The Effects of Taxation on Labor Income
Steven Davis and Magnus Henrekson look at “rich” countries and their different tax rates to assess the impact of taxes on things like work effort, household production, and the shadow economy. The results are pretty much what one would expect,
The authors stress that taxes affect work activity directly through labor supply-and-demand channels and indirectly through government spending responses to available tax revenues. They find that higher tax rates on labor income and consumption expenditures lead to less work time in the legal market sector, more time working in the household sector, a larger underground economy, and smaller shares of national output and employment in industries that rely heavily on low-wage, low-skill labor inputs.
The estimated tax effects are large for the authors’ preferred tax measures. Cross-country comparisons in the mid-1990s indicate that a tax hike of 12.8 percentage points (one standard deviation) leads to 122 fewer hours of market work per adult per year and a 4.9 percentage point drop in the employment-to-population ratio. It also increases the size of the shadow economy by 3.8 percent of official GDP, and it reduces by 10 to 30 percent the share of national output and employment in “Retail Trade and Repairs,” in “Eating, Drinking, and Lodging,” and in a broader category that includes “Wholesale Trade and Motor Trade and Repair.” The evidence suggests that tax rate differences among rich countries are a major reason for large international differences in market work time and in the industry mix of market activity.
In other words, taking part of people’s wages means they’ll work less for pay. Shocking I know, but given the way some liberals veiw taxes this kind of research is necessary. This is another reason why always raising taxes to deal with the Social Security problem isn’t always going to be the answer. Eventually you’ll start to get less money even though the rates are going up. A tax on wages basically lowers the wage for the worker. The worker really doesn’t care what is pre-tax wage rate is, but is instead concerned about the after-tax wage rate. A worker could have a pre-tax wage of $1,000, but if after taxes it is only $3.50 you might find that the only people applying for the job are pimply faced teenagers looking for some weekend fun money.
This part of the article is also interesting,
Second, countries with high tax rates on labor income and consumption expenditures have relatively generous tax-funded programs for social security, disability insurance, sick leave assistance, unemployment insurance, and general assistance. The benefit sides of these programs also alter labor supply incentives in ways that discourage market work activity and increase employment in the underground economy.
Which makes sense. If a person is working at a given job because of the benefits, then providing those benefits via the government and taxes that person might quit his job. Now maybe this is a good thing, or maybe not. But it is something that is not at all considered when there is campaign talk of nationalized/subsidized health care.