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Wednesday, March 11, 2009

Tax Cuts and Work Effort across Income Levels

A revenue neutral change that makes taxes more progressive increases work effort. That is, when taxes on the middle class go down by a dollar and taxes on the wealthy go up by a dollar, the increase in work effort by middle class workers more than offsets and fall in work effort by the wealthy:

So, based on my research, if a need to raise some revenue means tax rates have to be increased for someone, raising them on the wealthiest will result in a smaller reduction in work effort than raising tax rates on the middle class.

That's Julie Hotchkiss reporting on her research in macroblog. There is a catch:

An additional relevant question remains: What is the implication of changing work effort for GDP growth? The relationship between work effort and value of output is not necessarily the same across income levels. In other words, one hour of high-income (higher education) labor is expected to yield a higher value of output in the economy than one hour of labor from a middle-income (lower education) worker. A complete analysis of the aggregate impact of the administration's tax plan would have to also take this into account.

However, the effect on growth is only one metric by which to judge this policy, e.g. the benefits to the household that come from one more hour of work may also differ across income levels, particularly if the additional money is used to buy necessities in one case, and luxuries in the other.

    Posted by on Wednesday, March 11, 2009 at 10:08 AM in Economics, Taxes, Unemployment | Permalink  TrackBack (0)  Comments (46)


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