Study relates tax rate and work, but debate goes on
The White House believes income taxes are so high they discourage people from working. Is this a seat-of-the-pants theory, or is there statistical evidence to back up the claim?
Consider the conundrum. If you work harder, you'll get paid more. But if you get paid more, you'll float up into a higher tax bracket -- and the government will snatch a larger percentage of your income. When the dust settles on April 16, you'll probably be some dollars ahead. But is the extra effort worth it?
"No!" say supply-side economists. That's why they stress the importance of reducing marginal tax rates (the percentage taken out of additional dollars of income.) If workers can keep more of their raises and overtime, claim supply-siders, they'll have more incentive to work harder --American economy, creating more growth and greater tax revenues.
The Kemp-Roth personal income tax cuts, if passed, would slide everyone down into lower tax brackets. Additional income would be taxed at rates a few notches lower, so the government's share of the extra pay would be a smaller percentage. Thus the Reagan administration's claim that K-R is necessary to lighten the load on American workers, who will then work harder at longer hours, sure in their hearts that the reward will accrue to them, not the Internal Revenue Service.
Conventional wisdom, if there is such a thing in the brawling world of economists, has long held that labor supply is relatively inelastic in regards to tax rates. In less technical terms, that means workers as a whole don't really consider taxes when they decide how long to work. Male breadwinners have usually been thought particularly insensitive to tax rates, though working wives have been shown in the past as slightly reluctant to add on hours if it would scoot their joint income into a higher bracket.
But a study just published (though completed in 1979) by the Brookings Institution finds a stronger correlation. Dr. Jerry Hausman, the study's author , concludes that "the current tax system does significantly reduce labor supply." Dr. Hausman claims husbands as a whole work about 8 percent less than they would in the absence of taxes. The quintile of husbands that make the most money -- a slice of society supply-siders say is highly important to capital formation and investment -- reduce their labor hours 12.8 percent. Wives and female household heads are even more intimidated by looming tax rates.
"My study absolutely supports the claim that there would be an effect [on work effort] from a reduction in marginal rates."
To measure the impact of this foot-dragging on economic efficiency, Dr. Hausman uses a complicated yardstick called "deadweight loss." In effect, "deadweight losses" are the few extra dollars people won't pocket because taxes are discouraging them from working harder. Dr. Hausman concludes that a tax system that bit off the same percentage of everybody's income would be significantly more efficient than our current system, which takes progressively bigger bites as income goes up.
"The responsiveness for prime-age married men was surprising," says a government economist who has studied the Hausman report. "It should persuade people there is some impact."
But economists caution that the study is not entirely a statistical boost for the proposed Kemp-Roth cuts. When all the numbers have been jumbled together into a computer and cranked out the other side, the extra work and economic activity resulting from the lighter tax burden wouldn't be enough to make up the tax revenue lost.
Others point out that how long you work is a pretty narrow way of measuring labor effort.
"There are other dimensions of labor supply. How hard you work, how well you've been trained -- those kinds of things we know much less about," says Dr. Michael Boskin of Stanford University.
A commentary by Federal Reserve Bank of Atlanta economist Robert Keleher says these variables, "such as motivation, entrepreneurship, work intensity, the quality of work, and ambition," are difficult to measure but may be responsive to tax rates.
Dr. Hausman himself says much is still to be learned about the long-range effects of taxation on the labor supply. Do tax burdens shunt people into career paths such as academia, where pay is comparatively low but there are many nontaxable benefits?
The historical evidence cited by supply-siders stretches back to the Gladstone era in England, when reducing various tax rates resulted in a surge of economic growth. The move most often waved about is the so-called "Kennedy" tax cut of 1964, when the top marginal rate was cut from 91 to 70 percent.The resulting GNP figures are still being hotly debated.
Economist and psychologist George Katona of the University of Michigan claims in the latest issue of "Public Opinion" magazine that the Kennedy cut paid for itself, primarily by building "optimism and confidence" among businessmen and the public.
John Galbraith, a liberal economist associated with Kennedy, contends that the Kennedy cut and Kemp-Roth aren't comparable because the economic background was different in 1964 -- prices were much more stable, for instance, and there was much unused industrial capacity.
Many economists seem to agree that a supply-side tax cut would result in some increase in the supply of labor and investment. Revenues would probably not fall in proportion to tax rates. But there any sort of consensus unravels. Depending on your point of view, the increased revenue will be either a spoonful in a bucket or a flood that will more than compensate for the mone y lost through the percentage cuts.