Monday, November 2, 2009

Government Failure: Mankiw and Taylor on the Increases in Marginal Income Tax Rates

A labor income tax is not too different from having to pay the government for the right to work. It's also a punishment on working more hours or more productively. The more we work and the more we earn from working, the more the government collects from us as "access to work fees."

Right now, the government is not helping us, and particularly not helping the poor, when it increases "access to work fees" paid over the extra dollars that we earn from working harder or because of increased productivity, as explained by Stanford economist John Taylor in his blog and Harvard economist Mankiw in his blog and in this NYT article:

The bill that recently came out of the Senate Finance Committee illustrates the problem. Under the proposed legislation, Americans would have the opportunity to buy health insurance through government-run exchanges. Depending on a family’s income, premiums and cost-sharing expenses, like co-payments and deductibles, would be subsidized to make health care more affordable.

A family of four with an income, say, of $54,000 would pay $9,900 for health care. That covers only about half the actual cost. Uncle Sam would pick up the rest.

Now suppose that the same family earns an additional $12,000 by, for example, having the primary earner work overtime or sending a secondary worker into the labor force. In that case, the federal subsidy shrinks, so the family’s cost of health care rises to $12,700.

In other words, $2,800 of the $12,000 of extra income, or 23 percent, would be effectively taxed away by the government’s new health care system.

That implicit marginal tax rate of 23 percent is a significant disincentive. And it comes on top of the explicit marginal tax rate the family already faces from income and payroll taxes. Altogether, many families would face marginal rates at or above the 50 percent level that animated the Reagan supply-side revolution.

One might hope that such a large climb in marginal rates is a bug in the Senate Finance bill, one that could be fixed before the legislation became law. But there is no simple fix. Higher marginal tax rates are an integral part of the Obama health plan.

PS: the increase in marginal tax rates are even higher according to the CBO: 32%, as reported by Mankiw. And to this we must add the marginal effects of all other taxes on income and means-tested social programs!

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