In a recent column, I discussed some of the support for supply-side economics at the World Bank, International Monetary Fund and in academia. Today, I would like to extend my discussion to some emerging research on labor supply that further supports the supply-side view of tax policy.
For decades, most economists took the view that taxation has little if any effect on work. This followed from the experience of World War II, where tax rates rose very sharply in all countries with little falloff in work effort. Also, shortly after the war, the Harvard Business School did a major study of the impact of taxes on corporate executives, which found that taxes had a minuscule impact on their hours of work.
Obviously, when people feel that their lives are at stake, they will make sacrifices that they would never make under normal circumstances, especially if they are necessary for only a limited time. Therefore, a study of labor supply during World War II tells us virtually nothing about how people react to high tax rates during peacetime.
Similarly, an examination of corporate executives tells us little about how average people behave, especially if the analysis is limited to work hours. Executives get a lot of perks and a psychological kick from being the boss, have flexible (if long) hours and can probably adjust their income to compensate for tax changes in ways average workers cannot.
Nevertheless, the view that tax rates have no impact on labor supply was taken as a given until the early 1980s. Economist Jerry Hausman of M.I.T. was the first to break ranks. In a pathbreaking paper for the Brookings Institution in 1981, he showed that "the current tax system does significantly reduce labor supply." He found that the labor supply of married males was 7 percent less than it would be if the same revenue were collected from a flat rate tax system.
In the years since, economists have devised many new statistical techniques for measuring labor supply. They have also had a number of significant changes in tax structure over this period that provides data and opportunities to study the interaction between taxes and work. And better international data allows for comparisons between countries. The result is a growing consensus that taxes affect labor supply much more than previously assumed.
A study last year by economists Daniel Aaronson and Eric French of the Federal Reserve Bank of Chicago found that previous studies had understated the impact of progressive tax rates on labor supply in the United States by 10 percent for men and twice that for women.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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