NCPA - National Center for Policy Analysis

I Can Afford Higher Taxes. But They'll Make Me Work Less.

October 12, 2010

An important issue dividing the political parties is whether to raise taxes on those earning more than $250,000 a year, says N. Gregory Mankiw, a professor of economics at Harvard University.

Mankiw, being comfortably in the income range that would be hit by this tax increase, first acknowledges that the Democrats are right about one thing: he can afford to pay more in taxes.

Nonetheless, as Republicans emphasize, taxes influence his decisions.

  • Suppose that an editor offered him $1,000 to write an article.
  • If there were no taxes of any kind, this $1,000 of income would translate into $1,000 in extra saving.
  • If invested it in the stock of a company that earned, say, 8 percent a year on its capital, then 30 years from now, his children would inherit about $10,000.

Now let's put taxes into the calculus, says Mankiw.

  • First, assuming that the Bush tax cuts expire, he would pay 39.6 percent in federal income taxes on that extra income.
  • Beyond that, the phase out of deductions adds 1.2 percentage points to his effective marginal tax rate.
  • He also pays Medicare tax (which the recent health care bill is raising to 3.8 percent, starting in 2013) and state income tax.
  • Putting all those taxes together, that $1,000 of pretax income becomes only $523 of saving.

And that saving no longer earns 8 percent.  First, the corporation in which he has invested pays a 35 percent corporate tax on its earnings, so Mankiw gets only 5.2 percent in dividends and capital gains.  Then, on that income, he pays taxes at the federal and state level.  As a result, he earns about 4 percent after taxes, and the $523 in saving grows to only $1,700 after 30 years.

The bottom line is that without any taxes, accepting that editor's assignment would have yielded Mankiw's children an extra $10,000.  With taxes, it yields only $1,000 (after the estate tax).  In effect, once the entire tax system is taken into account, his family's marginal tax rate is about 90 percent.

Source: N. Gregory Mankiw, "I Can Afford Higher Taxes.  But They'll Make Me Work Less," New York Times, October 9, 2010.

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