For years, I have struggled to explain to people why high marginal tax rates on the “wealthy” create disincentives to work that make the entire society more poor.
I finally figured out a way to explain the problem in terms that everyone can relate to: High marginal taxes function as anti-overtime. Call it undertime.
Many people seem incapable of grasping the idea. They seem to see issues of taxation only in terms of relative wealth. They can only see that people with an upper middle-class income have plenty and that therefore if you take proportionally more of their income, they will still have enough. This comment on a post about taxes creating disincentives [h/t Instapundit] represents a common view:
Your point is well taken, I think the Bush tax-cuts should be extended, and I can see why this woman may be considering her options…..BUT, if the people in your example have a mortgage, 2 kids, etc., and the wife can even consider not working, they may be in an economic pinch, but they are not suffering very much.
What Clair and other like her miss is that this isn’t an argument about fairness or who suffers. It is an argument about how tax policy affects the overall production, and thus material wealth of the entire society.
All of us, from the rich to the poor, need upper-income workers to show up for work. People receive higher incomes because their work generates proportionately more material wealth for the rest of us. If some highly paid engineer doesn’t design a product, a highly paid industrial engineer doesn’t design a factory to build the product, highly paid investment types don’t find funds to build the factory, and a team of highly paid managers doesn’t organize everything, then lower-income people can’t get good jobs working in that factory. That is true for all economic sectors. We need highly paid doctors, accountants, farmers, business owners, etc. to do the critical work that makes us a wealthy society. The longer and harder they work, the better off all of us are.
Anything that reduces their output makes us all poorer. When we penalize people for putting in extra work, they work less and we all become poorer.
Progressive tax rates work like anti-overtime pay. Call it undertime pay. We are all familiar with overtime. It is an ancient idea based on the physical fact that it is harder to work the last hour of work than it is to work the first. The longer you work, the more difficult it becomes to keep working. In addition, to work longer hours you have to sacrifice in non-work areas of life, family, friends and relaxation. You don’t get to stop and smell the roses as much. We’ve all experienced this reality at first hand. As the job gets progressively harder and the tradeoffs more painful, people want increasing returns per unit of time worked. We call this increasing return “overtime.”
Ironically, it is leftists who have long declared it exploitative to the point of evil to pay people a flat per-hour rate regardless of how many hours they work. Leftists feel so strongly about this principle that they have encoded it into the labor law of every developed nation. They would explode with outrage at the idea of any policy that paid people “progressively” less per unit of time the longer they worked.
Yet this is exactly what “progressive” marginal tax rates do. With marginal tax rates, the more money you make in total, regardless of how hard you worked to make it, the higher the percentage of all that money that you pay in taxes. That means that you get paid “progressively” less per unit of time worked.
Let me explain for those unfamiliar with how marginal tax rates work. Current tax rates look something like this:
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Now suppose you land a job that pays $250,000/year or $20,833/month. Suppose that for some reason you have the option to work as little or as much as you want over the course of the year. You can work anywhere from one month to 12. Now, the more months you work the more money you make and the higher your marginal tax rate. So, you earn significantly less per month working the 12th month than you did the 1st.
(Remember, this is just federal income tax. It doesn’t include payroll taxes or state income taxes.)
Of course, only a few self-employed types like doctors, accountants, engineers, etc. can actually set how many months a year they work. Most of us show up twelve months out of the year. Instead, when we seek a promotion or try to expand our own businesses, we expand the number of hours per day and week that we work. However, the principle remains the same. You work more but, because of progressive taxation, you get less per hour the more you work.
This is important because not only are upper-income workers especially vital to the overall economy but they already work more than others. By quintile, the number of hours worked per week increases from 14.40 to 26.66 to 28.87 to 33.43 to 34.56.
When you work longer hours in a more challenging and higher-stress job, you are proportionately more sensitive to anti-overtime. You are already close to being maxed out. When the government cuts your pay even further, you are more likely to resist working more and may decide just to work less. If you have consumed proportionately less and saved proportionately more, you may find it more rewarding to just stop working altogether.
Somewhere along the line, we developed the idea that those who earn good money are just machines that will show up and work grindingly hard regardless of how much we pay them. I don’t know why we think that, when we know that we personally will not do so.
You don’t need a degree in economics to understand this concept. You just need to have worked your ass off at some point in your life. That is why so many, regardless of their education, don’t get such a simple idea.
[Note: I think many people have a similar problem grasping how taxation affects decisions to invest. I will cover that in a subsequent post.]
When I was working in the postal service during the 70s,my marginal tax rate,counting state and city and SS was 50%. I not only refused OT but stayed out sick for six months without sickpay; I had made too much from speculating and couldn’t see the advantage to working a full year.
It is rather obvious that salaried people will forgo a relatively marginal income increase if the amount of hours needed to procure the increase increases dramatically and the net after tax increase is substantially diminished is that most people won’t go for it.
As for the self employed it is even worse if the tax bite increases dramatically. At some point the conclusion is obvious; working 65-70 hours a week for the net marginal increase isn’t worth it.
For the small business owner you are probably working 60 hours already, any additional revenues that you push for unless it results in a dramatic jump, the additional expenses incurred to create the increase is offset by the higher amount of taxes on the net income and the increases in operating expenses.
The recovery won’t really begin until there is massive unemployment among government workers. I suggest that Republicans if they get control of Congress apply the AMT to all government workers (except the military), state, local and federal along with all employees of non-profits and call it a targeted tax hike on the non-productive class. They are free to look for work elswhere, if they can get it. It is time the taxpayers stop being extorted by these people. They are not doing the taxpayers any favor with their money.
“You just need to have worked your ass off at some point in your life.”
Which is why the current occupant of the Oval Office will never understand this concept.
Ah, but your analysis is missing out on a very important Progressive principle. If you believe, as Progressives do, that there is only a finite amount of income to go around, then hard working high earners are taking more than their fair share of that income. Making that additional hour of work unappealing, and thus unclaimed, leaves more work for the rest of us. Think of how the French like to create jobs: they declare by fiat that the 40 hour work week is now only 35 hours. Voila! Seven jobs (7*40) has just become 8 (8*35). Revel in the build of Progressive job creation!
I don’t think that most Progressives think too deeply about the impact of incentives on tax policy, but if they did they’d be happy either way: if you work extra hard, they take your money. If you don’t, they take your hours.
-John
Sorry for the typo, that’s “bliss” of Progressive job creation.
Because the upper-income workers are few in number, most people do not know the truth of the lifestyle. We see only the lifestyles of the rich and famous on TV, not the engineer living in an extended-stay hotel putting in 50+ hours per week on an assignment away from home.
I suggest that as good as your undertime explanation is, it will not resonate because people will not think it applies to anyone they know. “Yeah, I see the argument, but those aren’t the rich who need to pay more taxes.”
Rich (or upper-income) is a term of rhetorical vagueness. It always means somebody else.
Governments tax cigarettes to keep people from smoking. Governments have extra taxes on alcohol to keep people from drinking. Governments have extra taxes on gasoline to keep people from driving. Governments tax things they don’t want us to do or use.
Governments don’t tax things they want us to do or use.
No taxes on people who don’t work.
Heavy taxes on people who work too much.
Get the message?
I think the vast majority of voters of modest means get this message. Part of the problem is the 40% who don’t pay income tax. Even the poor resent the welfare cheats. Republicans made a big mistake when they exempted so many people from income tax.
MK…even the 40% of voters who don’t pay income tax are *effectively* paying for government excesses, of course, given that they buy products from companies who must load tax costs (property taxes as well as income taxes) into the prices of their products. But it’s not an easy point to get across, and you’re correct that the Republicans should have resisted this exemption more forcefully.
Indeed, even if someone is being completely supported by welfare, I think it would be worthwhile to have him make a small tax payment as a psychological token of citizenship. Increase the welfare payment if necessary to make up for this—yeah, it nets out the same, but I think the psychological point is not a trivial one.
Employer witholding was perhaps the greatest stroke of genius these tyrants ever had.
Imagine if people had to sit down – whether weekly, monthly, quarterly or annually – and actually WRITE A CHECK for their taxes.
We’d have seen a revolt DECADES ago.
Instead, we see fools celebrating a “large” refund of $5k instead of screaming about the $20k that was stolen from them.
WHO IS JOHN GALT??!!
I was raised to be a worker. I’ve worked since age 5 or so – whether shoveling snow, washing cars, collecting bottles for their deposit — something. I also learned that the harder you worked, the better you did.
In 2002 I had a motorcycle accident which pretty much destroyed one of my legs. Docs said I’d be out of work at least a year. 5 weeks later, I left a rehab-hospital on Friday and went to work on Monday.
5 weeks. I should have been in a hospital bed – not commuting 2.5 hours so high on morphine I barely remember the whole period – but I did it. And I kept on doing it.
By 2008 I’d reached the end of my rope. I was working 100+ hours a week, trying to keep up with client demands for an employer who kept cutting staff. At their request I’d repeatedly postponed needed surgery – and as a result I got more weak and more sick as every day passed. Still I kept on going.
My Doctors threatened to declare me disabled whether I liked it or not, but I begged them to bear with me “just a bit longer” — just as my employer was pressuring me.
Finally, I almost literally hit the wall. I couldn’t sleep for the pain, couldn’t take enough meds to kill it, and had become so sick I was struggling just to get through the next 18-hour day — so I finally put my foot down.
The “last straw” was having my employer add to my workload TWO major projects — either of which would have been a full-time job by themselves. My protests were rebuffed — they claimed I was the only Engineer they had with the skills and experience required to handle matters of such complexity, especially given that both were high-profile projects in which their biggest clients and vendors were all involved.
I told my Doc to schedule my surgery ~120 days out. I then told my employer that I would be having the surgery and it would take 3-6 months for me to recover. I told them I’d scheduled 120-days out, thus ensuring I could finish all projects and transition other duties to others who would cover until I was able to return.
11 days later I was informed that my services were no longer required. When I pushed for a reason, I was told that SOMEONE had to go, my skillset was “redundant” and that Mgt. had decided it would be me.
Funny disparity between that claim and the e-mails I’d received just 3 weeks earlier — but I digress. This was Friday. They told me that my Termination would be effective the following Friday.
Thanks to a minor miracle, Doc was able to schedule my surgery on Tuesday morning — 1.5 business days from my desperate call — thus ensuring that they’d have no choice but to honor my disability benefits.
I’d paid for disability insurance for over 18 years, and never filed a claim — not even after my accident in ’02. I’m not a mooch – I’d planned and made sure I was covered, and was going to get the care I needed.
Unfortunately, the surgery went poorly – I came out of it much worse than I went in, and haven’t been able to work since. Most days it’s all I can do to get out of bed – and I’d not wish this life on my worst enemy.
But I LEARNED SOMETHING — something I’ve been preaching to anyone who will listen ever since.
WHO IS JOHN GALT??
See, my Insurance pays me 50% of my usual gross pay. I made good money, and lived paycheck to paycheck like most folks. We lived within our means (THank G*D) but had no real savings but also no real debt except our reasonable mortgage.
Imagine trying to live on HALF the money you were used to making!
But here’s the lesson:
WHO IS JOHN GALT?
See, though we’ve had to tighten our belts a bit – and stop WASTING money, our lives really haven’t changed much at all.
The reason for this is simple: The increased taxes, combined with the inevitable expenses incurred while working 100_+ hours a week, were eating up HALF OF MY INCOME!
I was — quite literally — working myself to death FOR NOTHING.
I’m not giving up – I WILL return to work someday, when I am able, when some genius Doc finally figures out how to fix what’s messed up, but you can be da*ned sure that I will NEVER AGAIN be sucked into such a trap.
Further, I am proud to say that a significant number of others in my circle of acquaintance have also – now that they’ve been educated – run the numbers and given some serious thought to the situation.
These folks have also now deliberately reduced their working hours to the point that maximizes their benefits, and direct their energies to their family and to enjoying their lives as G*d intended.
Some – like me – still struggle with this, but it is the height of stupidity to work for the benefit of others who will not.
I strongly encourage everyone to do the math for themselves — and make sure they’re including ALL expenses. I – for example – averaged 1000+ miles per week on my car. Sure – I got a mileage deduction, but it wasn’t even close to covering the costs of depreciation (Destruction) of the vehicles I wore out, not to mention tires, oil, brakes, etc…
Meanwhile, I thank G*D every day for the blessings – even for the ongoing pain – because I am now a wiser man, and in a position to help others.
If everyone would “Go Galt” in this way, we’d help hasten the day when our .gov has no choice but to cut back.
WHO IS JOHN GALT? or – as Tom Baugh says – STARVE THE MONKEYS!
Thanks for reading —
DD
Dedicated_Dad,
I was ”” quite literally ”” working myself to death FOR NOTHING.
That is unfortunately quite common. A few years back my sister-in-law ran their family numbers and she said, “I figured out that I was working for nothing but medical care and taxes.” They have since moved on to start their own businesses.
The increased taxes, combined with the inevitable expenses incurred while working 100_+ hours a week, were eating up HALF OF MY INCOME!
I think a lot of people don’t realize that working, even for wages, cost money itself. When my daughter contemplated returning to the work force after the birth of my granddaughter, she ran the numbers on day care cost, transportation cost, wardrobe, likely eating out more, taxes etc and decided they wouldn’t make any money at all if she worked. Given the advantages to my granddaughter of a stay at home mom, it was a no brainer.