I have been making this argument in various forms for a while on this blog, but I think it might be helpful to go back to basics. Here is my basic point:
The idea that taxes decrease our incentive to work runs counter our basic observations about how human beings behave
Well the basic thing that taxes due is reduce your take home pay. If you work the same number of hours you earn less for every hour worked.
There are two basic effects here that have been long recognized by economists.
The substitution effect: The substitution effect says is that since I am getting less money for each hour I work I should work fewer hours. My reward from work is less, so I substitute away from work towards other things.
The income effect: The income effect says that taxes make me poorer. When people are poorer they “need” to work more to pay for the things they want. Therefore, taxes should make me work harder.
The question is, which one of these effects is more powerful?
In the absence of very strong evidence to the contrary we should believe that the income effect is slightly more powerful.
A few different reasons.
First, introspection. What would you do if your pay got cut? Would it make sense to say, well I got a pay cut so I might as well not put in as many hours? Or would it make sense to say, well I got a pay cut so I am going to have to put in more hours or find a second job?
You could probably think of scenarios in which both make sense, but the latter seems more natural for most people. This should push our estimate towards the income effect being stronger
Second, wage rates have gone up dramatically over the last 200 years. Does it seem like people are working more or working less than they did 200 years ago. It really seems like they are working less. There are lots of confounding factors of course, but the overwhelming sense is that when people made less money they “had” to work harder.
Third, high income people don’t seem to be working that much more than low income people despite the fact that a natural propensity towards work can make one high income.
Indeed, the data show us that low income folks used to work a little more, but now they work a little less than high income folks. Yet, if the income and substitution effects were balanced for each person we would still expect higher income people to work more.
That’s because working hard can lead to more education, more experience and more promotions. Being hard working is also associated with having a conscientious personality type which is itself more valuable.
So if someone was simply born with a stronger propensity to work, we would expect that person to earn more income per hour. Thus we when look at the data we should see that all these high income people are working lots of hours.
Yet, we actually don’t see that. We see only a mild effect and even then that effect is not robust over time. Sometimes, high income folks are working less.
Fourth, household leisure is one of the most common rewards from work. When people think about the return to working hard, many of them mention material consumption. However, very often they mention, leisure enjoyed by themselves or other members of their family. In particular, people mention leisure enjoyed by their children.
Here is a quote from John Adams that gets at what I am talking about
I must study politics and war that my sons may have liberty to study mathematics and philosophy. My sons ought to study mathematics and philosophy, geography, natural history, naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry, and porcelain.
Adams is saying that the goal of his labors is to free up the labor enjoyed by his descendants. Even in advocating lower tax rates Greg Mankiw displays similar sentiments.
I don’t want to move to a bigger house or buy that Ferrari, but I hope to put some money aside for my three children. They will never lead lives of leisure, but I hope they won’t have to struggle to find down payments to buy their own homes or to send their kids to college.
In short, he saying that he hopes his work will be paid off by decreasing the amount of work his children have to do.
We might find this a noble goal and we may decide that we don’t want to stand in the way of the Mankiw family’s pursuit of happiness. These are important questions.
However, to the narrow question of “will taxes cause people to work less” we have to note that even if taxes do cause parents to work less – which is questionable in itself – they may do so by causing children to work more.
Now there might be all sorts of reasons why you might feel lower taxes are better than higher taxes. Not least among these might be that you feel the government is inefficient at providing services.
I just don’t think the idea that taxes will cause people to work less is among them.