Everyone knows that we have a huge tax problem. It's figuring out what to do about it that has triggered such a big debate that Congress has once again come to a standstill rather than dealing with the problem.
The Obama administration has proposed allowing tax rates on taxpayers earning more than $250,000 to rise to their pre-2001 levels. Predictably, the proposal has pitted middle-class taxpayers who'd be unaffected by the move against higher-earning taxpayers who'd see many of the tax cuts they've had over the past 10 years go away.
A threat to all
But earlier this month, Harvard economics professor Gregory Mankiw wrote an article for The New York Times in which he put forward a scary theory: that raising taxes on high-income taxpayers would have the unintended consequence of making them work less, thereby hurting those who rely on the services that they provide.
Using himself as anecdotal evidence for his proposition, Professor Mankiw's argument goes like this: Once you're rich enough to earn $250,000 or more, you don't really need to take on extra work. When tax rates are low, though, you get to take home more of the pay you earn if you work more, so you'll tend to put in extra hours. Conversely, when tax rates rise, you don't get to keep as much of your earnings after taxes. So since you're not being rewarded as much to work more, you'll decide to take a break and stop doing that extra work -- thereby leaving those who depend on the essential services you provide out of luck.
On its face, that sounds like simple supply and demand economics. But in the real world, it doesn't always work that way.
Getting by on six figures
For one thing, Professor Mankiw says that when it comes to spending the money he earns, he is already "almost completely sated." If he gets some spare money, he'll set it aside for his kids, but he has no financial challenges at all. And apparently, he'd feel no inclination to work more to make up for any lost income going to higher taxes.
If you think that's how all high-income taxpayers feel, though, think again. Staying with anecdotes involving academics, turn to University of Chicago law professor Todd Henderson, who last month lamented how his $250,000-plus family income was barely enough to make ends meet. With massive student loan debt, various taxes, and household expenses like private school, child care, and lawn care, Henderson sounds like his family is anything but sated.
If you have all the money you need, then sure, maybe you'd turn down extra work. But for the many people who live at or above their means and face challenges to make ends meet regardless of their income, higher taxes aren't going to have them heading for the golf course. Rather, it's going to make them try to figure out how to replace the take-home pay that's now going to Uncle Sam -- and that could well make them work harder.
Making hay while the sun shines
Perhaps more relevant to the non-academic world is that most people don't have the luxury of deciding exactly how much they work. Those who receive salaries get a fixed paycheck irrespective of how many hours they put in. Trying to cut back, however, would potentially put their jobs at risk.
Meanwhile, many independent contractors have gone through several business cycles in their careers, during which boom times are followed by long lulls where work's hard to find. Even those who earn $250,000 and up know that if you try to cut back when times are good, you run the risk of not having enough during slower times. That's not a risk that many are comfortable with -- even if it means paying higher taxes.
If taxes rise on the rich, then we may not be reading more of Professor Mankiw's opinions in national newspapers. But to think that higher taxes will lead to losses of essential services is a red herring that draws attention away from the more important issue: figuring out the best way to return the government to some semblance of fiscal responsibility.
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