Tuesday, June 03, 2003

It is wierd to both agree with the conclusion and disagree with some of the arguments -- Marginal Benefits - Twenty years ago, cutting marginal income tax rates was a good idea. Today, it makes no sense at all. By Daniel Gross
Author argues that the current tax-cutting will be ineffective, primarily because people are not as responsive to tax rates as they were. A few reasons are given. Some I disagree with. Specifically:
Reducing marginal tax rates by a few points won't magically cause people to start working 50 hours a week instead of 40 hours; and raising them won't induce those same people to cut back their hours. Indeed, for all the attention paid to rates, Americans as economic creatures simply aren't that responsive to the current regime of marginal rates. If they were, you'd expect to see incomes clustering at points where there's an abrupt change in tax rates, as people strive to keep their income just below the next jump in marginal rates. But this paper by University of California at Berkeley economist Emmanuel Saez doesn't find much bunching.

I have not yet had a chance to study the paper, but I think the insinuation that absence of bunching around income levels comes through by itself. While I agree with the overall conclusion, I disagree with this specific point. Primarily, I just do not really think most people get to choose their income points, and when they do, they keep it as low as they can without alarming the IRS. Allow me to illustrate. There are, I think, four types of tax-payers out there.
1. Most are employees -- they get a salary and sometimes they get raises. They do not get to choose the size of their raise, and employers do not ask them. Even if the employer cared, there is no way to figure out what margin a specific person belongs to even if their salary is close to border line. Because of mortgage deductions primarily, but a host of other rules as well a person earning a raw amount well-above a tax bracket ceiling may end up sliding under it on April 15th. The accountant, or TurboTax for some, have taken the tax-cutting job away from the government. Add in the IRA contributions, college and medical savings plans, etc and an employer has no clue whether a raise will put someone over -- and a lot of employees do not either. Whenever you get a raise you take it and say "thank you".
2. Small businesses -- if the business is primarily a cash business -- look for the person in whatever bracket their lifestyle may minimally be afforded at. If you can justify your lifestyle to IRS at 50K that's the income. Again, the accountant will cut your taxes, not the government. Even if one truly declares all of their income, the host of deductions and loopholes with ensure that the minimal possible tax will be paid. These members of the economy do decide what rate they want to be, but that decision is not dictated by a rate ceiling or floor as long as the difference is between 28 and 36 percent. Successful business owners pretty much automatically end up in the top bracket because they have nice cars and houses and that requires proof of income. Unnsuccessful or smaller business owners will be at the very bottom. No clustering here.
3. Highly paid professionals -- they just end up in the top bracket. No clustering necessary. Again, they do not get to choose what they are paid, but with that circle being increasingly dual-income how can they possibly slide under a $120K or so limit? They would be laughed out of the local starbucks. (ok, cheap shot, but too hard to resist)
4. Rich folk. By definition they are in the top brackets. They use accountants for all its worth, but they will still end up in the top bracket. They do not really choose their income as it comes primarily from performance of their investments, and whenever they do choose to chill at a resort instead of an extra Friday at the office their lifystyle requires them to make at least enough money to still get top rate from IRS.
I just do not see how in the economy where wages are determined primarily by those in the top brackets we would ever have "bunching" at different bracket ceilings.


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