Greg Mankiw is concerned that if we raise taxes for the wealthy, he’ll have marginally less incentive to go to work, rather than spending more time with his kids.
The bottom line: If you are one of those people out there trying to induce me to do some work for you, there is a good chance I will turn you down. And the likelihood will go up after President Obama puts his tax plan in place. I expect to spend more time playing with my kids.
Greg Mankiw, of course, spent years as the Bush administration’s chief economic advisor. Considering how that turned out, it’s probably best for everyone if Professor Mankiw spends as much time playing with his children as possible.
Regarding Mankiw’s argument, the base assumptions underlying his math are ludicrous ((See also the first comment to this blog post.)) (as you’d expect from someone who once argued that we could pay off the deficit AND have huge tax cuts — how well did that work out, again?). Nor is it true that 100% of motivation for working is money. Nonetheless, specifics aside, Mankiw’s general point is correct: If we tax the 5% of highest income earners more, we can expect some of that 5% to work marginally less, all else held equal.
However, most taxpayers will have more take-home pay under Obama’s proposed tax increase; many of these people will experience a marginal increase in incentive to work.
Furthermore, in the real world, not everything is held equal. Under Bill Clinton’s economy, many entrepreneurs had more incentive to work, because marginally higher tax rates were more than offset by the higher profits available in a thriving economy. Similarly, Bush’s tax cuts will not be enough to counteract the damages to incentives caused by the Bush recession.
When I read a bit about Reagan and Bill Bradley working together on the ’86 tax reform, I formulated a theory. Both of them thought the top marginal income tax rates that had prevailed in the previous 30 years (91% until JFK’s tax reduction, down to 70% in the Carter Admin, down to 50% in 1982) were too high. Both had been paying high taxes because of their earnings in entertainment — Reagan as an actor, Bradley as a pro ball player.*
However, they had different views about people’s reactions to high marginal rates. Reagan, as an actor, could make marginal decision pretty easily; that is, he could decide to take one more project that would bump him up into the highest tax bracket, or he could decide not to act in that project and spend time on something else instead. Bradley, as an employee of the Knicks, didn’t have that option. He couldn’t get paid based on the number of games he felt like playing; unless he was injured, he was expected to be at every game.
Most people’s work lives are like Bradley’s (without the groupies). We don’t get to decide that we’d rather work 10% less and take a 10% pay cut that will keep us out of certain bracket. We can decide between jobs that are intensive and pay a lot, and jobs that are less-intensive and pay less, but we can’t finely tune our income on an annual basis. I was just advising a Republican, who was complaining about the likely tax increase, to leave his extremely stressful, 14-hour-day job at a big corporate law firm that pays $175k plus bonus, and go to a small firm that paid $100k and no bonus. He nixed the idea because such a down-shifting would derail his career trajectory.
Mankiw’s remark reminds me of a cartoon my professor in American history of economics passed around (despite being, like most econ profs, libertarian/ conservative politically): the cartoon depicts Marginal Decision Man, who decides each day how much time to spend on work, how much on leisure, lets his kids decide if school is worth it today, etc. MD Man is of course not very representative of most people’s behavior, providing example #24,534 of how Econ 101 models fail to capture real-life decision making.
* Although I didn’t particularly support Bradley in the 2000 Dem primaries, I think he has one of the more awesome stories in political life: height and freakishly wide peripheral vision allow him to be captain of the gold-medal-winning Olympic basketball team and become an NBA hall of famer, but first he goes to Princeton and is a Rhodes Scholar at Oxford. Ah, when student-athlete actually meant something for the “student” bit…
Also, of course, Americans work too much and take too little vacation time, to the great detriment of our health and happiness, so if the tax policy actually led to a decreased incentive to work (as though most of us were allowed to control the details of our working hours while keeping the same job) and therefore led to people working fewer hours, that would be to the benefit of us all.
Actually, of course, we need other sorts of policies to decrease the effective work week.
[Edited to add, PG beat me to it and said it better]
It is for me. Where to work is a different question than whether or not to work.
You’re not really saying what it looks like you’re saying, are you? It looks like you’re saying that it would be a rational decision to earn $249,999 rather than $300,000 because you’d have more after tax dollars if you made the smaller of the two amounts. Which, of course, isn’t true when we’re talking about progressive taxation.
I mentioned this post to my partner John, quoting Ampersand’s deft “it’s probably best for everyone if Professor Mankiw spends as much time playing with his children as possible.”
“Or himself,” he replied dryly, turning back to his email.
It should be added that, due to the quickly declining marginal value of money, increased taxes can actually increase incentive to work by decreasing incomes.
Jake,
You’re not really saying what it looks like you’re saying, are you? It looks like you’re saying that it would be a rational decision to earn $249,999 rather than $300,000 because you’d have more after tax dollars if you made the smaller of the two amounts. Which, of course, isn’t true when we’re talking about progressive taxation.
No, that’s not what I’m saying. You’re ignoring the value of leisure. It’s a rational decision to earn slightly less if the lower earnings come with inceased leisure, because then the total value of your time (earnings + leisure) is greater. Higher marginal tax rates make leisure a more attractive trade-off with income.
PG, you’re assuming that I value my leisure time at the same rate my employer values my work. You’re right that it’s a lot more complicated in practice than in Econ 101. But in fairness to Econ 101; Most 101 classes give you over simplified information. Hell, Physics and Chemistry 101 teach the ideal gas law in most places. That’s out and out wrong. But close enough in most places as not to matter. Your lawyer friend is likely thinking not just about how much money they’d loose this year (150K) but also about how much they’ll lose over time if they’re never a partner at a Big Firm.
joe,
No, he really doesn’t want to be a partner at this place. Otherwise I would have factored that in.
Also, I worry more about over-simplified models in the social sciences and humanities than in the hard sciences, because to some extent we get to vote on the economic and legal policies we’ll have, but we don’t get to repeal the law of gravity.
I am mostly motivated to work by money. I think at 250k even I’d lose some motivation anyway. I’d have a hard time justifying spending so much. I currently save something like 40% of my after-tax income and I don’t earn near 250k. What would I do with 250k? (rather, 170k or so after taxes). Yeah I think my incentive to work at that point might stop increasing. I couldn’t spend that much without a lot of Hawaii vacations.
Greg also calculates estate tax…. after 2009 estate tax (correct me if I’m wrong) doesn’t affect an estate of less than 3.5 million dollars. Most wealthy inheritors don’t pay much estate tax. They’ve got trust funds and other loopholes.
I guess it’s great that Greg Mankiw feels obligated to pay the full estate tax though, instead of finding a financial planner who is familiar with estate tax law.
Ha. Ha.
What would I do with 250k? (rather, 170k or so after taxes).
Depends on where you live and how you became able to earn that income. If you live in Manhattan and are paying off student loans, you’ll find a lot of your after-federal-income-tax income will go to state and local taxes, housing and loan repayment.
My point was that you have to start with a simple, and understandable model before you can understand more accurate descriptions. And the simple model is often useful even when it isn’t 100% accurate. I agree that voters should know more about economics than they seem to.
And the simple model is often useful even when it isn’t 100% accurate.
This is true, but my concern is along the lines of “a little knowledge is a dangerous thing.” If a voter feels that he knows enough about economics because he’s drawn a supply-demand graph, he easily is convinced that a minimum wage increase always and in all circumstances MUST decrease demand for labor, and will refuse to vote for politicians who suggest an increase in the minimum wage because he assumes they’re stupid job-killers. He won’t be open to considering empirical data that goes against the 101-level theory but makes sense in a real world of dynamic monopsony, transaction costs of recruitment and training, etc.
PG,
Thanks for clarifying. I didn’t think you really meant that, but it sure could be read that way.
PG,
State and city taxes are of course another story. NYS taxes are pretty high.
I never lived in the city but state taxes would be around 7%+, and city about 3.6%+. Fair to say another 28k or so… maybe a little more.
What would I do with 140k after taxes… ? It’s still so much money. Even with student loans to pay.
Maybe in NYC I would be motivated to reach for a little more money due to the higher cost of living, to get the penthouse. I AM motivated by eventual financial independence. Part of my reason for not living in NYC :). And maybe having more than 50cents of each dollar over 250k taken out would demotivate me at that point.