Work Incentives

The net incentive or disincentive effect of a given change in personal exemptions, therefore, will depend upon the extent to which taxpayers are concentrated at the boundaries of the various tax brackets rather than at the centers. For those at the boundaries the effect may go either way, but those at the centers will be induced to work harder by reduced exemption allowances and to work less by greater exemptions. A relatively even distribution of taxpayers over the various tax brackets, therefore, would create the presumption that lower exemptions are favorable to work incentives and higher exemptions unfavorable. On the other hand, a significant concentration at the bracket boundaries, especially at the bottom of the lowest bracket, could easily produce exactly the opposite result.

The Tax Treatment of Property Incomes

Another relevant issue to be taken into consideration in studying the incentive effects of any income tax is the treatment of incomes which are more or less independent of any labor services rendered by the income receiver. At given levels of yield—and this is the only important comparison to make—a general income tax which treats all types of income equally will be more favorable to work incentives than one which exempts some property incomes entirely and taxes others only partially.

As compared to the selective tax, the general one taxes certain kinds of property income more heavily but all other types of income less heavily. Since the two taxes are equally productive, taxpayers as a group have the same total disposable income in each case, but under the general tax they realize higher rates of take-home pay from the rendering of labor services. This acts as an incentive to still greater effort. The fact that this kind of tax treats some kinds of property income more severely has little or no effect on work incentives since little or no labor is involved in the creation of these incomes. On the average, therefore, the general tax is more favorable to productive activity. It has the further virtue, of course, of being more equitable since it treats all types of income the same way.

For these reasons policymakers should scrutinize closely proposals which would have the effect of narrowing the base of the individual income tax. If the incomes involved are largely of the property type, the influence of the income tax at given yields is shifted in the disincentive direction. Present provisions concerning capital gains and losses, tax-exempt bond interest, percentage depletion, certain allowable deductions (such as those for meals and the like, which to a large extent are personal consumption on the part of the taxpayer rather than costs of earning income) all tend to make the individual income tax less favorable to work incentives than it would otherwise be.

The Incentive Aspects of Excise and Sales Taxes

One of the traditional tenets with reference to the relative merits of different kinds of taxes is that excise and sales taxes are more favorable to work incentives than are income taxes. Let us examine this assumption for a moment.

Consider first the probable effects on work incentives of the price changes induced by sales and excise taxes. A general increase in consumer good prices, for example, makes consumers with relatively fixed money incomes worse off and thereby tends to induce more effort.

The rewards from that effort, however, have undergone a reduction in their buying power and so the effort itself is less attractive than it once was. When considering the extra work the worker finds himself both pushed toward it (by his lower real income) and repelled (by the lower real rates of pay) at the same time, and he may in the final analysis expand his labor supply, contract it, or leave it unchanged.

It is true that many consumers may fail to perceive the price changes induced by changes in excise taxes, but they are likely to be much more aware of what it costs them to maintain their accustomed standard of living and what happens to the level of their cash balances in the process. Some evidence of the effects of high prices on worker behavior is provided by a recent British investigation which found that approximately 40 percent of the workers interviewed regarded high prices as a factor which deterred their productive efforts and some 70 percent thought they were also a factor making for greater incentive.

Taxpayers may, of course, do more work not in order to buy additional things but primarily to raise their level of saving. Even in this case, however, the tax-induced price increases are by no means irrelevant. The saving may be specifically earmarked for a future purchase of a taxed good or service. Unless the tax is believed to be temporary, the incentive effect is likely to be the same here as in the case of a person who works in order to consume. Even the person who saves in order to accumulate a certain amount of capital may adjust his goals upward when prices rise.