to back up this claim, he does not present it in this post.

Scott:

Second, when you tax people, they are poorer, and they need to work more to maintain their standard of living. 

This is a common misconception that I see all the time.  There is no first order effect of taxes on national income, as the tax money gets recycled into the economy.  Now it’s true that the government might waste the tax money, leaving a country poorer, but in that case it would be more accurate to say that government waste causes people to work harder.  In modern economies most extra spending at the margin goes back in transfer programs.  Since national income doesn’t fall from the direct impact of taxes, there is only a substitution effect on labor supply, not an income effect.

Well, this would be a good point if taxes left income unchanged - in other words, if tax revenue was redistributed lump-sum to the people from whom it was extracted, as is the case in many economic models. However, if taxes represent income redistribution - as they often do in the U.S. - this is not the case, and we do need to think about income effects. In particular, our tax system is highly progressive - rich people pay most of the taxes, poor people get most of the services. Thus, if we want to think about whether taxes make the rich work less, we do need to think about income effects, contra Scott.

Scott:

You don’t want to use time series data, as there is a long-term downward trend in hours worked due to increasing affluence. 

Of course, but this does give you some general idea of how much we might increase labor supply (or fail to increase it) by cutting marginal tax rates. The long-term trend really seems to dominate. Of course, this by itself is not dispositive, but that's why I mentioned it.

Scott:

Lower income people face a much higher implicit MTR than in the 1950s and 1960s.

This is a good point, and I probably should have mentioned something about this in my article (I was focused on the idea of taxing the rich). Casey Mulligan has argued that implicit taxes (from benefit phase-outs) are high. Paul Krugman has also made this argument. I'd like to see more research on it, but it's a very important point, and one that is totally left out of the discussion in most U.S./Europe comparisons.

For a rundown of the relevant research on taxation and labor supply, see these fun slides. (hat tip to Claudia Sahm)