Via Mark Thoma a paper a self-recommending paper by David Romer. A key take away – I think this comes from James Kwak paraphrasing.

To put this in perspective, an elasticity of 0.19 implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.

This is roughly inline with my reading of the data which says a marginal tax rate of around 70 – 80% would maximize the government’s take.

An important thing that is not commonly talked about is the way income and work effects interact and this has important implications.

We usually think of income effects as causing people to substitute away from work towards leisure. However, causal empiricism suggests that one important use of income is to substitute out of household production.

For example, one definition of the “work” I do is attempting to interpret data for the benefit of public officials and my blog readers. However, at my current wage I also have to cut my own grass and wash my own dishes.

If I were paid more I would use some of that money to have my grass cut and a maid do my housework which would leave me with more time to look at data.

However, it would be wrong to interpret that as a substitution effect – which is how most studies would pick it up. Its really an income effect. If I won the lottery the same thing would happen. I wouldn’t look at less data, I would look at more data, because now I can pay someone to do household production for me.

The same thing is likely true with folks who become superrich. You might think that they became super rich because of they wanted to make a lot money. Unlikely. It is more likely that their obsession just so happened to coincide with something the market paid a lot of money for.

And, so as they get richer they can spend more and more time with their obsession. At lower levels of income it looks like you are picking up a substitution effect. Higher wages –> more work. But, you are really picking up an income effect. More wealth –> less household production.

Thus once you get to the super wealthy it looks like a surprising drop in the substitution effect, but its not. You have simply satiated the income effect. They now do almost no household production so it doesn’t matter.

The ironic thing is that even if you are a Randian, you can see this. Hank Rearden says he only cares about making money but this is an obvious lie. Like most male obsessives he cares about steel and about women who care about steel and about nothing else.

If he made money, so be it. If not, so be it. If metallurgy made you a billionaire he’d be a billionaire. If it made you a homeless crank, he’d be a homeless crank.

That’s the way obsession works.

What pisses him off is not taking away his money, its taking away his metal.

Its funny that intuitively folks pick up on that but then in an effort to defend egoism make up this story about loving money that is actually both less accurate and less compelling.

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