Tax Cuts Do Not Increase Labor Supply

A central tenet of U.S. “conservative” and Republican economic policy since at least the election of Reagan in 1980 is that tax cuts cause people to work more and longer hours. This is part of the so-called “supply side economics”.  The implication is that the longer hours and more labor supply will then raise the dollars of taxes collected despite the rates being lower, the so-called Laffer Curve effect.

The argument is overly simplistic and fallacious on it’s face. The theoretical support is the one-liner theory idea that “people respond to incentives, take-home money is an incentive to work, and therefore increased take-home pay causes people to work more”. It’s just a version of the retailer’s “cut the price and make it up on volume” logic.  And as such it is dependent on the elasticity of the responses – remember when the response is inelastic, as in “I have to work to live”, the volume won’t be made up.  Despite their being no strong empirical evidence of tax cuts helping raise more tax dollars or motivate widespread increased labor supply at least in the range of real-world tax rates, the concept persists – another Zombie Economics idea.

Dillow adds more to the evidence pile:

Taxes and labour supply: more evidence

Do tax cuts boost labour supply and hence tax revenues? Here’s some evidence that they don’t. Pierre Cahuc and Stephane Carcillo report on an experiment* in France:

The detaxation of overtime hours introduced in October 2007 was intended to allow individuals in France to work more so as to earn more. The evaluation conducted in this article indicates that the detaxation of overtime hours has not, in fact, had any significant impact on hours worked…
Detaxation is a measure costly for the public purse, without any ascertained impact on hours worked.

We can put this alongside the evidence we have for footballers and New York cabbies, which suggests that we are on the positive side of the Laffer curve, where tax cuts do not increase revenues. It’s also consistent with the – very tentative – evidence we have from UK tax receipts this year, which suggests that the introduction of the 50p tax rate has not (yet) reduced revenues.
Now, this is not to deny that Laffer curves exist. No doubt, there is a point at which higher taxes would be counter-productive and tax cuts would pay for themselves. And I’ll concede that it’s possible that the 50p tax rate will, eventually, have adverse effects.
But where is the hard evidence that, at tax rates around current levels, there are such effects? Do the glibertarians  have anything more than prejudice, half a theory, and the post hoc ergo propter hoc fallacy?

Readers and students should note: There is no conflict between these claims and the Keynesian macro-economic policy assertion that tax cuts can stimulate the economy.  The Keynesian policy mechanism works differently.  It asserts that tax  cuts work to widen the budget deficit.  The households spend part of the tax cut while the government continues to maintain it’s other spending. Therefore Aggregate Demand, total spending, in the economy increases. As the spending is received by firms who then pay for labor & resources in the circular flow, the increased spending has a multiplied effect.  The Laffer curve concept is different. It asserts a direct greater willingess-to-work labor supply response.

The “Tax Cut” Bill

I have problems calling the bill currently in Congress about tax rates a “tax cut” bill.  Yes, there are some genuine “cuts”.  But most of it is fake cuts.  Congress and the Bush administration made a promise 10 years ago to raise our taxes at this time.  Now the current Congress decides to not actually do the previously-promised increase.  That’s not a real “cut” in my book, it’s a reprieve from a threat.  I mean, suppose I hold a gun to your head and promise to shoot you next Sunday. Then on Saturday, I decide to drop the gun and not shoot you for another two weeks.  Can we really say I “saved your life”?

Nonetheless, since everybody seems to want to call it a “tax cut” bill, I will too.  So what’s my take on the bill? It’s bad, very bad, and very poorly done.  But it’s also necessary at this time.  It’s probably the best we can get with this Congress and this President.

Most important, while necessary, it won’t do the job people want it to do.  People want genuine recovery. People want jobs and the unemployment rate to decline from near 10% back down to full employment (under 5% at least).  This bill won’t do that.  It’s too small.  And, it’s structured wrong.

First, it’s too small.  The biggest problem with the original Obama stimulus bill (there were several problems) was that it was too small.  It was clear by December 2008 that we needed a fiscal stimulus at least twice as big as what we got. And we needed it extended for longer. Politics triumphed and we got a bare-bones.   Instead of triggering recovery, it simply stopped the decline.  This bill repeats the mistake. While at first it looks big ($857 billion), most of it is simply perpetuating the current tax rates  – little new stimulus.  What stimulus is there, the unemployment benefits extension and the payroll tax cut (Social Security tax) amounts to maybe $200 billion or so for one year.  At best, I expect this bill to help lower unemployment to 8-8.5% during 2011.  Not enough.

Second, it’s poorly structured.  Despite the fury, rage, and disdain conservatives claim to have for “Keynesianism”, make no mistake. This is a Keynesian stimulus bill.  A poorly designed one, but one just the same.  Why?

There are two ways to implement stimulus fiscal policy: increase government spending or decrease taxes.  This bill is almost all decrease taxes.  The problem with cutting taxes as a way to stimulate the economy is basic Econ 202 principles stuff.  A tax cut may get saved, put in the bank, or used to pay down debt.  Not all of it gets spent by households.  Without the spending, no stimulus.  With this bill slanted towards tax cuts for the higher income folks it is highly likely that much of it will be saved or used to pay down debt.  The only real spending part is the extension of unemployment benefits.  That stimulus money gets spent immediately and helps generates demand for jobs.  For evidence, see here.

There are more problems with the bill, but I’m out of time right now and will address them in another post.  In particular, there are possible consequences for Social Security.

The Election Campaign Con Game: “Tax Cuts Pay for Themselves”

Continuing a series to help voters and everybody else cut through the nonsense, lies, garbage, and con games that has become American electoral campaigns – at least with respect to economics. The claim up for consideration now is the claim that by cutting taxes now (particularly for the wealthy, very high income earners, capital income (as opposed to wages), and business taxes) we can both stimulate the economy and that the growth in the economy will increase the dollars collected, thus making the tax rates pay for themselves with no increase in deficits.  Just like magic.  Except that like most so-called magic, it’s just a con.  IT’S NOT TRUE.  Unlike the first con game (“I’ll cut the deficit“) which is an equal opportunity con between parties, the tax cut con does seem to be Republican focused.

This time, I’ll outsource the argument to Mark Thoma of Economist’s View:

Republicans are selling snake oil once again:

Some Republican Senate candidates have suggested that extending the Bush tax cuts — which are scheduled to expire at the end of the year — will actually be good for the country’s bottom line, as the economic growth that results will more than offset the trillions of dollars in lost revenue. “By extending tax cuts you pay down the deficit, you grow the economy by giving people more money,” said Colorado Republican Ken Buck.

Today, on Fox News Sunday, Pennsylvania’s Republican Senate nominee Pat Toomey joined this club, telling Fox’s Chris Wallace that “it’s not clear” that extending the Bush tax cuts — while also lowering the corporate tax rate — would increase the deficit…

But, of course, the Bush tax cuts did not even come close to paying for themselves. The Bush tax cuts cost us around $1.7 trillion in revenue from 2001 through 2008, in part because of weak output and job growth following the cuts (contrary to assertions about how the tax cuts would stimulate economic growth).

As for the cost of extending the tax cuts to the wealthy, the Tax Policy Center estimates that making all the Bush tax cuts permanent, as opposed to extending them only for the middle and lower classes, would cost $680 billion over the next decade.

The disappointing part is that the press still lets them get away with this. At best, the press generally says something like “some economists claim this isn’t true,” implying there’s a debate about this issue — that some credible economists think the tax cuts will, in fact, pay for themselves — when there is no debate and the answer is clear. Tax cuts don’t pay for themselves.

If the press won’t call them on this obvious falsehood, how can we trust them on anything? Instead of reflecting poorly on the press, this ought to bring the general credibility of the people making these claims into question. The press ought to ask something like, “Are you this ignorant about economics, in which case why should anyone vote for you, or are you deliberately misleading people? I’ll assume you aren’t ignorant, so here’s the question. If you are willing to make false claims about the revenue generated from tax cuts in order to promote them for the wealthy, what other falsehoods will you be willing to promote in order to serve political ends? If voters can’t trust you to tell the truth about tax cuts, how can they trust you on anything?”