NCPA - National Center for Policy Analysis

Work and Taxes

October 27, 2003

Economists have devised many new statistical techniques for measuring labor supply. A number of significant changes in the tax structure provide data and opportunities to study the interaction between taxes and work. And better international data allows for comparisons between countries. The result is a growing consensus that taxes affect labor supply much more than previously assumed, says Bruce Bartlett.

Some recent examples:

  • A study last year by economists Daniel Aaronson and Eric French of the Federal Reserve Bank of Chicago found that previous studies had understated the impact of progressive tax rates on labor supply in the United States by 10 percent for men and 20 percent for women.
  • Earlier this year, Syracuse University economists James Ziliak, Thomas Kniesner and Douglas Holtz-Eakin (now director of the Congressional Budget Office) found that the labor response to tax changes was twice the standard estimate; their research suggests that we could increase our living standard by 20 percent if we just collected the same revenue from a flat-rate system.

In his Richard T. Ely lecture to the American Economic Association in 2002, economist Edward Prescott of the University of Minnesota concluded that almost all of the difference in living standards between the United States and France is accounted for by the impact of taxes on work. He notes that while the capital/output ratio is about the same in both countries, French workers work 30 percent less, due entirely to the much heavier French tax burden on labor. Prescott concluded that if France had the U.S. tax system, the French standard of living would immediately rise by 20 percent.

Common sense tells us that people work less when their after-tax reward is reduced. It's good to see that economists finally agree, says Bartlett. (See the figure.)

Source: Bruce Bartlett, "Work and Taxes," National Center for Policy Analysis, October 27, 2003.

 

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